Which Foreign Tax Credits Should Expats Know About?

Being an expat is fun, but the lifestyle poses certain challenges, particularly when it comes to taxes. Many people are genuinely unaware of crucial foreign tax credits, which might be difficult if they frequently country hop.

Needless to say, expats need to thoroughly examine the local taxes before relocating. It is also recommended to contact the local expat community to learn the ropes and get advice.

As regards digital nomadism, the fundamental problem is that the concept is poorly understood and barely legalized in many countries. As a result, many digital nomads travel on tourist visas, but that isn’t to say that they are excluded from taxation.

Whether you are a digital nomad looking to relocate or an expat desiring to retire abroad, there are many things about taxes that you should learn before setting out.

We’ll offer a couple of useful tips hereby.  

Keep Track of State Taxes

All Americans need to pay U.S. state taxes regardless of their location. Still, some exemptions apply.

First of all, only residents of the state for tax purposes need to mind the state taxes.

You’re considered a resident if:

• You lived in the state for any duration during the tax year
• If you have a permanent place of residence in the state
• If your immediate family lives in the state while you’re abroad
• If you keep your voting rights, ID card, or driver’s license in the state

Next on, you should determine whether you have income in the state. Income earned in the state is subject to taxation. If you have state residency, other income may also be taxable (e.g., pension- and retirement income, government benefits, etc.).

The states that don’t charge state income taxes are:

• Alaska
• Florida
• Nevada
• South Dakota
• Texas
• Washington State
• Wyoming

New Hampshire and Tennessee apply income tax on dividend- and interest income alone.

California, South Carolina, New Mexico, and Virginia (a.k.a., “sticky states”) have rigorous rules. Residents of these states need to pay the taxes even if they didn’t live in the state during a year if:

• They own a property
• They own a bank or investments account
• They hold an ID card, a driving license, and/or a voter registration
• They have a mailing address in the state (relatives included)
• They have dependents in the state

Prevent Double Taxation

Few people are aware that despite having to pay state taxes, Americans do not actually own anything.

What does that mean, exactly?

Basically, there are a few plans to avoid paying taxes on income generated abroad. We’ll mention the three most popular ones.

The Foreign Tax Credit (FTC)

The Foreign Tax Credit (FTC) helps expats claim a dollar-for-dollar credit on foreign income taxes. You qualify for the program if you’ve obtained a foreign tax liability.

The Foreign Earned Income Exclusion (FEIE)

The Foreign Earned Income Exclusion (FEIE) is designed for expats who can pass either the Bona Fide Residency Test or the Physical Presence Test. You can exclude up to $107,620 of your foreign earned income in tax (the sum may vary, so make sure to double-check).

Tax Treaties

The U.S. has established tax treaties with more than 70 countries. Not all of them follow the same pattern, so make sure to look it up.

Consider Streamlined Tax Filing Procedures

The Streamlined Filing Procedures, which were made available in 2012, are frequently considered an alternative to the IRS's programs. They were created particularly to help Americans who reside abroad to make up for unpaid taxes.

There are only a small number of tax returns, which makes them easy to keep up with.

You qualify for the program if:

• You can demonstrate that the reason for not filing taxes in the past was because you didn’t know you were required to
• You have been living outside the U.S. for at least 330 full days during one or more of the three most recent tax years
• You haven’t had an abode in the U.S. for one or more of the three most recent tax years
• You can produce and mail off a signed statement (Form 14653) certifying the above-mentioned

What Happens If You Fail to File Taxes?

Failure to file U.S. taxes while living abroad can result in a number of issues, such as penalties and interest charges. The worst-case scenario also includes the possibility of criminal charges.

If an American expat willfully avoids the tax requirements, the IRS may levy penalties for late filing and late payments.

A failure to file penalty will result in a 5% monthly fine applied to the unpaid taxes, with the maximum sum being 25% of the unpaid taxes. A failure to pay penalty will result in a 0.5% monthly fine applied to the unpaid taxes, with the maximum sum being 25% of the unpaid taxes. Payments that are overdue 60+ days will result in a fine up to 25% of the unpaid taxes.

As you can see, it is definitely a good idea to consider your options before moving abroad. No matter which option you choose, do familiarize yourself with tax deadlines for American expats.