Tax Considerations for U.S. Citizens and Permanent Residents Moving Abroad

These obligations are rooted in Internal Revenue Code (IRC) Section 61 and Code of Federal Regulations (CFR) Section 1.1-1 where the statutes confirm U.S. citizens and permanent residents are taxed on income from all sources from within and outside of the United States. Careful planning and understanding of one’s ongoing U.S. filing and reporting obligations is paramount to avoid unforeseen tax liabilities and substantial penalties. Below are a few key tax planning strategies to consider as you plan to relocate.

Exposure to Double Taxation when Moving Abroad

Like the United States, foreign countries may also tax U.S. citizens and green card holders who establish residence in their country. As a result, the same income may be subject to tax in both the United States and the foreign country. Luckily there are sections in the tax law to reduce this liability.

Under Section 901, individuals can offset their U.S. tax liability by taking a foreign tax credit (FTC) on their U.S. returns for taxes paid to a foreign country on foreign sourced income. The United States has tax treaties with many counties which provide guidance on income sourcing related to the claiming of foreign tax credits and can also exempt certain income from taxation. Under IRC section 911, individuals can elect to exclude foreign earned income (known as Foreign Earned Income Exclusion) up to certain limits from U.S. taxation if they meet certain time or residency requirements. In addition to the foreign earned income exclusion, individuals may also be able to claim a foreign housing exclusion if their foreign housing expenses are high enough.

Given these options, it is crucial for individuals to carefully choose the approach that grants the best tax outcome. Strategic planning for leveraging both FTC and foreign earned income exclusion may also result in huge tax savings. However, individuals should keep in mind that while the tax code is sometimes generous on credits and deductions, it prohibits “double dipping,” or taking a tax credit on income that was excluded.

U.S. citizens and permanent residents should also consider any ongoing state tax filing and reporting obligations while living and working abroad. Carefully review domicile and residency guidelines for their respective states and consider breaking residency, if possible and desired, to avoid ongoing state tax liabilities. Individuals can demonstrate clear intent to break state residency by maintaining substantial documentation related to their move overseas and intent not to return.

The following list (although not exhaustive) outlines a few actions that can be taken to show intention to break state residency. Keep in mind that these are all driven by the facts and circumstances of the taxpayer as well as the judicial lens through which the authorities see and assess these scenarios.

• Abandoning a domicile (Selling or renting previous home, moving family possessions out of state, relinquishing drivers’ licenses, moving financial accounts away from local banks etc.)
• Establishing a new domicile (buy or rent home, create new social and economic ties, register to vote, obtain driver’s license, spend significant time in new location)
• Not maintaining a permanent place of abode, or spending 183 days or more in the state

It is also important to note that while many states apply worldwide income taxation like the federal government, most states do not allow a foreign tax credit. However, most allow the foreign earned income exclusion. If breaking domicile is not desired or possible, it is important to understand how your state taxes expatriates.

Social Security Taxes

Social Security taxes are generally due where the taxpayer resides and services are performed. However, a U.S. citizen/resident performing services abroad on a temporary basis (generally up to 5 years) while still being employed by an American employer as defined by IRC 3121(b), may be exempt from Social Security taxes in the foreign country under a totalization agreement. The U.S. has totalization or social security agreements with several countries that eliminate double taxation on social security wages.

Where there is no agreement between the U.S. and the foreign country, the U.S. person employed abroad for an American employer would generally be subjected to social taxes in both the U.S. and the foreign country. However, if the U.S. person is hired locally in the foreign country by a foreign employer, U.S. FICA generally does not apply, and social taxes will be due to the foreign jurisdiction.

Interest/Ownership of Foreign Financial Accounts and Assets

In addition to income reporting obligations, U.S. citizens and residents are also required to report information on ownership or interest in foreign financial accounts and specified foreign financial assets if the value of these accounts and/or assets exceed certain thresholds. Form FinCEN 114 (FBAR) and Form 8938 are the standard forms used to satisfy these reporting requirements. Failure to comply with these information reporting obligations may lead to substantial penalties (civil and/or criminal) therefore careful consideration and review of the respective guidelines should be done each year to determine whether a U.S. person who owns or acquires interest in foreign financial account/asset has a reporting obligation. Having signature authority only over foreign accounts can also trigger a Form 114 filing requirement.

Ownership Interest in Foreign Entities

In addition to FBAR and 8938 reporting, U.S. citizens and residents may also need to file information returns to report transfer of property or interest in certain foreign partnerships, foreign corporations, foreign disregarded entities, and foreign branches. Below are some of the common information reporting that may be needed.

• Form 8865 – Return of U.S. Persons With Respect to Certain Foreign Partnerships
• Form 5471 – Information Return of U.S. Persons With Respect To Certain Foreign Corporations
• Form 8858 – Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)
• Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation
• Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
• Form 3520 – Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts

If your overseas move involves starting or acquiring a business or investing in foreign financial assets directly through a trust or retirement plan, then some of the above forms will most likely apply to your U.S. tax compliance. Pay careful attention to the above, as most of these international forms come with significant penalties for the failure to timely file and/or accurately complete them. Filing a return without a required international information form may also result in the suspension and/or extension of the assessment statute of limitations and if applicable, a potential reduction in allowed foreign tax credit.

For more information on reporting requirements for international income, read our article, “Reporting Requirements for International Income and Foreign Assets.”

Circumstances for all taxpayers differ, so it is important to choose the set of strategies that align with your situation. At GRF, we understand that the key to unlocking great results is great planning, and we encourage you to plan in advance. We are committed to ensure your move to a foreign country is as smooth as possible. Contact us online to set up a consultation or reach out at the contact info below.