Your US Tax Obligations When Working Abroad

The United States employs a unique tax system that often surprises its citizens and Green Card holders residing abroad. Many individuals mistakenly believe that moving overseas automatically exempts them from US tax obligations. This assumption is incorrect, as the US generally taxes its citizens and long-term residents on their worldwide income, regardless of their physical location. Navigating these international tax requirements involves understanding complex rules and specific reporting obligations to ensure compliance.

Understanding US Tax Obligations for Expats

Worldwide income encompasses all earnings from any source, including wages, salaries, business profits, investment income, and capital gains, whether derived from US or foreign sources. Even if an individual lives and works entirely in another country, their income earned there is still considered taxable by the Internal Revenue Service (IRS).

While living abroad, a US citizen or Green Card holder remains a US taxpayer for federal income tax purposes. They are generally required to file an annual federal income tax return, even if they owe no tax. The obligation to file is separate from the obligation to pay tax, and it is a continuing requirement as long as US citizenship or Green Card status is maintained.

This system can lead to situations where an individual’s income is subject to taxation by both the foreign country of residence and the United States. To alleviate this potential for double taxation, the US tax code provides specific mechanisms. These provisions allow individuals to reduce or eliminate their US tax liability on foreign-earned income, preventing them from paying taxes twice on the same earnings.

Key Mechanisms for Avoiding Double Taxation

To prevent US citizens and Green Card holders from paying taxes on the same income to both a foreign government and the US, several relief mechanisms are available. These provisions help mitigate the financial burden that could arise from worldwide income taxation.

The Foreign Earned Income Exclusion (FEIE) allows eligible individuals to exclude a certain amount of their foreign earned income from US taxation. To qualify for the FEIE, an individual must meet one of two tests: the Bona Fide Residence Test or the Physical Presence Test. The Bona Fide Residence Test requires the individual to be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.

Alternatively, the Physical Presence Test requires an individual to be physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. This test is purely quantitative, focusing on the number of days spent abroad. For the 2024 tax year, the maximum exclusion amount for foreign earned income is $126,500. This amount is adjusted annually for inflation.

Another significant mechanism is the Foreign Tax Credit (FTC), which allows individuals to claim a credit for income taxes paid or accrued to a foreign country. Unlike the FEIE, which excludes income, the FTC directly reduces the US tax liability dollar-for-dollar for qualifying foreign taxes paid. The FTC can be particularly advantageous when foreign tax rates are higher than US rates, or when income exceeds the FEIE limit.

Individuals must choose between claiming the FEIE or the FTC on their foreign earned income, as generally, both cannot be applied to the same income. The FTC may also be more beneficial for individuals with significant foreign unearned income, such as investment income, which does not qualify for the FEIE. Unused foreign tax credits can often be carried back one year and carried forward for up to ten years.

Tax treaties between the United States and many foreign countries also play a role in preventing double taxation. These bilateral agreements aim to clarify taxing rights between the two countries, often by reducing or eliminating tax on certain types of income. Treaties can specify which country has the primary right to tax particular income or may provide for reduced withholding tax rates on dividends, interest, and royalties. Treaty provisions can be complex and are specific to each country, sometimes overriding general US tax law.

Essential Filing Requirements

Even if an individual’s foreign earned income is fully excluded under the FEIE or offset by foreign tax credits, US citizens and Green Card holders generally retain a requirement to file a federal income tax return. Form 1040 remains the primary document for reporting worldwide income to the IRS. This filing obligation persists regardless of whether any US tax is ultimately due, ensuring the IRS has a record of the individual’s income and deductions.

Beyond the annual income tax return, individuals with foreign financial accounts may have additional reporting obligations. FinCEN Form 114 (FBAR) requires US persons to report financial interest in or signature authority over foreign financial accounts if the aggregate value of all such accounts exceeds $10,000 at any point during the calendar year. This includes bank accounts, brokerage accounts, and mutual funds held outside the United States. The FBAR is filed electronically through FinCEN’s BSA E-Filing System and is not part of the federal income tax return.

The Foreign Account Tax Compliance Act (FATCA), enacted in 2010, introduced additional reporting requirements for specified foreign financial assets. US individuals must report these assets on Form 8938 if their aggregate value exceeds certain thresholds. For individuals living abroad, the threshold for single filers is typically $200,000 on the last day of the tax year or $300,000 at any point during the year. For married couples filing jointly, these thresholds are $400,000 and $600,000, respectively. While both FBAR and FATCA require reporting of foreign financial accounts, they have different thresholds, types of assets covered, and filing methods, meaning an individual may need to file both.

Other forms may be necessary depending on an individual’s specific financial situation abroad:
Form 2555 is used to claim the FEIE.
Form 1116 is used to claim the FTC.
Business owners or those with interests in foreign entities might need to file Form 5471.
Individuals who receive large gifts from foreign persons or have transactions with foreign trusts may need to file Form 3520.

For US citizens and Green Card holders residing abroad, an automatic two-month extension to file their federal income tax return is typically granted, moving the deadline from April 15 to June 15. This extension applies even if no specific request is made. If further time is needed, an additional extension can be requested through Form 4868, pushing the deadline to October 15. While these extensions grant more time to file, they do not extend the time to pay any taxes due; interest and penalties may still apply to underpayments after the original April 15 deadline.

State Tax Implications

While federal tax obligations for US citizens and Green Card holders are based on citizenship, state tax obligations are generally determined by domicile or residency. Moving abroad does not automatically sever ties with a former US state, and many individuals may still have a state tax filing requirement. Each state has its own rules for determining residency and domicile, which can be more complex than federal guidelines.

States typically consider various factors when assessing an individual’s domicile, which refers to their true, fixed, and permanent home. These factors might include:
Location of voter registration
Driver’s license
Vehicle registration
Property ownership
Address used on tax returns
Location of professional licenses
The intent to return to a state, even if living abroad for an extended period, can also maintain domicile there. Maintaining significant connections to a state can lead to continued state income tax liability on worldwide income.

To avoid state tax obligations while living abroad, individuals often need to formally sever ties with their former state of residence. This process typically involves changing residency documents, selling or renting out property, and establishing clear intent to abandon the previous domicile. Some states may require a specific number of days spent outside the state, while others focus more on the qualitative aspects of one’s connection to the state. Simply leaving the state does not automatically terminate tax residency.

The implications of continued state domicile can be significant, as some states tax worldwide income similar to the federal government. This means an individual could face state income tax on earnings already taxed by a foreign country and the US federal government. Therefore, understanding and proactively managing state residency status is an important consideration for any US person planning to live and work abroad. Consulting with a tax professional knowledgeable in multi-state taxation is often advisable to navigate these complex rules.