How Can I Mitigate Double Tax While Working Abroad?

The US is one of the only countries to require its citizens and permanent residents (i.e., green card holders) to file annual tax returns and report their worldwide income, regardless of their actual work location. When working outside the United States, it is often the case that US persons are subject to taxation in the county where they are physically located.

Although the resulting tax complexities can be a headache for a US taxpayer working abroad, it does not necessarily mean that double taxation will occur. Here, the US tax rules and regulations provide options to address the double taxation of foreign earned income. By utilizing available credits and exclusions and through upfront planning, US taxpayers can stay compliant while mitigating the impact of taxation in multiple locations.

What is the foreign tax credit?

The foreign tax credit is one of the primary tools used by US taxpayers to avoid double taxation on foreign source income. By utilizing this credit, US taxpayers can claim a dollar-for-dollar tax credit against the US tax that is related to taxable income from sources outside the US. Here, the source of income is generally based on where the services are performed, although there are exceptions for certain types of foreign assignment-related allowances (e.g., foreign housing, non-US tax reimbursements).

The foreign tax credit is limited to the lesser of the following two amounts:

1. The US tax attributable to earnings from outside the US.

This amount is calculated by multiplying the taxpayer’s total US tax liability, before credits, by a fraction. The numerator of the fraction is the taxable income from sources outside the United States. The denominator is the total taxable income from US and foreign sources.

2. The foreign taxes paid or accrued by the US taxpayer during the year, plus carryover from prior tax years of foreign taxes as applicable.

In most cases, only foreign income taxes qualify for the foreign tax credit. Taxes such as foreign personal property taxes would not qualify. If foreign taxes are available for credit but are not used because of the foreign tax credit limit (point 1 above), you may be able to carry them back to the previous tax year and forward to the next 10 tax years. 

Alternatively, taxpayers working abroad can claim an itemized deduction for foreign income taxes on their Schedule A (Form 1040), however, in most instances it is more advantageous to utilize the foreign tax credit.

What are foreign earned income and housing exclusions?

A US taxpayer working abroad also has the option of electing to exclude foreign earned income of up to $126,500 (2024 tax year) and certain foreign housing costs from gross income. However, a taxpayer cannot apply both the foreign tax credit and foreign earned income and housing exclusions to the same foreign-sourced income.

The foreign housing costs eligible for the housing exclusion are those that exceed 16 percent of the foreign earned income exclusion and are generally capped at 30 percent of the exclusion. However, depending upon the Host location, there is the potential for increased housing costs to be utilized. If US taxpayers are self-employed and working abroad, then they are not allowed to claim the foreign housing exclusion but could potentially utilize a foreign housing deduction.

To qualify to claim the foreign earned income and housing exclusions, a US taxpayer must have foreign earned income, have had a tax home outside of the United States, and must meet either the bona fide residence or physical presence test for the tax year in question. To meet the bona fide residence test, a taxpayer must be one of the following: 

• A US citizen who is a bona fide resident of a foreign country, or countries, for an uninterrupted period that includes an entire tax year (January 1–December 31, if they file a calendar year return) OR
• A US resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country, or countries, for an uninterrupted period that includes an entire tax year.

To meet the physical presence test, a taxpayer must:

• Be a US citizen or resident alien who is physically present in a foreign country, or countries, for at least 330 full days during any period of 12 months in a row. A full day means the 24-hour period that starts at midnight.

There are several factors that must be considered when choosing between taking advantage of the foreign tax credit or the exclusions. For example, the US state income tax position may impact this decision. Here, some states will not allow foreign tax credits but will allow the foreign earned income exclusion if taken on the taxpayer’s US federal return. Consulting with a mobility tax professional will help a taxpayer consider both their federal and state income tax position when determining the appropriate options.

Use a tax-efficient compensation structure

A mobility tax professional can also help US taxpayers working abroad mitigate double taxation by structuring the timing of the assignment and the arrangement of the mobile employee’s compensation in a tax-efficient manner. For example, some countries will not tax housing costs paid directly to a landlord or as an expense reimbursement, whereas the provision of a housing allowance (i.e., cash payment) is considered taxable income.

The length of a mobile employee’s assignment may also allow the employee to qualify for advantageous tax treatment. For example, under some income tax treaties, a mobile employee present in a Host country for less than 183 days will not be subject to income tax if certain other requirements are met. As the rules often vary by country, it is important to consider both the Home and Host country tax position in designing a tax-efficient assignment and compensation structure.

Through consideration of available tax credits, exclusions, and other planning opportunities prior to working abroad, US taxpayers can proactively make sure they are in position to mitigate double taxation.

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.