Even if you are a US citizen residing in some other country, you qualify as an expatriate American and owe the US some taxes each year on your income. You have a legal duty to file US tax returns each year, which failing to do so your tax liability will keep on increasing. You may be served notice to pay taxes, as well.
You cannot give up US citizenship just to avoid paying taxes, as this is illegal. An overall knowledge of how much you owe and when should you pay taxes and file returns is very important. For this, let us know in brief some important terms of this process.
Important Terms For Expatriate Tax Payers
Foreign Earned Income Exclusion: You qualify for the exclusion if you have been earning and living abroad for a full calendar year, or at least 330 consecutive days out of any consecutive twelve-month period. You can exclude up to $87,600 of your income earned in year 2008. For earlier years, it is lesser as per US income taxation. If you are married and your spouse is also earning and staying abroad, you can exclude another $87,600 from your spouse’s income. These exclusions are not automatic and you will have to file the tax return for it by filling up appropriate forms.
Here, the income in question is the earned income, that is, the income that you earn from your work or services. This does not include income from rent, dividends or interest. In short, all that income is excluded which is not earned from your own personal efforts. A certain amount of deduction can also be claimed for your foreign housing expenses.
Tax Credits: You may have to pay taxes even for things for which you have paid taxes in the foreign land. You can claim tax credits on foreign taxes that accrue on the same income. The disadvantage of being in a higher tax country is that the tax credits will accrue faster than you will be able to claim for. In low tax countries, you will have enough time to apply for tax credits and get the refund. There are several tax help companies who will help you do this, the right way.
US tax treaties with other countries: To eliminate double taxation, the US has Tax treaties with over 60 countries. These benefit you as a US citizen, as they lay down some rules with the objective of reducing double taxation on the same income by both the countries. This is done mostly through reciprocal foreign tax credits by both the countries. The treaties also address tax issues that are specific to the two countries involved.
Stature of limitations: You must file your tax returns every year. It has many advantages, you get the tax liability cleared every year and it does not get accumulated. Also, the stature of limitations from IRS audits will expire three years after you file the return. It means that after three years, IRS cannot audit or change your returns. On the other hand, suppose you are staying and earning abroad for six years and have not filed any US tax returns, then, when you come back or whenever IRS runs an audit, you will be liable to pay all the taxes plus the interest and penalties accumulated during all those years.
US Social security and Medicare taxes: If you are earning abroad, but are an employee of US Corporation, the employer will withhold your Medicare and social security taxes. In case you are working in one of the 20 plus countries with which the US has the Social Security Totalization Treaty, you may participate in that country’s social security system. In this case, the employer will not withhold your social security and Medicare taxes. If you are an employee of a foreign firm, you will be following the foreign laws governing their social security taxation system.
For self–employed persons, you will have to pay self employment tax to US apart from your income tax. You must file a schedule C with your US tax return and pay US self-employment taxes by filing a schedule S-E.
The expatriate US taxation system is a bit complex, but you must remember that filing tax returns every year is a good practice and helps you in many ways.