All US citizens and permanent residents must file federal income tax returns if they meet the Internal Revenue Service (IRS) filing threshold. The size of this threshold will vary depending on factors such as age, filing status, and type of income (e.g., income from employment or self-employment). For example, a single individual under the age of 65 would be required to file a 2024 US federal income tax return if their gross income exceeded $14,600. If the earnings came from self-employment, this same person would need to file a US federal tax return if their net earnings exceeded $400.
You can find the specific filing threshold that applies to your situation by visiting the IRS website here.
These same thresholds apply to individuals working abroad. Unfortunately, the definition of gross income for determination of the IRS filing requirement includes “all income” that is not exempt from tax, including income earned from sources outside the US. For this reason, many US persons working in other countries still have an annual US tax filing requirement, even if they are paid from a non-US payroll and work exclusively outside of the US. In addition, it is important to note that certain US informational filings may be necessary even if an income tax return is not required.
However, being required to file a US federal tax return does not necessarily mean that a US citizen or permanent resident must pay US federal income taxes. US taxpayers working abroad may be eligible to exclude certain foreign income and housing costs and/or claim the foreign tax credit, either of which could result in reducing or even eliminating the US tax obligations of a taxpayer working abroad. We explore both below.
Qualified individuals can elect to exclude certain foreign income earned in a given year from their gross taxable income for that year, subject to an annual limitation ($126,500 for 2024). A self-employed taxpayer may still be allowed to claim the foreign earned income exclusion, but the exclusion will not reduce their self-employment tax obligations.
To qualify for the foreign income exclusion, a taxpayer’s “tax home” must be in a foreign country and they must meet either the bona fide residence test or the physical presence test. These rules can be complicated to apply and have many nuances. However, the following provides a high-level overview of each factor:
A person’s tax home is generally the location of their regular or principal place of business. If there is no regular or principal place of business, then the individual’s permanent place of residence (location where substantial living expenses are incurred) may be considered the tax home. If there is no regular place of business or residence, then the individual’s tax home would follow the individual as they travel.
In addition to having a tax home in a foreign location, qualification for the exclusion also requires that the taxpayer meet either the bona fide residence or physical presence test.
The bona fide residence (BFR) test is determined on a review of all facts and circumstances, including factors such as the intent, purpose, and duration of the taxpayer’s travel. The person needs to be a bona fide resident of one or more foreign countries for an uninterrupted time that includes an entire tax year (e.g., for most taxpayers, a period including January 1 – December 31). In general, the taxpayer must also be subject to tax in their Host location and must not have submitted a statement of non-residence to the tax authorities in their Host location.
Once a taxpayer qualifies under BFR, they would be eligible to consider the exclusion from the date the bona fide residence was established. For example, a US citizen who establishes a tax home in France on December 1, 2023, and who maintains this tax home through January 1, 2025, could qualify for a prorated exclusion on their 2023 return from December 1. A special filing extension for the 2023 US federal tax return would be needed to allow the taxpayer to meet the qualifications to meet the BFR test.
US resident aliens looking to qualify under BFR would need to be a citizen of a country that has an appropriate income tax treaty with the US.
To qualify under the physical presence test (PPT), a US taxpayer must have been physically present in another country for at least 330 days in any consecutive 12-month period. Here, the 12-consecutive-month period can include days in which the individual is neither physically present in a foreign country nor maintains a foreign tax residence, as long as the individual’s tax home is in a foreign country during each of the 330 days. For this reason, the 12-consecutive-month period can be moved backward or forward in order to maximize the exclusion amount under the PPT. It is important to note, however, that this particular scenario may result in a taxpayer needing to spread the claimed exclusion over two tax years and prorating the maximum exclusion for each year.
Key Difference: While the BFR test focuses on establishing long-term residency in a foreign country, PPT focuses on the number of full days an individual is physically present outside of the US.
A US taxpayer who qualifies for the foreign earned income exclusion may also be eligible to exclude amounts paid for the taxpayer’s housing by an employer, such as rent, utilities, or other living costs. Payments made by an employer directly to a housing provider may also be eligible. Self-employed taxpayers are able to deduct qualified housing expenses rather than using an exclusion.
It is important to note that a US taxpayer claiming the foreign earned income exclusion must still pay their US tax at the rate applicable to the income bracket that would apply had the taxpayer not claimed the exclusion. This means a taxpayer must calculate their US federal tax obligations based on their total taxable income, then subtract from that amount the tax that would be paid on just the excluded income. In other words, a taxpayer earning more than the $126,500 exclusion amount would calculate the tax due on their total income and then subtract the tax that was due on the $126,500 in excluded income.
Separate from the foreign earned income exclusion, the foreign tax credit allows US taxpayers working abroad to mitigate double taxation by providing them with a non-refundable credit. This credit is based on the income taxes paid to the employee’s Host country and is deducted directly from the taxpayer’s US federal income tax due. To illustrate in simple terms, a US taxpayer who has paid $8,000 in income taxes on their salary to the Host country and has a $10,000 income tax obligation in the US on that salary could potentially reduce their US tax bill to $2,000 by using the foreign tax credit.
Because the foreign tax credit is non-refundable, a taxpayer cannot claim a credit that is larger than the US federal income tax due. Excess foreign tax credits can, however, be carried back for one year then carried forward for 10 years to help offset the US tax on foreign source income in other years.
A US taxpayer claiming the foreign tax credit need not prove that they resided abroad, only that they have paid taxes to a foreign government on income they have earned. It is important to note that a taxpayer cannot claim both the foreign earned income exclusion and foreign tax credit on the same income, so they will need to determine which method yields the largest tax benefit based on their personal tax situation.
Comparing the benefits of the foreign earned income exclusion to the foreign tax credit for a US taxpayer working abroad requires a complex series of calculations. A taxpayer often must calculate their income tax obligations in both the Host country and the US prior to making a decision. If the taxpayer has an ongoing state tax filing obligation while working abroad, the state tax rules may also need to be considered.
This analysis should not be based solely on a taxpayer’s income because the decision will depend on a taxpayer’s unique circumstances, all of which should be taken into consideration when determining whether the taxpayer will benefit more from the credit or the exclusion at a particular income level.
Even if an individual’s income is below the filing threshold, they may still need to file a US tax return to claim a refund of taxes withheld or to receive certain tax credits. Additionally, if an individual has foreign financial accounts, they may be required to file the Report of Foreign Bank and Financial Accounts or FBAR if the aggregate value of their foreign accounts exceeds USD $10,000 at any point during the year.
US citizens or residents abroad are generally required to file a US tax return if their income exceeds specified thresholds, regardless of where the income is earned. While the foreign earned income exclusion and foreign tax credit can help reduce or eliminate an individual's US tax liability on foreign income, they do not remove the obligation to file a US return.
Navigating US tax obligations while living abroad can be complex, with varying filing requirements and important tax elections that impact your financial situation. Understanding these responsibilities is crucial to staying compliant and optimizing your financial outcomes. Given the complexities involved, working with a mobility tax specialist is highly recommended. They can provide the expertise needed to navigate these challenges confidently and help manage both compliance and financial risks.
The information provided in this article is for general guidance only and should not be utilized in lieu of obtaining professional tax and/or legal advice.