Overseas American Citizens: When You Need to File a Tax Return or Pay U.S. Taxes

U.S. citizens have to file a tax return with the IRS every year, irrespective of the fact that they may have lived or worked outside of the country for the year in question—and they may owe taxes, as well.

By , J.D.

Every year, scores of American citizens who think they are exempt from the obligation to pay up to the IRS because they are living outside the U.S. are met with a cruel reality: U.S. tax law continues to apply to them, and unwelcome consequences may await those who fail to comply. The U.S. Internal Revenue Service (IRS) seems to scoff at the notion of international borders as an impediment to collecting money that Uncle Sam says must be rendered unto the U.S. government.

As counterintuitive as it may seem, most U.S. citizens must submit a tax return to the IRS even though they've never set foot in the U.S. and have had few, if any, contacts with the country during the tax year. The rules governing who among American expatriates must file with the IRS, how much they owe, and what the implications of their out-of-country status are on their tax situation are complex. This article provides an overview of two of the most commonly asked tax questions by Americans abroad:

  • whether one has to pay U.S. taxes, and if so
  • whether they might claim any special breaks related to their expat status.

Do All U.S. Citizens Living Abroad Have to File a U.S. Tax Return?

As a general rule, yes, U.S. citizens have to file a tax return with the IRS every year, irrespective of the fact that they may have lived or worked outside of the country for the year in question. The IRS taxes all "worldwide income" of American citizens, so it is of no import that a person's employer is located in a foreign country or that the person was paid in a currency other than the U.S. dollar—overseas citizens still have to report their income to the IRS.

It bears noting that U.S. tax laws apply to all American citizens, including those who may have never taken affirmative steps to document their citizenship by way of procuring a U.S. passport. Indeed, people who may not know that they are U.S. citizens—a scenario occurring with some frequency in the context of children born abroad to U.S. citizens who acquire citizenship by derivation – and who have never been to the United States are subject to United States tax law.

But there is an exception to the general rule that all U.S. citizens must file a tax return: A person, whether living in the U.S. or abroad, does not have to submit a tax return if his or her gross income is below a certain threshold. (Gross income is defined as "all income you receive in the form of money, goods, property, and services that is not exempt from tax," while IRS Publication 501 clarifies that this includes "any income from sources outside the United States.") For filing thresholds and categories, see IRS Publication 501.

Of course, your foreign income won't be in U.S. dollars—so how to figure out if you're below the threshhold? See How Do I Value My Foreign Income for U.S. Tax Purposes? for more on this.

The exemptions discussed above are unlikely to apply to anyone who worked part time for most of the year or who had a full-time job for several months.

The exemption that allows people to not file a tax return at all does not apply to many people of working age, since the overwhelming majority make too much money to qualify.

The result is that, while most American citizens living abroad do have to submit a tax return every year, many of them do not actually have to pay any taxes, thanks to the foreign earned income exclusion rule.

Why You Might Not Have to Pay U.S. Taxes as an American Abroad: the Foreign Earned Income Exclusion Rule

Average income earners who are U.S. citizens living abroad, take heart: While you still need to undertake the administratively burdensome task of filing each year with the IRS, you likely will not have to pay a dime—you can, in most cases, "exclude" from your income for U.S. tax purposes up to a certain amount of foreign income, as well as in many cases exclude or deduct income that comes in the form of foreign housing (yes, pretty much anything you get of value, including housing that someone else provides for you, counts as "income" as far as the IRS is concerned).

But to qualify for this exemption, an American living abroad must:

  • have a "tax home" in a country other than the United States
  • receive income that qualifies as "foreign earned income," and
  • either be a "bona fide resident" of a country other than the U.S. for "an uninterrupted period that includes an entire tax year," or have been physically present in a country or countries other than the United States for at least 330 days during "any period of 12 consecutive months."

All three of those conditions must be met in order for a U.S. citizen abroad to benefit from the foreign earned income exclusion. More information on each of the stipulations follows.

What Constitutes a "Tax Home" in a Foreign Country

The IRS defines your "tax home" to be "the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home." Nevertheless, a person who has an "abode" in the United States is not considered to have a foreign country as a "tax home," and accordingly does not qualify for the foreign earned income exclusion.

An "abode" is one's "home, habitation, residence, domicile, or place of dwelling." To illustrate the concept of an "abode" in the U.S. that would result in one's tax home being in the U.S., and thereby disqualify one from the foreign earned income exclusion, the IRS provides the example of a person who works on an oil rig off the coast of another country for 28 days at a time, returning to his home in the U.S. for 28 days between stints on the rig. Such a person has a U.S. abode (a home, where he normally lives and to which he returns during off-duty periods) and therefore does not satisfy the foreign tax home test.

Crucially, most overseas work assignments that are expected to last no more than one year are considered by the IRS to be "temporary" in nature, which means that the worker does not establish a foreign tax home.

What Counts as "Foreign Earned Income"

Foreign earned income can be thought of, for purposes of qualifying for the exclusion of the same name, as any income that a person receives for services performed during a period in which he or she satisfies the other two "tests" discussed in this section (the "tax home in a foreign country," and the "bona fide residents for a year / physical presence for 330 days" tests).

Such income includes: salary and wages; commissions; bonuses; tips; and professional fees. It does not normally include: capital gains; interest; dividends; Social Security benefits; annuities; pensions; or alimony.

Bona Fide Residents for an Entire Tax Year, or Physical Presence for 330 Days

By way of reminder, the third requirement for qualifying for the foreign earned income exclusion is that the U.S. citizen must either have been a "bona fide resident" of another country for a whole tax year, or must have been physically present in another country for at least 330 days during a period of 12 consecutive months.

The bona fide resident test asks whether a person has truly made another country home for an "uninterrupted" period including a whole tax year (January 1 through December 31 for people who file on a calendar year basis, which is most people).

This decision is made on a case-by-case basis. The IRS will look at details, as described in the taxpayer's Form 2555, like the nature and overall length of the person's stay abroad, the reason for the time abroad, and the person's intentions for the future.

The more permanent—or at least indefinite—the arrangement appears to be, the more likely the person is to satisfy bona fide resident test. For example, a short business trip abroad would not make someone a bona fide resident of the country visited, but going to work in another country for an indefinite period and arranging long-term housing for yourself and your family probably would satisfy the test. Short trips outside of the foreign country, including back to the United States, normally will not count as an "interruption" of the relevant period.

The "physical presence for 330 days" test is straightforward: did the taxpayer spend at least 330 full days outside the U.S. during a period of 12 consecutive months? It does not matter why the person was abroad or whether he or she intends to stay abroad; all that matters is that that the person was, in fact, abroad for a total of at least 330 full days.

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