Now we know that the US government is keen to know all about our money and assets abroad, doesn’t that mean that we can get taxed twice- once on the income in our foreign country, and another in the US?
Yes, and no. There are a variety of options that one can utilize to reduce the effect of this:
- Foreign Earned Income Exclusion
If your earned income is less than the threshold (currently about $110,000), you can elect to exclude it from US taxation in your US return. If it is higher, you can elect to exclude the full amount and pay tax or take a tax credit on the remainder. As with most cases regarding US taxation, there are twists- any amount taxable after the exclusion is taxed at the rate as if the exclusion does not exist, you cannot make IRA contributions on excluded income, and you cannot claim certain credits if you exclude. Plus, if you stop excluding, you cannot exclude again for five years.
2. Foreign tax credits
You can claim a tax credit for taxed paid or accrued in a foreign country on your income. You cannot claim more than the US tax paid on that income- any excess is carried over for up to 10 years. The income usually must arise outside the US, and another drawback is that income and taxes paid are allocated into categories of income (for example, passive income) and taxes in one category cannot be offset against income in another.
3. Tax Treaty claim
The United States has entered into treaties with various countries to agree on how certain items are treated and which country gets to tax you on that income. If there is one for your country of residence, it may be that your income from abroad is excluded from US taxation by virtue of a treaty, or that the US is required to give tax credits on taxes paid abroad on US-based income. If this is the case, then a claim form is required to be attached to your return.
The obvious question is- how do we know which method to take? Can we mix and match?
As with all other areas of taxation, there is no simple answer. It depends on the following factors:
- How much tax you pay in your country of residence
If you are in a low-tax jurisdiction then tax credits may not work as well as taking the exclusion. Plus low-tax countries tend not to have treaties with the US. If you are in a high-tax jurisdiction you can choose between the tax credit or election, or, depending on how much you ear, both.
2. Whether you have kids or want to make an IRA contribution.
If you have kids then you generally cannot claim the refundable child tax credit if you claim the exclusion. If your earned income is less than the exclusion threshold you cannot make an IRA contribution. If it is higher, you may be able to make a contribution.
3. If you are self-employed
The exclusion is on gross income and you cannot take a deduction for expenses attributable to income excluded. Thus if your net income is over the threshold, you will end up with a reduced exclusion to account for expenses in your business that are no longer deductible.
