As a a recently retired U.S. expat, how will my changed financial situation affect my U.S. taxes?

When a U.S. expat will and won't have to pay U.S. taxes on items like a pension and a part-time job.

Question

I’m a naturalized U.S. citizen living in Europe – I spent a decade in the United States but have been back in my native country for quite a while, and just started earning a pension last year from the local private company I retired from. I also earn a small amount of money from a part-time job I picked up as a hobby; I’m in a dispute at the moment with the local tax authorities over exactly what I owe in income taxes from that job. I haven’t paid what they say I owe, and I plan to fight it in court. I pay a ridiculous amount in property taxes for the place I recently purchased (thanks to a generous separation package). What’s the upshot of all this for U.S. tax purposes insofar as it concerns the foreign tax credit and foreign earned income exception? I've benefited from those in the past, but that was when my situation was a little less complex.

Answer

Congratulations on your retirement - hopefully you’re in some lovely European spot where you can enjoy your well-deserved break.

Indeed, changes in how you’ll be taxed from the U.S. side are afoot given your life changes.

Let’s start with your income. The bad news is that the pension you’re receiving is not excludable under the foreign earned income exclusion (FEIE), despite that the income you were getting from the same employer for the same job, in the form of salary, was excludable. Unfortunately, the rules on what counts as “foreign earned income,” which is eligible for exclusion under the FEIE, rule out pensions. For more information on the FEIE, check out “Overseas American Citizens: When You Need to File a Tax Return or Pay U.S. Taxes.”

You may, though, be able to avoid paying U.S. taxes on this income stream thanks to the foreign tax credit (FTC) (for a discussion on the FTC, see “How Foreign Tax Credit May Reduce Tax Bill for an American Expat.” That determination depends on the specifics of the pension program. Also, if a tax treaty exists between the two countries, you may be off the hook with respect to U.S. taxes on that income.

In contrast, your income from the part-time job likely is excludable under the FEIE or the FTC. It’s of no import for purposes of the FTC that you’re disputing that tax in the foreign country - as far as the FTC is concerned, you just must have accrued the obligation to pay the tax (and it sounds like you have). Remember that you can’t double dip and count the same income for both the FTC and the FEIE. Even if it would qualify independently for both, you can only attribute it to one of them.

The property tax you pay doesn't qualify for the FTC or FEIE, but you thankfully can deduct those costs in the same way you could if you were in the United States. You just need to list those costs on line seven of IRS Schedule A (Form 1040).

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