2020 Tax Planning for US Individuals Living Abroad

00 2020 Tax Planning for US Individuals Living Abroad | Contents

Contents

Introduction 1 Chapter 1: Filing Requirements 2 Chapter 2: Special Foreign Exclusions 5 Chapter 3: Moving and Travel Expenses 14 Chapter 4: Principal Residence 15 Chapter 5: Alternative Minimum Tax 19 Chapter 6: Foreign Tax Credit 20 Chapter 7: Tax Equalization Policies 25 Chapter 8: Payroll Taxes and Special Situations 28 Appendix A: Key Figures 32 Appendix B: Sample of the Increased Section 911 Housing Exclusions that have been published by the IRS 34 Appendix C: 2020 US Federal Rates 35 Appendix D: Decisions Checklist 37 Appendix E: Forms and Statements Location Information 38 Appendix F: US Income Tax, Estate Tax, and Social Security Treaties and Agreements 39 2020 Tax Planning for US Individuals Living Abroad | Introduction

Introduction

US citizens and resident aliens living On December 22, 2017, President • Under prior law, moving expenses abroad must file a US tax return and, Trump signed into law U.S. tax reform were excludable from income. with several important exceptions, legislation (P.L. 115-97, commonly However, starting in 2018, these must use the same forms and must referred to as the 2017 Tax Reform expenses are now includable in compute tax by referring to the same Act). This bill represented the largest gross income. tax rules as their stateside change to the U.S. tax system in over • Alimony payments are no longer counterparts. The main exception is 30 years. Though initially enacted in deductible by the payer or special rules that allow taxpayers to 2017, updates to this legislation are includable in income by the exclude all or part of their foreign ongoing. This guide considers the recipient spouse if the divorce earned income if they meet statutory provisions of the US tax reform agreement was executed after foreign residence or physical presence legislation. The following summarizes December 31, 2018. Alimony abroad tests. While these provisions some key changes effective for tax payments made under divorce may allow significant tax benefits, it is years 2018-2025: agreements executed before this important to remember that income date are still eligible for treatment earned abroad is frequently subject to • Reduction of individual tax rates under the former rules. foreign income taxes. In turn, credits or and revision of tax brackets. deductions for these foreign taxes may • Increase of the standard provide an additional measure of US deduction. tax relief. • Repeal of Personal exemptions. This publication combines a general • Combined deduction for state explanation of the rules with an and local income taxes and real analysis of the tax issues and decisions estate taxes is limited to $10,000. to consider in preparing for, and during the course of, a foreign • Foreign real property taxes are no assignment. It is not intended to longer deductible. answer all questions but only as an • Mortgage interest is deductible introduction to the many issues facing only up to the interest on US taxpayers living abroad. When $750,000 (previously $1 million) of specific advice is necessary or acquisition indebtedness for appropriate, consultation with a indebtedness incurred on or after professional adviser who specializes in December 15, 2017. expatriate taxation is strongly recommended. • Interest on home equity indebtedness is now only Deloitte professionals in member deductible if the loan is used to firms throughout the world are buy, build, or substantially improve prepared to help US taxpayers abroad the home secured by the loan. plan for their specific US and foreign tax issues.

1 2020 Tax Planning for US Individuals Living Abroad | Chapter 1: Filing Requirements

Chapter 1: Filing Requirements

Who Must File? See Appendix A for current year While no formal request for this While residing in foreign countries, US amounts. additional time is necessary, the citizens and aliens considered US taxpayer’s return must include a residents must continue to follow the Joint Versus Separate Returns statement that his or her tax home standard rules for filing US income tax A US citizen or resident alien may file a and abode were outside the United returns. A single taxpayer must file if joint return with a spouse. If the States and Puerto Rico on the regular his or her gross income is in excess of spouse is a nonresident alien, due date. If a joint return is filed, only the standard deduction, and married however, the couple can elect to file a one spouse must reside outside the taxpayers who are entitled to file a joint return only if the nonresident United States in order to obtain the joint return must file only if their spouse agrees to be subject to US tax automatic two month extension. This combined gross income is at least as on his or her worldwide income for postponement of the due date does high as the value of the standard the entire year. The election to be not relieve taxpayers from paying any deduction for a married couple. A treated as a US resident may be interest due on the unpaid portion of child who is claimed as a dependent advantageous as long as the their ultimate tax liability. The tax on the parents’ return must file his or nonresident alien spouse has little or liability is still due on 15 April, and her own return if the child’s unearned no income or has foreign-source interest is calculated from such date or investment income exceeds certain income that is taxed at a higher rate (without extension) until payment is amounts or if the child has any earned overseas than in the United States. The received by the Internal Revenue income. See Appendix A for the use of a standard deduction for Service (IRS). current year amounts. In determining married individuals filing jointly may these amounts, all compensation also make the election beneficial. This An additional automatic extension of earned abroad is included in gross election can later be terminated by four months, to 15 October, is income; income that is excludable for death, revocation, or separation. In available by filing Form 4868, other reasons, such as interest on tax- considering this election, the Application for Automatic Extension of free municipal bonds, is not included nonresident spouse should also be Time To File US Individual Income Tax in gross income. A tax return must be aware that, as a US resident, US Return. This extension will not excuse filed even when the taxpayer’s foreign income tax treaty benefits that might the taxpayer from interest unless he exclusions or deductions equal or otherwise be available could be lost. or she has paid at least 100% of his or exceed gross income or when credits, her ultimate US tax liability by the time If the election is made, the such as the foreign tax credit, the extension is filed. nonresident alien spouse is taxed on completely eliminate US tax liability. worldwide income and may be entitled If the due date for filing a return Tax Rates to the special foreign earned income (including the automatic extension) There are seven tax brackets. For exclusions. falls on a Saturday, Sunday, or national 2020, the tax brackets are: 10%, 12%, holiday, the due date is the next 22%, 24%, 32%, 35%, and 37%. When to File business day. A federal return mailed Tax returns for individuals are due on from a foreign country will be The brackets are applied at different the fifteenth day of the fourth month accepted as filed on time if there is an levels of income to each of the four following the close of the tax year (15 official postmark dated on or before categories of taxpayers: single, married April for calendar-year taxpayers); the last day for filing, including filing jointly, married filing separately, however, taxpayers who are US citi- extensions. Tax returns filed by a and head of household. Children under zens or residents and whose tax private mail service must reach the IRS age eighteen at year-end are taxed on home and abode are outside the office by the required due date; unearned income in excess of certain United States and Puerto Rico on the however, returns filed with certain amounts at the trust and estate tax regular due date have an automatic designated delivery services will be bracket/rate. extension of two months (to 15 June considered to have been filed when for calendar-year taxpayers) for filing.

2 2020 Tax Planning for US Individuals Living Abroad | Chapter 1: Filing Requirements

they are given to the delivery service. bona fide foreign residence test or The exclusions may be elected on a See Appendix A for a list of currently physical presence test is expected to return that has been filed by either its designated private delivery services. be met. regular or properly extended due date, or on a timely filed amended If a return is mailed after its original or The extension application is filed using return. They may also be elected on a extended due date, it is not Form 2350, Application for Extension of late return, if the return is filed within considered filed until actually Time To File US Income Tax Return, and one year of its original due date. received by the IRS. may be filed with the IRS Center in Austin, TX, or with an IRS office located Th e exclusions may also be elected on Interest and Penalties on Balance in a major US embassy in another a late return filed after one year of its Due country. A copy of the approved original due date, provided one of the A properly filed extension relieves the application should be attached to the two following conditions is met: taxpayer from a late filing penalty on return when it is filed to help reduce • The taxpayer owes no federal the net tax due (4.5% per month for IRS processing delays. late filing plus .5% per month for late income tax after taking into payment until the payment is made; Filing a US tax return without account the exclusion and files the combined penalties may not claiming the special foreign Form 1040 with Form 2555, exceed 25%). It does not, however, exclusions may require payment of US Foreign Earned Income, attached eliminate the liability for interest that taxes, particularly when the taxpayer’s before or after the IRS discovers is charged on any unpaid tax from the compensation has not been subject to that the taxpayer failed to elect the original due date (without extension). US tax withholding. Although all or a exclusion. See Example 1. portion of these taxes may be • The taxpayer owes federal income refunded at a later date, it is usually tax after taking into account the Alternative First-Year Filing advantageous to obtain the extension exclusion and files Form 1040 with Procedures and file the return when the special Form 2555 attached before the IRS Taxpayers who expect to qualify for the foreign exclusions can be claimed. discovers that the taxpayer failed special foreign exclusions but are to elect the exclusion. required to file a return before A taxpayer who is already entitled to a qualifying, may either obtain an refund may consider it worthwhile to Taxpayers filing a late income tax additional extension to defer filing file by the original due date and obtain return more than one year after its until they qualify or file the return a refund. At a later date, he or she original due date under these rules without claiming any foreign exclusion, may file an amended return (Form must note this on page one of their pay any tax due, and file an amended 1040X) to obtain an additional refund Form 1040. return to apply for a refund when the because of the special foreign requirements are met. The IRS will exclusions. This situation may occur Estimated Tax grant an extension until thirty days when a foreign assignment begins late Estimated tax payments are required after the date on which either the in the year. if the amount of taxes due with the return after withholding is expected to exceed $1,000. No estimated tax Example 1: payments are required if there was no Taxpayer B is living in the US as of 15 April 20X2. On 10 April 20X2, he files a valid tax liability in the preceding year. See Form 4868 extension for his 20X1 US income tax return. He then files the return on Appendix A for a schedule of current 15 September 20X2, and there is a $1,000 balance due. year payment due dates. If there is an underpayment of the estimated tax Because B filed his return prior to the 15 October extended due date, there is no and none of the exceptions to the late filing penalty assessed. He will be subject to the late payment penalty and penalty applies (i.e., payments and interest charges, calculated as follows (assume a 3% annual interest rate): withholding are greater than or equal Late payment penalty: 0.5% x 5 months x $1,000 = $25 to 90% of current year tax; payments and withholding are equal to 100% of 5 months counted from 15 April to 15 September last year’s tax if adjusted gross income Interest: 3% x 154 days / 365 days x $1,000 = $13 on last year’s return was less than or 154 days counted from 15 April to 15 September equal to $150,000, or payments and

3 2020 Tax Planning for US Individuals Living Abroad | Chapter 1: Filing Requirements

withholding are equal to 110% of last Assets. Form 8938 applies to certain When required, all accounts and year’s tax if adjusted gross income is individuals holding an interest in financial assets located outside the US greater than $150,000), a penalty is specified foreign financial asset(s) over require disclosure on Form 8938. imposed at the interest rate that the applicable Form 8938 reporting applies to assessments of tax. This threshold for the underlying tax-year. US Immigration Reporting penalty is not generally deductible for Passport applicants and green card income tax purposes. Interest is not “Certain individuals” generally include applicants must affirm that they have charged for the late payment of US citizens and green card holders, as properly filed required US returns. estimated tax. well as US aliens filing a resident US Failure to file this information carries a income tax return. These individuals penalty. The purpose of this provision It is important to note that alternative must attach Form 8938 to their US tax is to identify US persons who fail to minimum tax must also be paid by return when they hold an interest in file US tax returns during their period estimates. For a complete discussion specified foreign financial assets in of foreign residence. of alternative minimum tax, see excess of the applicable reporting Chapter 5. threshold. A US green card holder is generally subject to US income tax on Foreign Bank Accounts and “Specified foreign financial assets” may worldwide income during the entire Specified Foreign Financial Assets include: time he or she holds the green card, Foreign Bank Account Reporting even if residing outside the US. • any depository, custodial, or other (FBAR). The Department of the Complex tax statutes govern financial account maintained by a Treasury requires that every US citizen individuals who abandon lawful foreign (non-US) financial or resident alien with an interest in or permanent residence status. In institution, signature authority over foreign bank general, revoking a green card accounts, securities, or other financial • any stock, security, financial subjects the individual to an accounts that exceed $10,000 in instrument or contract issued by a expatriation exit tax regime which may aggregate value at any time during the person other than a US person serve to tax the individual on their net calendar year must report that held outside of a financial wealth. Consultation with a relationship. The original deadline to file institution, and, professional adviser specializing in this the FBAR will align with that of the area is strongly recommended when • any separate interest in a foreign individual income tax return (that is, 15 considering potential tax entity not held in a US institutional April). An automatic six-month extension consequences and other legal account is provided for anyone who fails to meet implications associated with the original deadline. surrendering a green card. The table below summarizes the Form 8938 reporting threshold for each type The report is made electronically on of individual classified as a specified Form 114, Report of Foreign Bank and person and is based on the aggregate Financial Accounts (FBAR) and is filed total value (in US dollars) of all specified online and separately from the income tax return through the BSA E-Filing foreign financial assets held on either System website. Form 114 is for the last day of the tax year, or at any disclosure purposes only and does not time during the tax year: impact or serve to assess any amount of tax on the return. However, failure to file Form 114 may result in the imposition of civil and criminal penalties.

Specified Foreign Financial Asset Reporting. Additional reporting of specified foreign financial assets may be required as part of the individual’s tax return by attaching Form 8938, Statement of Specified Foreign Financial

4 2020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions

Chapter 2: Special Foreign Exclusions

Qualifying US taxpayers with a tax • Real and personal property Example 2: home outside the United States are insurance entitled to elect two exclusions to Bill and Anne Smith are US citizens • Certain occupancy and personal reduce their US taxable income: the who qualify for the foreign earned property taxes foreign earned income and the housing income exclusion for all of 20X1. cost exclusions. The exclusions are Assume the exclusion limitation for • Nonrefundable fees paid for available only if the taxpayer maintains 20X1 is $100,000. Anne’s 20X1 securing the leasehold a foreign tax home and meets either foreign earned income is $110,000 • Rental of furniture and household the bona fide residence or physical and Bill’s is $50,000. In a joint accessories presence requirements explained on return, the Smiths may exclude a pages 8–10. total of $150,000: $100,000 of her • Household repairs earnings and the full $50,000 of his • Residential parking Foreign Earned Income Exclusion earnings. Anne is not allowed to A qualifying taxpayer may elect to use the unused portion of Bill’s Qualifying housing expenses exclude exclude foreign earned income up to exclusion. If they file separately, the following: certain thresholds. The exclusion each would report the exclusion on amount is indexed for inflation (see a separate return. • Cost of a house purchase, Appendix A for current year improvements, and other costs limitations). The exclusion is allowed in considered capital expenditures full only if the taxpayer remains Housing Cost Exclusion • Cost of purchased furniture or qualified during the entire tax year. Qualifying taxpayers may make an household accessories Otherwise, the exclusion is reduced additional election to exclude from proportionately for the number of days their gross income an amount equal • Domestic labor expenses (maids, during the tax year that the taxpayer to certain housing costs, as long as gardeners, etc.) does not qualify for the exclusion (see these costs are not considered • Mortgage payments (both principal Example 3 on page 6). Also, to be extravagant. A taxpayer is generally and interest) excluded, the foreign earned income subject to US income tax on the value must be received no later than one of accommodations, meals, and most • Depreciation expenses year following the tax year in which it is other living expenses paid for or • The cost of a television pay earned. Income deferred for more than provided by the employer. However, if subscription one tax year may not be excluded. these items are supplied for the convenience of the employer and • Telephone charges In the case of married persons who several other standards are met, they • Certain other housing-related each earn foreign income, a full are excluded from income. expenses claimed elsewhere on exclusion is available for each individual the return and is computed separately against The election to exclude housing costs each individual’s foreign earned is available only to those who have In addition, if the taxpayer’s family is income. See Example 2. This procedure received foreign earned income as an required to reside in a separate abode applies even if the income is earned in employee. Qualifying housing overseas because the living conditions a foreign country that is a community expenses include the following: in the location where the taxpayer is property jurisdiction. If married • Rent employed are not safe or healthy for individuals file separately, each may the family, the reasonable housing elect to take his or her foreign earned • Fair rental value of housing expenses of maintaining the second income exclusion on a separate return provided in the foreign country by foreign household may be eligible for (see Example 2). (Also see “Foreign the employer the housing cost exclusion. Earned Income” and “Foreign-Source • Utilities (other than telephone Income,” pages 11-13) charges)

5 2020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions

The housing cost exclusion is equal to cost location, an individual would (1) the exclusion. The spouse claiming the the excess of the “qualifying housing take the lower of their actual housing exclusion may aggregate the couple’s expenses” over a “base housing expenses or the high cost amount and housing expenses and subtract his or amount.” The maximum housing (2) subtract the base housing amount her base-housing amount. Generally, expenses allowable are capped at 30 discussed above. Appendix B provides the joint election is more beneficial, percent of the maximum foreign a sample of housing exclusions for since the qualified housing expenses earned income exclusion limitation. popular foreign assignment locations are reduced by only one base housing The base housing amount is calculated around the world. For a complete list, amount. as 16 percent of the maximum foreign please contact a professional tax earned income exclusion discussed advisor. These amounts will be Foreign Housing Expense above. Thus, the maximum housing updated annually by the IRS and other Deduction exclusion allowable is the equivalent locations may be added as cost of The foreign housing expense to 14 percent of the foreign earned living data on those locations are deduction is roughly equivalent to the income exclusion and will increase as evaluated by the IRS. foreign housing cost exclusion, the foreign earned income exclusion except that its use is restricted to self- is adjusted upward for inflation. Married Taxpayers. Spouses residing employed individuals. Under these together and filing joint returns may circumstances, the qualifying taxpayer If the housing expenses are incurred in elect to compute their housing cost must deduct his or her housing cost a year in which the employee begins or exclusion separately or jointly. If they amount. If the taxpayer has earned completes the foreign assignment, the elect to calculate the exclusion income during the year as an base housing amount is reduced separately, they must use a separate employee and as a self-employed proportionately. Also, assuming both base housing amount. They may individual, the housing cost amount is exclusions have been elected, the allocate expenses to either spouse or reported as an exclusion and as a housing cost exclusion must be divide them as they wish. Married deduction in proportion to the two calculated first (see Example 3). persons filing separately must income sources. compute their housing cost amounts The IRS has provided for certain individually and file separate returns. The deduction for the housing cost exceptions to the limitation on amount is limited to the excess of the "qualifying housing expenses" for If they elect to compute the housing taxpayer’s foreign earned income for taxpayers living in high cost locations. cost amount jointly, the spouses must the year over the foreign exclusion. If Accordingly, in calculating the amount also decide which spouse is to claim part of the housing cost amount of foreign housing exclusion in a high

Example 3:

Smith qualified for the foreign exclusions during 20X1 from 1 January through 31 May. His total foreign income earned during the qualifying period was $45,000, and he incurred $8,000 in qualified housing expenses. The number of days in the qualifying period during 20X1 is 151, and this number serves as the basis for the apportionment of the foreign earned income exclusion and the base-housing amount. Assume the foreign earned income exclusion limitation for 20X1 is $100,000. Smith’s foreign exclusions would be calculated as follows: Qualified housing expenses $8,000 Less: proportional base housing amount (151 / 365 × (100,000 * 16%)) $(6,619) Housing cost exclusion $1,381 Foreign earned income exclusion (151/365 × $100,000) $41,370 Total foreign exclusions $42,751

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cannot be deducted due to this 2. By qualifying for the physical of countries to which this exception limitation, it may be carried forward to presence test (PPT) by being applies is strictly limited. A special the succeeding tax year and deducted physically present in one or more provision denies the exclusions to up to the amount of the limitation in foreign countries for 330 full days individuals violating federal travel that year. The expenses may be in any consecutive twelve-month restrictions. carried forward for only one year and period may be taken into account only if the Foreign Tax Home foreign earned income for the In many cases, only PPT is available to A prerequisite for either BFR or PPT is following year exceeds both the US resident aliens (“green card” that the taxpayer must establish a exclusion and the housing expenses holders) since they are, by nature, foreign tax home. A person’s tax home incurred in that year (see Example 4). bona fide residents of the United is generally defined as the location of States. The IRS can waive the time his or her principal place of business, Qualifying for the Exclusions requirement needed to quality for rather than his or her abode or A US citizen may qualify for the foreign either of the two tests if it is residence. A tax home normally must earned income and housing determined that the individual had to be established and maintained solely exclusions in two ways: leave a country because of a war or for reasons of employment. If a person has no principal place of 1. By establishing himself or herself other adverse living conditions that business, his or her tax home is as a bona fide foreign resident existed in that country. The IRS considered to be his or her regular (BFR) for an uninterrupted period publishes every year a list of countries abode. that includes an entire calendar for which this waiver applies. The list year, or

Example 4:

Smith’s 20X1 foreign earned income was $112,000, $21,000 of which is considered self-employment income. His qualified housing expenses were $35,000. Assume the foreign earned income exclusion limitation for 20X1 is $100,000. Smith’s housing cost amount exclusion and housing cost amount deduction would be calculated as follows: Qualified housing expenses (limited to 30% of FEIE) $30,000 Less: base housing amount (16,000)

Housing cost amount $14,000

Housing cost amount exclusion:

Employment income × Housing cost amount = Excludable housing cost amount Total income $91,000 × $14,000 = $11,375 $112,000 The housing cost deduction is $2,625 (the $14,000 housing cost amount less the $11,375 exclusion). However, since Smith’s foreign earned income is exceeded by the combination of the $100,000 exclusion and the housing cost exclusion, a portion of this housing cost deduction will be carried forward to 20X2. Foreign earned income $112,000 Less: housing cost exclusion (11,375) Less: foreign earned income exclusion (100,000) Housing cost deduction in 20X1 $625 Housing cost amount deduction carried forward to 20X2 $2,000

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A taxpayer is not considered to have a If a person meets the tests for Bona Fide Foreign Residence Test foreign tax home for any period establishing a foreign tax home and To qualify as a bona fide foreign during which his or her abode maintains his or her principal dwelling resident, a US citizen must reside in a remains in the United States. For abroad, merely retaining ownership of foreign country for at least an entire example, a taxpayer who lives in the former US residence will not cause tax year—for a calendar-year Detroit but commutes daily to work in him/her to have a US abode for taxpayer, one beginning before 1 Windsor, Ontario, would ordinarily purposes of this rule. The result is January and ending after 31 have his or her tax home in Windsor generally the same even if the December of the same year. For (principal place of business); individual’s spouse or dependents purposes of the BFR test, it is crucial however, because the abode continue to reside in the US house. A that the taxpayer establish foreign continues to be located in the United final determination would depend on residence before 1 January. Being on States, he or she would be ineligible for all other facts and circumstances. the foreign company’s payroll is not the exclusions. The IRS considers a sufficient; residency begins only when new tax home to have been It should be noted that once a foreign the taxpayer arrives in the foreign established if the taxpayer actually tax home has been established, any country with a genuine intent to stays at the new place of employment reimbursements for housing or living establish a foreign residence (see for at least one year. expenses in that location may not be Examples 5, 6, and 7). treated as “away from home” Equally important as the establishment business expenses. Therefore, it is not The BFR test requires that the taxpayer of a foreign tax home and foreign place possible to claim the exclusions for a have an intent to reside in a foreign of employment is the taxpayer’s period of time in which housing or country, as supported by the related demonstration that he or she has living expense reimbursements are facts and circumstances. A person established a foreign abode. The IRS, in taking place unless these who travels abroad for a temporary Revenue Ruling 93-86, lists three reimbursements are included in the period of time for a specific purpose is factors for determining whether a taxable compensation of the not usually considered a BFR. Merely taxpayer has established a foreign employee. being in a foreign country for the abode: required length of time is not The lack of a precise definition of sufficient; the required intent must 1. the taxpayer’s family accompanies foreign tax home makes it very exist. In determining a taxpayer’s him or her to live in the new important that taxpayers document intent to establish a foreign residence, home, factors in their personal situation that US courts have considered factors 2. living expenses are not being support the establishment of a foreign such as the duration and nature of the duplicated by maintaining an old tax home. As previously mentioned, a stay; whether the taxpayer’s US house home, and foreign tax home is absolutely was sold, leased, or abandoned in necessary to qualify for the exclusions. favor of one in the foreign country; 3. a preponderance of business whether the taxpayer was contacts are now at the new Foreign Country accompanied by his or her family; the location. T he term foreign country for purposes type of foreign visa obtained; the of the physical presence and bona nature and degree of the taxpayer’s fide foreign residence tests includes participation in the foreign community; any territory under the sovereignty of the taxpayer’s command of the foreign a government other than that of the language; and the location of the United States. It includes the territorial taxpayer’s economic interests. The fact waters of the foreign country, as they that a taxpayer intends to return to the are defined under US laws, and the air United States when the foreign space over the foreign country. US assignment is over does not prevent possessions and territories are not his or her qualification as a BFR (see considered foreign countries, nor are Examples 6 and 7). international waters.

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becoming BFR of a foreign country is taxpayer must have established a Example 5: determined under all provisions of the foreign tax home and a foreign abode Smith, a calendar-year taxpayer, treaty, including specific provisions as of that day. The time spent on or arrived in the United Kingdom on 19 relating to residence or privileges and over international waters is not January 20X1. He cannot qualify as a immunities. considered when counting the days a BFR for 20X1 because he is a UK taxpayer was physically present in a resident for only part of 20X1. Another determining factor may be foreign country unless the points of However if he remains a UK resident the manner in which the taxpayer departure and arrival are both foreign for all of 20X2, the benefits of BFR presents his or her status to the countries. During such a trip, a person status can be retroactively applied foreign tax authorities. If the taxpayer may visit the United States and, starting from 20 January 20X1. Should gives a statement to the foreign tax provided that the US presence is for Smith relinquish his UK residence at authorities seeking exemption from less than twenty-four hours, the day in any time during 20X2, he will be the foreign country’s tax on the the United States will still qualify as unable to qualify for the exclusion grounds that the taxpayer is not a one of foreign physical presence. under the BFR test for either year. resident of the foreign country, and if the tax authorities of the foreign The intent to establish a foreign country agree with the claim for residence is irrelevant for purposes of Example 6: exemption, then the taxpayer will not the physical presence test. All that is US citizen Smith moved to the UK qualify under the BFR test. required is that the taxpayer actually with the intention of residing/working be present on foreign soil and be A change of foreign residence from one there for an indefinite period of time. able to claim that his or her tax home foreign country to another does not He plans to return to the US after his and abode are outside the United affect BFR status. However, even assignment is done. He rented his States during the time of foreign temporary residence in the United home in the US and took his home presence. An individual may qualify States between foreign assignments furnishings with him to the UK. Smith under the physical presence test re- may terminate BFR status. has the intent necessary to qualify as gardless of whether he or she is Consequently, a taxpayer should a BFR. subject to income tax in the foreign maintain his or her foreign residence country. status until becoming a resident in a Example 7: new foreign country. (Note, however, Time spent in a foreign country in the that a temporary period of US employment of the US government Brown, a US citizen, leaves the residence status does not revoke the will count toward satisfaction of the United States to work in Belgium for election to exclude foreign earned 330-day requirement. However, thirteen months. She leaves her income. If the taxpayer moves abroad income earned from the US family in the United States. Brown again, the election remains in effect.) government may not be excluded. may or may not qualify for BFR. Additional factors must be examined. The IRS frequently determines whether A taxpayer qualifies for the exclusions a taxpayer qualifies as a BFR on the in any twelve-month period in which Being considered a nonresident under basis of the facts reported on Form he or she has been physically present foreign tax laws should not preclude a 2555 Foreign Earned Income. This form outside the United States for at least taxpayer from applying the BFR test. must be filed with each tax return for 330 full days, and the taxpayer can Also, the possession of a tourist visa, which the foreign exclusions are select the period. The objective is to with its implications that one is not a claimed. have as many days as possible in a tax resident of the country under local year fall within a twelve-month Physical Presence Test immigration laws, does not in itself qualifying period. The foreign tax To qualify for the special foreign cause one to fail the BFR test. home and abode need not have been exclusion under the physical presence established throughout the entire An income tax exemption provided in test, a US citizen or resident alien twelve-month period, but they do a treaty or other international must be physically present in a foreign need to have been established for agreement will not in itself prevent a country for 330 full days within any each day of the taxpayer’s 330 foreign person from BFR status. Whether a consecutive twelve-month period. A days within that period. treaty prevents a person from full day is a twenty-four-hour period beginning at midnight. Also, the

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As a result, for the first year of physical Example 8: presence, the qualifying period and amount of excludable earned income Brown arrives in Belgium at 11:59 p.m. on 31 March 20X1. She remains there are maximized as follows: Count back throughout 20X1 and 20X2. The earliest possible date which Brown can qualify for twelve months from the 330th full day the foreign earned income exclusion is 330 days from the date of arrival, or 24 of physical presence abroad. Then February 20X2: count the number of days between 1 April 20X1 + 330 foreign days = 24 Feb 20X2 the first day of that twelve-month period and the end of the first year of Because Brown arrived in Belgium on 31 March 20X1 and remained outside the foreign physical presence (see U.S. for the following 330 days the physical presence qualification test is met on Example 8). 24 Feb 20X2.

Similarly, in the year the taxpayer There are 35 days remaining (i.e., 330 of 365) in the consecutive twelve month terminates his or her foreign qualifying period which Brown can use to claim an earlier qualifying start date assignment, the qualifying period may than 1 April 20X1 to maximize the number of qualifying days and the excludable be extended beyond the date of amount in 20X1: repatriation (see Example 9). 25 Feb 20X1 1 April 20X1 24 Feb 20X2 In summary, the foreign exclusions 35 U.S. + 330 foreign 365 days may be increased in the first and last Days days = years of an overseas assignment in certain situations when the physical Brown’s qualifying period during calendar-year 20X1 is 25 February 20X1 through presence, not the BFR, rule is used. 31 December 20X1, or 310 days. This is the only exception to the rule The maximum amount of the 20X1 earned income exclusion available is therefore that taxpayers must maintain a 310/365, or 85% of the total annual exclusion amount, even though Brown was foreign tax home throughout the physically present in Belgium only 275 days during calendar-year 20X1. period during which they qualify for the special foreign exclusions. Nevertheless, the foreign tax home must be maintained throughout the Example 9: time the taxpayer counts as having been physically present outside the Brown leaves Belgium on 1 July 20X2, having been physically present there for United States. three consecutive years. To maximize the number of qualifying days and the excludable amount in 20X2, Brown performs the following calculation:

The date physical presence ended is 30 June 20X2. Because Brown was physically present outside the U.S. for 330 consecutive days prior to this date, the physical presence ending date may be deferred 35 days after Brown leaves to 4 August 20X2:

5 Aug 20X1 30 June 20X2 4 Aug 20X2 330 foreign + 35 US days = 365 days days

Brown’s qualifying period during calendar-year 20X2 is from 1 January 20X2 through 4 August 20X2, or 216 days. The maximum amount of the 20X2 earned income exclusion available is therefore 216/365, or 59% of the total annual exclusion amount, even though Brown was physically present in Belgium for only 181 days during calendar-year 20X2.

10 2020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions

Foreign Camp Exclusion Either of the elections may also be differing tax rates, and other relevant A taxpayer is generally required to made on an amended tax return if the facts and circumstances. IRS consent include as taxable income employer- original return was filed on time. An is obtained by filing a request for a provided housing and meals, as well amended tax return may be filed up to private letter ruling with the IRS as most other in-kind three years following the extended National Office of Chief Counsel. accommodations and allowances. One due date of the original return, as exception to this rule is that an described on pages 2 to 3. Either Foreign Earned Income employee may exclude from gross election may also be made on a late The basis for calculating the foreign income the value of meals and lodging return filed after one year of its original exclusion is the taxpayer’s foreign furnished by or on behalf of his or her due date as described on page 3. A earned income for the year. Earned employer and for the employer’s taxpayer must make separate income generally includes all typical convenience. This exclusion applies elections for the first year he or she compensation items received by an only if the meals are furnished on the intends to exclude foreign earned employee in providing personal employer’s business premises. In the income or qualified housing expenses. services to the employer. It includes case of lodging, the employee is Each election may be made regardless all types of reimbursements, required to accept it on the business of whether the other is made. allowances, commissions, and in-kind premise of his or her employer as a payments associated with the condition of employment. This It may not always be to the taxpayer’s provision of services, such as: advantage to elect one or both of the exception applies to employees inside • Incentive payments relating to exclusions. However, once elected, the and outside the United States. foreign assignments exclusions must be applied in all later A second, more liberal exception years unless they are revoked. The • Cost-of-living and housing applies to employees stationed taxpayer may revoke either election in allowances overseas. This exception provides that the current tax year or use an • Market value of employer-provided if a taxpayer resides overseas in amended return to revoke elections housing, automobiles, financial employer-provided housing qualifying made in previous years. However, this services, and so forth as a camp, the “on the business will also revoke the exclusion claimed premises of the employer” in any intermediate year. • Tuition and home leave requirement for excluding the value of • US, state, and foreign income tax lodging and meals is waived. If the taxpayer has never previously allowances elected to claim the exclusions (e.g., There are detailed rules under which first year on assignment), and chooses When a taxpayer operates as a sole the meals and lodging must be not to claim the exclusion, that is not proprietor or professional, separate provided in order for this exception to considered a revocation. rules apply to determine the amount apply. of earned income, depending on Should the taxpayer return to the whether the income generated is the Electing the Exclusions United States and become a US result of personal services only, or a The exclusions for foreign earned resident and then, a number of years combination of personal services and income and for housing costs are later, move abroad again, the other capital investments. Where both elective by the taxpayer. These elections would remain in effect. are included, the taxpayer may elections must be made on a tax Should he or she decide in a later year consider up to 30% of the net profits return with Form 2555 attached that to revoke either election, the as compensation for personal services is filed no later than one year after the revocation would be binding for that qualifying for the exclusion. If capital is original due date. This due date will be year and at least five subsequent tax not a factor in producing the overall determined without respect to the years. A taxpayer can, however, reelect income, the total profit may be extension of time to file. As a result, a either exclusion within this six-year considered earned income. In all person may elect the exclusions for period by obtaining the IRS’ consent. cases, the amount paid for personal 20X1 on a 20X1 tax return filed no In deciding whether to consent to a services for a sole proprietor or later than 15 April 20X3. This special- reelection, the IRS considers the professional must be considered election deadline does not extend the period of the taxpayer’s US residence, reasonable, based on all of the return’s due date or the time period whether the individual moved from circumstances of the situation. for other provisions in the tax law. one foreign country to another with

11 2020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions

Professional fees will generally In the arts and sciences, distinguishing exclusion cannot be increased by constitute earned income, even if the compensation for personal services deferring receipt of foreign earned taxpayer employs assistants who from income and from the transfer of income to a later year. perform part or all of the services, artistic property (for example, a provided that the patients or clients painting, book, or copyright) has often Also, to qualify for the exclusion, the look to the taxpayer as the person been difficult. Since 1973, the IRS has income must not be received later responsible for the services rendered. agreed that, at least for purposes of than the end of the year following the the foreign earned income exclusion, year in which the services were The IRS has ruled (contrary to at least a painter’s income from the sale of his performed. Consequently, payments one court case) that, when or her paintings is earned income for the employee’s salary, expense determining the earned income of a eligible for the exclusion. Furthermore, reimbursements, or tax equalization member of a foreign partnership, the the IRS has extended its analysis to will not qualify for the exclusion if paid foreign earned income exclusion is writers who transfer the property later than one year after the year in applied to the partner’s share of the rights to their works to a publisher, which the services were performed partnership’s gross income, rather and to composers who transfer the (see Example 10). than to its net income. Furthermore, if copyrights to their musical the partner’s income partly depends compositions. Consequently, the Foreign-Source Income To exclude the income, not only does upon the services of the fellow income that authors and artists derive it have to be earned income, the partners and employees both inside from transferring their work can be taxpayer must also establish that the and outside the United States, the earned income for purposes of the income is from a foreign source. The partner’s income qualifying for the earned income exclusion. exclusion is based on a ratio of the source of compensation for the partnership’s earned income from As a rule, employees of the US performance of personal services is sources outside the United States to government are not eligible for the determined on the basis of the place its total earned income. However, if special foreign exclusions. They where the services are performed. the partnership agreement provides usually receive other exemptions for Factors such as the place from which that a particular partner’s share of certain cost-of-living and foreign-area payment is made, the location of the partnership income is derived solely allowances. employer, and the employee's home from the profits of the partnership’s base are not relevant. foreign branch, that partner can Foreign earned income does not The IRS has issued regulations that consider his or her proportionate include pension or annuity income, address the proper method for share of earned income to come from income received as a “nonqualified determining the source of foreign sources. annuity,” or income received from a nonexempt trust. compensation for personal services “Guaranteed payments” received by a performed inside and outside the partner for services rendered outside Earned income qualifying for the United States. Generally, the the United States are considered exclusion is deemed to have been regulations state that the source of separately as compensation for received, for purposes of applying the compensation should be determined services performed outside the United limitation, in the year in which the based on either a "time" or States. services were performed. The "geographical" basis.

Example 10 Smith, who is entitled to the foreign earned income exclusion, earned $105,000 working outside the United States during 20X1. Smith received payment for these services over a three-year period: $60,000 in 20X1, $15,000 in 20X2, and the remaining $30,000 in 20X3. Assuming he reports on the cash basis, Smith would report the income in the year it is received. Assume the exclusion limitation for 20X1 is $100,000.

Since it was earned in 20X1, the maximum amount that may be excluded, provided that it is received no later than 31 December 20X2, is $100,000. Smith therefore would be allowed to exclude the $60,000 received in 20X1 and the $15,000 received in 20X2, since this total—$75,000—does not exceed the $100,000 exclusion allowed for 20X1. Smith cannot exclude any of the 20X1 income received in 20X3, even though an additional $25,000 ($100,000 - $60,000 - $15,000) could have been excluded had it been received in either 20X1 or 20X2.

12 2020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions

The time basis requires all • Moving expenses — Sourced on Treaty re-sourcing provisions may be compensation other than certain the location of the employee’s new relied on for assignees on assignment listed fringe benefits (listed below) to principal place of work, or if more to a treaty country that has a re- be sourced based on days worked appropriate based on specific facts, sourcing provision to ensure optimal during the tax year. This category of then the former place of work. sourcing of compensation, in cases in income would include, among other which such re-sourcing is applicable Alternatively, a "facts and items, salary, incentive compensation and the treaty provisions of the treaty circumstances" basis may be used if it and taxable group term life insurance. are met. The treaty provisions can be shown to the satisfaction of This income would be sourced based generally require that the individual is the Commissioner that this basis is on the ratio of foreign workdays over a US citizen who is considered more appropriate. This may occur, for total workdays for the year. resident in the foreign country under example, when an employee's the treaty. Compensation related to prior or compensation is tied to the multiple tax years should be sourced performance of a specific action Income Tax Calculation After on the time basis, applied to the entire rather than earned ratably over a Considering the Exclusions period to which the compensation is specific time period. The tax calculation with the exclusions attributable. For example, a bonus requires the taxpayer to determine his Some states have also published rules received in 20X2 related to 20X1 or her taxable income after all on sourcing which need to be performance would be sourced based deductions and exemptions and, considered in applying state income on 20X1 workdays. The IRS regulations before calculating the tax liability, the tax withholding rules and preparing prescribe that the time basis for stock taxpayer must add back the amount state income tax returns. option income is the time period of the exclusions, calculate the tax, between grant date and vesting date, Treaty Re-sourcing of and then subtract an amount of tax rather than between the grant date Compensation calculated as if the exclusion amount and the exercise date. Treaty re-sourcing provisions allow was the taxable income. An example certain taxpayers to re-source US.- of the tax calculation follows: The geographic basis sources income source income as foreign. received in the form of certain fringe benefits based on the geographical work location for which it relates. The Example 11 regulations list certain fringe benefits Married Filing Joint, No children 20X1 that should be sourced geographically, Assume for 20X1 that the foreign earned income exclusion and set forth the following sourcing limitation is $100,000, the maximum allowable housing exclusion is provisions: $14,000 and the standard deduction is $24,000. • Housing — Sourced on the Gross Income Including Wages $150,000 location of the individual’s principal Foreign Earned Income Exclusion (100,000) place of work; Housing Exclusion ($50,000 Qualified Housing Expenses) (14,000) • Education — Sourced on the $ 36,000 location of the individual’s principal Adjusted Gross Income place of work; Less: • Local transportation — Sourced Standard/Itemized Deductions (24,000) on the location of the individual’s Taxable Income $ 12,000 principal place of work; Calculation of Tax • Tax reimbursements — Sourced Taxable Income $ 12,000 on the location of the jurisdiction that imposed the tax; Plus: Exclusions 114,000 • Hazardous or hardship duty pay — Tax Base $126,000 Sourced based on the duty zone Tax Calculation $ 19,599 for which the fringe benefit was Less: Tax on Exclusions 16,959 paid; Net Tax Liability $ 2,640

13 2020 Tax Planning for US Individuals Living Abroad | Chapter 3: Moving and Travel Expenses

Chapter 3: Moving and Travel Expenses

Moving Expense Reimbursement exclusion in that year is based on the When a taxpayer’s employment away Moving expense reimbursements will number of days the taxpayer resided from home is expected to last more be included in gross income as abroad in the tax year of the move. than one year, the employment will be compensation for services. Moving However, the moving expense treated as indefinite, as opposed to expense reimbursements include any reimbursement is attributable entirely temporary, and the related travel amount received, directly or indirectly, to the year of the move, as long as the expenses will be nondeductible. If the by an employee from an employer as individual has a qualifying period of at employment away from home is a payment for, or a reimbursement of, least 120 days in the year of the move. expected to last one year or less and expenses for a move. during this period it is determined that If the individual does not have a the assignment period will exceed one Source of Moving Expense qualifying period of at least 120 days, year, the “away from home” provisions Reimbursements. A reimbursement for he or she must attribute the moving no longer apply as soon as the intent a move to a foreign country will expense reimbursement both to the to remain exceeds one year. generally be considered foreign- year of the move and to the source income and will therefore succeeding year, on the basis of the Thus, a person who works abroad but qualify for the foreign earned income following ratio: maintains a US tax home while on a exclusion. A reimbursement for moving temporary foreign assignment can Number of qualifying days for expenses incurred to return to the claim deductions for the cost of travel year of move United States will generally be and lodging, as well as 50% of the cost considered US-source income, since it of meals and entertainment, related to Total number of days in the year is deemed to be paid for future his or her foreign (or US) business services to be performed in the trips. By maintaining a US tax home, Travel Expenses “Away from United States. the person is not eligible for the Home” special foreign exclusions. However, a reimbursement for the Deductions are allowed for un- return move back to the United States reimbursed expenses of travel, lodging, If, on the other hand, the person will be considered foreign-source and meals and entertainment, maintains a foreign tax home (and income if it is made under a written provided that the amounts are maintains a foreign abode), he or she agreement prepared before the move reasonable and necessary for the is eligible for the foreign exclusions to the foreign country as an conduct of the taxpayer’s business. and can, in addition, claim similar inducement for the move. The The expenditures cannot be “lavish or deductions for lodging, meals, and agreement must state that the extravagant” under the circumstances. travel on business trips away from the employer will reimburse the employee Travel and lodging expenses are foreign tax home. At times it may be for moving expenses incurred in allowed only when the taxpayer is advantageous for a taxpayer to returning to the United States temporarily away from his or her tax arrange his or her affairs in such a whether or not the employee home. way that he or she continues to continues to work for the same maintain a US tax home (and forgo An employee’s reimbursed expenses employer after returning to the United the foreign exclusions) to claim away under a reimbursement or other States. from home deductions for foreign expense allowance arrangement with business trips. This arrangement may his or her employer should not be Attributing Moving Expense be beneficial if it prevents foreign included in compensation, if the Reimbursements. When an individual residence status and the resulting employee is required to substantiate does not qualify for the foreign obligation to pay foreign income tax. earned income exclusion for the the expenses. entire tax year of the move, the portion of the moving expense reimbursement that qualifies for the

14 2020 Tax Planning for US Individuals Living Abroad | Chapter 4: Principal Residence

Chapter 4: Principal Residence

Selling the US Principal Residence residence, or for the owner's death, Example 12: Unmarried taxpayers are allowed to cessation of employment for which exclude the gain on the sale of their the individual is eligible for Smith purchases a home on 1 principal residence to a maximum of unemployment compensation, a September 20X1 for $100,000 and $250,000, and $500,000 for married change in employment status so that sells it on 1 September 20X9 for taxpayers filing joint returns, provided the individual can no longer pay $200,000. During the period of such taxpayer(s) meet certain housing costs and reasonable basic ownership, the home was rented for a qualifications. In general, to qualify for living expenses, a divorce or legal brief period and depreciation of the exclusion, a taxpayer must have separation, or multiple births from the $3,000 was claimed, so that the owned and occupied the residence as same pregnancy. Preference for a depreciated cost of the home is a primary residence for at least two of different residence or an $97,000. The gain realized on the sale the five years preceding the sale. improvement in financial is $103,000 ($200,000 – [($100,000 - Taxpayers who fail to meet the two- circumstances is not considered an $3,000)]. The first $3,000 of realized year requirement because of a change unforeseen circumstance that would gain is recaptured depreciation in place of employment, health, or allow for the reduced maximum subject to the special 25% tax, and other unforeseen circumstances exclusion. the remaining $100,000 is eligible for (described below) may be eligible for the exclusion (assuming there is no a portion of the exclusion based on When a taxpayer sells a home on applicable nonqualified use, see the ratio of their own qualifying period which depreciation has been claimed examples 14 & 15). to the two-year period. For example, a during a rental period, the taxpayer who has owned and depreciation is recaptured at the time occupied a residence for one year and of sale (assuming that the sale price Example 13: is then transferred abroad will be exceeds the depreciated cost of the Smith purchases a residence on 1 entitled to one-half of the exclusion home) and taxed at a special rate of September 20X1 for $100,000. On 1 (see Partial Exclusion, below, for more 25% (see Example 12). However, June 20X2 Smith sells the residence detail). In addition, the exclusion for depreciation claimed before 7 May for $150,000, as a result of taking up a gain does not apply if the principal 1997 is not treated this way. foreign assignment. Smith is entitled residence was acquired in a like-kind The exclusion is generally not available to 9/24ths of the maximum exclusion exchange in which any gain was not to individuals who are deemed to ($250,000 * (9/24) = $93,750), since recognized within the prior five years. have expatriated to avoid US tax he has owned and occupied the The exclusion may be claimed once under Section 877 (i.e., former long- house as his principal residence for every two years. term residents or former US citizens). nine months of the required twenty- Regulations help to define what is four-month total period and the Partial Exclusion. If a taxpayer has considered a sale by reason of house was sold as a result of a owned and occupied a residence as a unforeseen circumstances. The change in place of employment. Since primary residence for fewer than two regulations state that a sale is by his total gain of $50,000 ($150,000 - of the five years preceding sale, but reason of unforeseen circumstances if $100,000) is less than the maximum the primary reason for the sale is the has sold the residence because of a exclusion available ($93,750), the full change of place of employment or occurrence of an event that could not amount of the gain is excluded. health or other unforeseen reasonably have been anticipated circumstances, the taxpayer is before purchasing and occupying the entitled to a pro-rata portion of the residence. Examples provided include the involuntary conversion of the exclusion (see Example 13) residence, a natural or man-made disaster or acts of war or terrorism resulting in a casualty to the

15 2020 Tax Planning for US Individuals Living Abroad | Chapter 4: Principal Residence

For sales or exchanges occurring after See Examples 14 and 15 for Example 15: 31 December 2008, gain attributable application of these new changes. to a period of nonqualified use by a Smith buys a principal residence on 1 taxpayer is not excludable from gross Example 14: May 20X1 and is sent abroad by her income. The amount of gain allocated employer on 1 May 20X3, leaving the to a period of nonqualified use is the Brown buys a principal residence on 1 property vacant. She returns to live in total amount of the gain multiplied by May 20X1 and moves out of his the residence on 1 May 20X6 and sells a fraction, the numerator of which is principal residence on 1 August 20X3 the property on 1 May 20X8 for a gain the total period of nonqualified use to work abroad. While living abroad, of $200,000. Smith meets the two-of- during the entire period the property Brown rents out his home. Brown five year test so she is eligible to was owned, and the denominator of does not reoccupy this home and he exclude a full $250,000 of the gain. which is the total period the property sells the property on 1 June 20X6 for a However, a portion of this gain is was owned. gain of $100,000. Brown owned and related to a period of nonqualified used the property as his principal use so the exclusion is limited, as A period of nonqualified use is defined residence for at least two of the last follows: as any period (not including any five years (1 June 20X1 through 31 July • 1 May 20X1 – 30 April 20X3 – 2 period prior to 1 January 2009) during 20X3), so he meets the two-of-five years in which the property was which the property is not used by the year test, and even though he rented used by Smith taxpayer, the taxpayer’s spouse or the property, he still meets the first former spouse as a principal exception above, in that the rental • 1 May 20X3 – 30 April 20X6 – 3 residence. Three exceptions apply to period is considered a period after years property was not used. this definition: the last day the property was used as However, per the third exception his principal residence. Therefore, this above, she is entitled to a 2-year • Any period of the five-year period period is not considered a period of absence by reason of change of after the last day the property is nonqualified use. Brown is therefore employment. Therefore, only one used as a principal residence of entitled to the full exclusion of year is considered nonqualified the taxpayer or spouse $250,000, subject to the depreciation use. • Any period, up to 10 years, during from the rental period being taxable. • 1 May 20X6 – 30 April 20X8 – 2 which the taxpayer or spouse is on years in which the property was extended duty with the military, used by Smith Foreign Service, or the intelligence community, and Accordingly, one out of her seven years of ownership is considered a • Any period, up to two years, during period of nonqualified use. Therefore, which the taxpayer is temporarily one seventh of the gain is not eligible absent by reason of change of for the exclusion, or $28,571 employment, health conditions or ($200,000 gain * 1/7), and is included other unforeseen circumstances in gross income in the year of sale. The remaining gain of $171,429 is less than the $250,000 exclusion so it is fully excluded from gross income.

16 2020 Tax Planning for US Individuals Living Abroad | Chapter 4: Principal Residence

Implications of the Sale of Home Rules Purchasing a Foreign Residence Example 16: for Foreign Assignments. Employees The law does not restrict the exclusion who will take, or have taken, a to gain from the sale of a principal Brown purchases a home in Germany foreign assignment should consider residence in the United States; a on 1 May 20X1 for €300,000, when the possible effects of these rules on foreign principal residence may also the exchange rate is € 1 = US$1.4802. gains that they might realize from qualify. There are, however, several The purchase is effected by a down their US residences. There are issues that should be considered payment of € 60,000, and a mortgage numerous possibilities. before a foreign residence is of € 240,000. On 1 May 20X4, Brown purchased. sells the home for € 300,000, when • An employee who cannot yet meet the value of the Euro against the US the two-year ownership and use First, the purchase of a residence in dollar has changed to € 1 = requirements might attempt to the foreign location may affect the US$1.3832. In the interval, € 10,000 of delay the foreign assignment until taxpayer’s status under the tax laws the mortgage has been paid off, so the requirements are met. of the foreign country. A number of that the remaining mortgage is € • An employee who has owned and countries maintain special tax regimes 230,000. occupied the house for the two for expatriates assigned temporarily, In Euro, there has been neither a gain years immediately preceding and the purchase of a residence may nor a loss on the house sale. foreign assignment will have a jeopardize a taxpayer’s opportunity to However, in US currency the value of foreign assignment “window” of take advantage of such a regime. the home has declined from three years at the end of which the US$444,060 to US$414,960. The loss employee would still be entitled to Second, a taxpayer who rents a home of US$29,100 is a nondeductible the full exclusion, since at that point abroad may be entitled to a housing personal loss. Moreover, there has (but not beyond it) the employee cost exclusion (see Chapter 2, Special been a gain on the retirement of the will have owned and occupied the Foreign Exclusions). The exclusion is mortgage. The remaining mortgage of residence for precisely two of the not available for costs associated with € 230,000 was valued at US$340,446 preceding five years. a home that is purchased abroad. at the time it was issued, but at only • An employee who is uncertain Third, foreign real property taxes on a US$318,136 at the time it was retired. whether the foreign assignment personal property are not deductible In other words, the debt is settled for may extend sufficiently to impair in the United States. US$22,310 less than its value at issue, access to the full exclusion, or who and this $22,310 represents a taxable is uncertain about repatriating to Finally, the purchase of a home gain that cannot be offset by the loss the same US location at the abroad may give rise to a foreign suffered on the sale of the home conclusion of the foreign currency exchange gain when the itself. assignment, may want to sell the home is sold and a mortgage retired residence before taking up the because of a change in the exchange assignment. rate between the time of purchase/mortgage acquisition and • An employee who, as a result of a sale/mortgage retirement. In fact, it is foreign assignment, will at the possible that the sale of a foreign conclusion of that assignment not home will give rise to a nondeductible meet the two-year test may wish to personal loss on the sale of the home avoid repatriating to a different US itself, and at the same time a taxable location, so that the residence may exchange rate gain on the retirement be reoccupied and re-qualified for of the mortgage (see Example 16). the exclusion.

As there are a great many more possibilities, along with issues involving marriage, ownership, and the assignment, it is strongly recommended that planning be carried out with the assistance of tax advisers.

17 2020 Tax Planning for US Individuals Living Abroad | Chapter 4: Principal Residence

Renting the US Residence If a taxpayer rents the US residence If a taxpayer rents the former principal during the foreign assignment period residence during the period of a but does not return to live in it, there foreign assignment, the net rental may be some risk that the US income or loss is reported on the US residence will be considered to have income tax return. Expenses consid- been converted to business or income ered necessary for earning the income property. Case law indicates that this are deducted in determining the net conversion will not be considered to amount. If the taxpayer intends to have occurred if the taxpayer can return to the US residence, renting it demonstrate that the rental activity will not necessarily disqualify any later was temporary, was necessary owing gain on its sale from the exclusion, to a difficult real estate market, although the taxpayer will still have to coincided with sales efforts, or arose meet the ownership and use owing to uncertainties concerning requirements for the exclusion. future employment plans.

Deductibility of rental losses may be Conclusion restricted in several ways. First, if a The rules regarding the exclusion on taxpayer’s adjusted gross income the gain from the sale of a principal does not exceed $100,000, the residence in general provide stronger taxpayer can deduct up to $25,000 of incentives to sell a residence before annual losses, but the deductible loss taking up a foreign assignment, is phased out by fifty cents on the especially if the length of the dollar as adjusted gross income assignment is uncertain. The longer exceeds $100,000, so that at $150,000 the assignment continues, the risk there will no longer be a deductible that access to the exclusion may be loss. Second, if a taxpayer uses the reduced or eliminated increases. residence for personal purposes for Given the risks associated with rental the greater of fourteen days or 10% of of the US residence, and with the number of days during which the purchase of a foreign residence, many house is rented during a given year, employees taking a foreign no loss may be deducted. This loss assignment may wish to sell the US restriction, however, does not apply to residence before or just after mortgage interest or real estate tax departure and rent a residence in the charges. If personal use does not foreign location for the duration of the exceed the limits, a deduction is assignment. While certain factors may allowable for a proportionate share of exist that could prevent this tax other expenses, including depreciation, planning from being universally attributable to rental of the unit. beneficial, special consideration should be given to the treatment of a person’s principal residence.

18 2020 Tax Planning for US Individuals Living Abroad | Chapter 5: Alternative Minimum Tax

Chapter 5: Alternative Minimum Tax

The alternative minimum tax (AMT) is The preferences and adjustments intended to prevent a taxpayer with that are exclusion items include the substantial economic income from standard deduction, medical and avoiding all tax liability by using dental expenses, taxes, depletion in excessive deductions, exemptions, excess of the basis, and private and credits. Essentially, AMT is a activity bond interest. separate tax imposed on certain types of income and deductions. A taxpayer There may be little or no tax benefit must pay AMT if it exceeds the regular from the above deductions, which are tax. AMT is calculated in the same considered exclusion adjustments or manner for expatriates as it is for preferences. For example, the domestic US taxpayers. deduction for state income taxes paid in a year when the taxpayer is subject AMT is especially impactful to US to AMT may never provide a tax benefit taxpayers who earn foreign income since this deduction is ignored in the that exceeds the exclusion amounts AMT calculation. Since the same rule and is subject to foreign income tax at applies to a deduction for foreign a rate greater than US rates. The income taxes, the taxpayer may want foreign tax credit may help decrease to elect the foreign tax credit (vs. taking the US tax (see Chapter 6 for an a deduction for foreign taxes) in years explanation of the foreign tax credit); he or she is subject to AMT. taxpayers are allowed to claim the foreign tax credit as re-calculated for As with the regular tax, AMT must be AMT purposes. paid either by withholding or by making quarterly estimated payments. AMT Credit If these payments are inadequate, the Once paid, AMT may be allowed as a penalty due for underpayment of credit against the regular tax in later income taxes is not deductible in years. The AMT credit can be carried calculating AMT. Therefore, taxpayers forward indefinitely; it cannot be living abroad are urged to estimate carried back. both their regular tax and their AMT periodically to confirm that tax Carryovers are created only from payments are adequate. deferral preferences and adjustments, not from AMT that may arise for exclusion preferences and adjustments (see below). The reasoning is that deferral preferences and adjustments provide the taxpayer with only temporary relief from the regular tax.

19 2020 Tax Planning for US Individuals Living Abroad | Chapter 6: Foreign Tax Credit

Chapter 6: Foreign Tax Credit

A US citizen or resident alien may Scaleback (Disallowance) of the either deduct foreign income taxes in Foreign Tax Credit arriving at taxable income or claim Foreign income taxes are scaled back them as a credit against US income (disallowed) as credits to the extent tax. The use of a foreign tax credit that the taxes relate to earned income often results in lower taxes than does excluded under the special foreign the deduction of foreign income taxes exclusions. A taxpayer may therefore since it permits a dollar-for-dollar decide not to elect the foreign earned offset of foreign income taxes against income or housing cost exclusions for US income taxes. the years that he or she is subject to foreign taxes on earned income. A US taxpayer can credit taxes imposed Forgoing the exclusions may be by a foreign country, its political reasonable to consider in a year in subdivisions, or a US possession, such which the foreign income tax rate as Puerto Rico. Income, war profits, exceeds the taxpayer’s US tax rate. and excess profits taxes, as well as The excess foreign tax credits may be taxes paid in lieu of income taxes, can used to reduce US tax on certain be claimed as foreign tax credits. Some other foreign-sourced income or be foreign social security taxes are carried to another year. creditable. Social security taxes paid to a foreign country that has a A decision to revoke a foreign “totalization agreement” with the exclusion election may also be United States are not creditable or advisable in a year in which the deductible. taxpayer moves from a foreign country with low income tax rates to Each year, an individual must either one with high income tax rates. deduct all foreign income taxes or Remember that if a taxpayer revokes take a credit for them. Switching a foreign exclusion election, he or between deductions and credits from she is barred from reelecting that year to year is permitted and may exclusion for the five successive tax enable a taxpayer to further reduce years following the revocation, unless his or her income tax. Once the the IRS consents to the reelection. taxpayer makes the election to deduct Any decision to revoke a foreign or credit foreign taxes, he or she may exclusion election should be revoke the election any time before discussed with a tax advisor the period to file a claim for a refund specializing in this area of taxation. expires (usually three years from the due date or date of filing, if the time If foreign taxes are considered related for filing was properly extended to excluded earned income, they are beyond the original due date). permanently disallowed as foreign tax credits (or as deductions). To determine the amount disallowed, an apportionment of the foreign tax is made between the excluded foreign net earned income and the total

20 2020 Tax Planning for US Individuals Living Abroad | Chapter 6: Foreign Tax Credit

foreign net earned income subject to is then traced to the year in which the If the taxpayer has received foreign the foreign tax, as illustrated in credit was taken. As a result, a foreign income from more than one country, Example 17. (If the foreign tax is country’s different tax year or the the income and taxes are combined imposed on earned income and some taxpayer’s election to claim the credit from all foreign sources, and one other income, and the taxes on the on either the cash or accrual method calculation is made to determine the other amount cannot be segregated, will not affect a foreign credit foreign tax credit limitation for taxes then the denominator equals all disallowance. paid to different countries. The amounts subject to tax less allocated limitation formula is based on foreign- deductions.) When foreign net income Limitation source and US-source taxable income. is calculated, foreign income is The amount of foreign income taxes To increase the foreign tax credit, the decreased by any expenses considered that may be credited in a particular taxpayer’s income that is considered directly related to that income (such as year is again limited to the lesser of (a) foreign-source taxable income must employee business expenses). the allowable foreign taxes paid or also increase. Only the foreign- and Furthermore, if the housing cost accrued or (b) the amount of the US-source income subject to US tax is amount is taken as a deduction, it is applicable limitation. included in the limitation fraction. treated as related to foreign earned The limitation is that part of the gross income that is not excluded (that is, it Since the foreign tax credit could be US tax (before the foreign tax credit) reduces the denominator, not the increased by simply shifting the that applies to the taxable income numerator). This rule causes a higher source of investment income from US from foreign sources. The following disallowance of the foreign tax credit to foreign sources, thus increasing the formula is used to calculate the than might have been anticipated (see numerator of the limitation formula, limitation: Example 17). separate credit limitations apply for Foreign different types (or “baskets”) of The calculation for disallowing the taxable income. There are three baskets of Gross Credit foreign tax credit assumes that foreign income income that typically apply to × = limitation taxes on earned income accrue Total taxable US tax individual taxpayers. The two primary ratably as the income is earned. Once income baskets are the passive income a foreign tax is deemed disallowed, it category and general income

Example 17: Smith began working in the United Kingdom on 1 January 20X1, earning $10,000 a month. For the first three months of 20X1, he earned $30,000. On his UK tax return for the fiscal year ending 5 April 20X1, Smith was subject to UK tax of $6,000. For the fiscal year ending 5 April 20X2, Smith reported UK earned income of $120,000 and was subject to a UK tax of $40,000, of which $30,000a was attributed to the nine months from 6 April through 31 December 20X1. Smith incurred allowable foreign housing costs that exceeded the base-housing amount by $3,000. The UK tax subject to disallowance for the 20X1 calendar year would be $36,000: the $6,000 for his foreign tax year ending on 5 April of that year, plus the $30,000 attributable to 20X1 from his foreign tax year ending on 5 April 20X2. Assume the foreign earned income exclusion limitation is $100,000 for 20X1. Based on these facts, the disallowance of the foreign tax credit attributable to 20X1 would be $30,900 $100,000 + $3,000 36,000 x $120,000 = 30,900

Consequently, $5,100 ($36,000 less $30,900) would be the maximum amount eligible for the credit. a. The $30,000 is determined by apportioning the $40,000 tax for the nine months in 20X1. This calculation is simplified because Smith received an equal amount each month. If he had received $1,000 a month more starting in 20X2, causing him to have a UK tax of $42,000 for the year ending 5 April 20X2, the UK tax attributed to 20X1 would have been $36,732: the $6,000 accrued through 5 April 20X1, plus $30,732, calculated as follows: $90,000 [$10,000/month for 9 months] 42,000 x $123,000 [$10,000/month for 9 months = 30,732 + $11,000/month for 3 months]

21 2020 Tax Planning for US Individuals Living Abroad | Chapter 6: Foreign Tax Credit

category. The passive income category separately with regards to any income Itemized deductions that do not includes dividends, rents, royalties, that, without regard to the treaty, generally relate to a specific source of gains from the sale of non-inventory would be treated as US-source income, such as medical expenses property, annuities, interest subject to income and is being re-sourced as and qualified residential interest, are withholding of less than 5%, and foreign for purposes of calculating the ratably apportioned to US- and several other kinds of passive income. foreign tax credit. foreign-source income on the basis of Individual taxpayers must calculate gross income. Certain interest separate foreign tax credit limitations The calculation of foreign taxable incurred to acquire passive or for interest subject to withholding income requires that foreign-source portfolio assets is apportioned taxes of 5% or greater and for gross income be reduced by (a) according to the adjusted basis of the dividends received from a foreign special foreign income exclusions and taxpayer’s US and foreign assets. This corporation that is between 10% and deductions, (b) expenses directly apportionment of interest is not 50% owned by US shareholders. The related to the foreign income, and (c) required, however, if the individual’s general income category is defined as a ratable portion of other deductions. foreign-source income does not all income other than passive income exceed $5,000. Charitable In addition to the special foreign and generally consists of wages or self- contributions are allocated only to US exclusions and deductions, items employment income. Certain passive source income. deducted in arriving at adjusted gross income may be reclassified into the income generally relate to a specific general limitation basket if subject to Taxpayers who do not itemize their item of income. Consequently, there is foreign taxes above a certain level. deductions must apportion their usually little question as to whether standard deductions on the basis of Legislation enacted in 2010 added a the item should be allocated to US or gross income. third basket of income for “certain foreign income. income re-sourced by treaty.” The A calculation of the foreign tax credit foreign tax credit is calculated limitation is given in Example 18.

Example 18: The facts are the same as in the previous example, except that Smith, who is unmarried, made visits to the United States that added $10,000 to his total earnings, and he received $5,000 in US-source interest income. Smith also had $13,500 of regular itemized deductions. Assume the foreign earned income exclusion limitation is $100,000. He would compute his 20X1 US income tax and foreign tax credit as follows: Total US Foreign Earned income $130,000 $ 10,000 $ 120,000 Interest income 5,000 5,000 — Gross income $ 135,000 $ 15,000 $ 120,000 Gross income percentage 100% 11.11% 88.89% Foreign earned income exclusion (100,00) — (100,000) Housing cost deduction (9,000) — (3,000) Adjusted gross income $ 26,000 $ 15,000 $ 17,000 Less: itemized deductions apportioned on the basis of the gross income percentage) (13,500) (1,500) (12,000) Taxable income $ 12,500 $ 13,500 $ 5,000 US income tax $ 3,000 Based on these calculations, the 20X1 foreign tax credit limitation is as follows: Foreign taxable income Credit × Gross US tax = Total taxable income limitation $ 5,000 $ 12,500 × $ 3,000 = $ 1,200 Shown below is the taxpayer’s US income tax, after reduction for the foreign tax credit: Gross income tax $ 3,000 Less: foreign tax credit (1,200) Net US income tax $ 1,800

22 2020 Tax Planning for US Individuals Living Abroad | Chapter 6: Foreign Tax Credit

Carryovers Cash or Accrual Option Example 19: The decision to elect or revoke the Most individuals use the cash basis to foreign exclusions becomes more file income tax returns and would thus Brown goes to the United Kingdom on complex because of the foreign tax normally credit foreign taxes in the 30 April 20X1. Her wages are subject credit carryover rules. Foreign income year in which they were paid or to UK withholding, and, by 31 taxes that cannot be credited in a withheld. Taxpayers may, however, December 20X1, $10,000 has been particular year because they exceed credit foreign taxes on the accrual withheld. Brown’s UK income tax year the applicable limitation may be basis even though they use the cash ends on 5 April 20X2 (as required by carried back one year and forward basis for all other purposes. Once the UK law). Her UK income tax liability for ten. They are subject, of course, to the accrual method is elected, it must be that year is $15,000, of which $14,000 limitation formula for the year to used in future years. is satisfied by withholding and $1,000 which they are carried. In Examples 17 by a check sent to the UK HMRC in and 18, Smith was allowed a credit of Cash or Accrual Option November 20X2. only $1,200 in 20X1, although he had Most individuals use the cash basis to Brown’s US income tax liability for foreign taxes of $5,100 eligible for file income tax returns and would thus 20X1 (before credits) is $20,000. credit. His foreign tax credit carryover normally credit foreign taxes in the Brown does not elect to benefit from would be $3,900. year in which they were paid or the foreign earned income and withheld. Taxpayers may, however, housing cost exclusions. Thus, none Use of Credits credit foreign taxes on the accrual of Brown’s eligible foreign income tax US taxpayers living abroad may incur basis even though they use the cash is disallowed. If she uses the cash substantially more foreign income basis for all other purposes. Once the method to calculate her foreign tax taxes than can be used to offset US accrual method is elected, it must be credit, the $10,000 withheld in 20X1 income taxes. To the extent that the used in future years. would be considered eligible for the excess can be used as a credit against credit. The regular limitation formula the tax on other foreign income in the Taxpayers sometimes find it would determine the amount actually same basket, it will decrease US advantageous to accrue foreign income creditable for 20X1. income taxes otherwise payable. The taxes. Using the accrual method for more income considered “sourced” foreign taxes may accelerate the use of However, if Brown elects to use the foreign on a tax return, the higher the a tax credit when foreign taxes accru- accrual method to account for the potential exists to use foreign tax ing to a given year have not been fully foreign tax credit, no foreign tax credits or credit carryforwards. paid prior to 31 December of that year. would be eligible for the credit since her first accrual date for UK tax is not If the accrual method is chosen, the For example, many US taxpayers who until 5 April 20X2. Some or all of foreign tax is deemed to have been once lived abroad and have unused Brown’s foreign tax credits for her 5 paid at the end of the foreign tax year. foreign tax credits are required to April 20X2 UK tax liability of $15,000 If the foreign tax year does not end on make business trips abroad after their may, however, be carried back to the same date as does the taxpayer’s return from a foreign assignment. 20X1 on an amended tax return, US tax year (for most taxpayers the Determination of the source of resulting in a refund of 20X1 US US tax year is the calendar year), the income from the performance of income tax. personal services is based on the use of the accrual method may place the services are performed. create timing differences. Although the foreign tax credit carryover rules Therefore, the salary earned while on will solve most problems created by business trips abroad is foreign these timing differences, a taxpayer source income and is available to use may nonetheless experience up the otherwise unusable excess temporary cash flow problems and be credits attributable to previous years required to file amended tax returns. when the taxpayer lived abroad. Because of these issues, a taxpayer with different US and foreign tax years may find it more convenient to be on the cash method for foreign tax credit purposes (see Example 19).

23 2020 Tax Planning for US Individuals Living Abroad | Chapter 6: Foreign Tax Credit

Foreign Tax Credit and the AMT Example 20: If the AMT applies, a taxpayer must Jones begins an assignment to calculate a supplementary foreign tax Singapore on 1 June 20X1. There are credit limitation under a separate no tax payments made during the formula. Basically, the foreign tax 20X1 calendar year. Jones’ 20X1 credit is limited to the extent that the Singapore tax liability is $20,000, as taxpayer’s gross AMT is attributable to calculated on the 20X1 Singapore foreign-source alternative minimum income tax return, and this payment taxable income (AMTI): is made in 20X3. Foreign- Foreign If Jones elects to use the accrual tax credit Gross source AMTI method to account for the foreign tax × = limitation AMT credit, he can claim a credit for the Worldwide under the $20,000 accrued liability when he files AMTI AMT his 20X1 US tax return. Additional adjustments are then However, if Jones elects to use the necessary to allocate this foreign tax cash method to account for the credit between the regular tax and the foreign tax credit, there is no credit to AMT. claim in 20X1 as there are no foreign taxes paid in that year. The $20,000 can be claimed as a credit in 20X3 when the taxes are paid and any excess credit may be carried back to 20X2. The carryback is limited to one prior year and, as a result, there is no foreign tax credit for 20X1.

24 2020 Tax Planning for US Individuals Living Abroad | Chapter 7: Tax Equalization Policies

Chapter 7: Tax Equalization Policies

Tax rates vary greatly throughout the Hypothetical Obligation world. In Germany, for example, the The hypothetical tax obligation is top rate for individuals is over 40%, intended to approximate the amount while in Nigeria the overall rate may that an employee would have paid if never exceed 25%. A few countries, he or she had continued working in such as Saudi Arabia, have no the United States. A number of issues personal income tax. A US citizen or arise when determining the itemized permanent resident considering deductions in arriving at an employee’s whether to accept a foreign hypothetical taxable income. assignment may be unfamiliar with the tax laws of the foreign country and State and Local Taxes. If an employee may hesitate to move abroad if he or going overseas for several years takes she were unsure of the tax the necessary steps to break residency consequences. in his or her home state, he or she will generally not be subject to state and For this reason, many US companies local income tax after departure with operations abroad have adopted (unless he or she has sufficient income tax equalization policies for US from that state to be required to file a employees on foreign assignment. nonresident return). Therefore, the Under tax equalization, the employer federal return will often have no assumes responsibility for the deduction for state and local income employee’s US and foreign income taxes. If the company charges the taxes (and, in most cases, foreign employee a hypothetical state or local social security taxes, where income tax, the amount charged is applicable). In exchange, the employee normally allowed as a deduction in the pays the company a hypothetical tax hypothetical calculation subject to the equal to the amount the employee $10,000 cap ($5,000 if married filing would have paid in federal, state, and separate). local income tax had he or she not gone on foreign assignment. Normally, Mortgage Interest. Most employees on an amount similar to what the overseas assignments do not employee had withheld for income purchase homes abroad. If they retain taxes is deducted from his or her their US residences, they may rent paycheck. After the actual income tax them out and receive the mortgage returns are prepared, a final interest deduction as a rental computation is made to adjust the expense on Schedule E. Therefore, final hypothetical tax on the basis of many expatriates do not have a the figures in the actual return. mortgage interest deduction on Schedule A. However, since many Most expatriates receive extra companies charge their employees a allowances from their employers home housing equivalent as part of when going overseas, and these the overseas allowances, effectively allowances are generally provided tax- offsetting a portion of the rent free to the employee. An illustration of expense in the foreign country, a a tax equalization is provided in reasonable interest and real estate tax Example 21. deduction may be allowed in the hypothetical tax computation.

25 2020 Tax Planning for US Individuals Living Abroad | Chapter 7: Tax Equalization Policies

Example 21: Smith, a plant manager, is sent to Germany on assignment for two years, beginning 1 January 20X1. His base salary is $120,000, and he receives a foreign service premium of $12,000, which is provided to him tax-free. Smith has $2,000 of interest income. He is married with one child; his wife is not employed. Smith is a resident of Pittsburgh, Pennsylvania. Assume Pennsylvania has a 3.07% income tax with almost no deductions allowed; Pittsburgh has a tax on earned income of 3.00%. For simplicity, we will ignore alternative minimum tax. We also assume Smith will be able to break state and local tax residency during his assignment.a Smith’s employer engages a tax provider to prepare an estimate of his hypothetical tax liability for 20X1. The provider calculates that Smith’s hypothetical tax liability will be approximately $22,000 for 20X1 and this amount is withheld from Smith by the employer throughout the year. Assume the following amounts are applicable for 20X1: foreign earned income exclusion limitation of $100,000 and standard deduction of $24,000 for a married couple. His actual and hypothetical 20X1 taxes under the tax equalization policy of his company are shown below: Hypothetical Actual Base salary $ 120,000 $ 120,000 Foreign allowances not subject to hypothetical tax — 12,000 Outside income 2,000 2,000 Hypothetical tax withheld (22,000) German taxes paid by employer on Smith’s behalf — 50,000 Less: foreign earned income exclusion — (100,000) Total income $ 122,000 $ 62,000 Less: standard deduction (24,000) (24,000) Taxable income $ 98,000 $ 38,000 Federal tax (joint filing assumed) $ 13,439 $ 8,360 State tax (3.07% of $122,000 income) 3,745 —a Local tax (3.0% of $120,000 wages) 3,600 —a Total $ 20,784 $ 8,360 Foreign tax credit — (7,920) Net tax payable $ 20,784 $ 440 By contrast, if Smith were not under equalization, but received the allowances shown above, he would be liable for all domestic and foreign taxes, as illustrated below:

Actual Base salary $ 120,000 Foreign allowances 12,000 Outside income 2,000 Gross income $134,000 Less: foreign earned income exclusion (100,000) Less: standard deduction (24,000) Taxable income $ 10,000 Tax $ 2,200 Foreign tax credit (1,760) Net US tax $ 440 Due to the exclusion, Smith owes very little US tax and no state or local tax. However, without equalization, he would have had to pay the German tax on his income, which would in almost every case be higher than his US liability would have been had he remained at home. a. An employee going on assignment for two years may be able to terminate state and local residency and therefore no longer be liable for tax, depending on the facts and circumstances of the individual. See discussion of state and local taxes.

26 2020 Tax Planning for US Individuals Living Abroad | Chapter 7: Tax Equalization Policies

Partial Equalization Policies Final Computations Foreign Tax Credits Some employers do not want to Under most equalization policies, the When an employee is subject to reimburse actual US or foreign tax on hypothetical tax withheld is not a final equalization, the employer generally an employee’s personal (non- determination of the employee’s tax pays the foreign taxes. Some portion company) income. Therefore, they obligation. After the employee’s tax of those taxes can frequently be apply equalization to company income return is prepared (often by an claimed as a credit on the US return. only, which is an alternative to full independent accounting firm so that Because the employee did not in fact equalization. Under this policy, the confidentiality is protected), a final pay the foreign taxes, he or she is not company withholds a hypothetical tax reconciliation is prepared. At that generally entitled to any benefit from on company income only, calculated as point, the employee receives or pays them in the hypothetical tax though the employee had no other any discrepancy between the calculation. income, and pays the US and foreign amounts owed and those already paid, tax only on that income. Outside just as he or she would have had an income, such as a spouse’s wages, actual refund or balance due on the interest and dividends, are excluded actual return if the employee had from the calculation, and the employee stayed in the US. is responsible for paying US and foreign taxes on this income.

27 2020 Tax Planning for US Individuals Living Abroad | Chapter 8: Payroll Taxes and Special Situations

Chapter 8: Payroll Taxes and Special Situations

Relief from Income Tax employer has no cause to believe that whether working in this country or Withholding the employee will not satisfy the abroad. While US taxpayers employed Generally, a US employer is required relevant test. The statement must, by foreign employers are usually not to withhold US income taxes from US according to IRS regulations, contain eligible for social security coverage, citizens and residents regardless of certain factual representations and special rules for US taxpayers where the services are performed. commitments and contain a employed by foreign affiliates of US However, a US employer is not declaration that the statement is corporations may provide for the required to withhold US income tax made under penalty of perjury (either employee to be covered by US social on foreign earned income under the Form 673 (see Appendix E) or the security. following circumstances: taxpayer’s own statement may be used). Self-employed individuals who reside 1. If the income is earned by a US abroad are subject to SECA taxes as Citizen in a foreign country or US US income tax withholding is required though they had remained in the possession and, under the law of to the extent that a taxpayer’s United States. US citizens working that country or US possession, compensation is not covered by any of abroad must compute their earnings the employer must withhold the above exceptions. This will from self-employment without respect foreign income taxes on that happen, for example, if the employee’s to any amount qualifying for the income. foreign earned income exceeds the foreign earned income exclusions. (US 2. To the extent that it may be allowable foreign income exclusion or taxpayers abroad who are not reasonably anticipated that the if he or she rendered services in the covered by social security and are not income will be excluded under United States. The total withholding for self-employed cannot cover the special foreign exclusion the year may be estimated and themselves for social security rules. withheld ratably throughout the year. purposes merely by paying SECA taxes.) 3. If the income was earned in In calculating the tax to be withheld, Puerto Rico and it is reasonable to the employee may take into FICA and SECA tax rates are split expect that the employee, who is a consideration anticipated deductions, between old-age, survivors, and US citizen, will be considered a such as interest, contributions, losses, disability insurance (OASDI or “Social bona fide resident of Puerto Rico as well as credits, such as the foreign Security”) and hospital insurance (HI or during the calendar year. tax credit. Determination of the tax to “Medicare”). The base for OASDI is 4. If it is reasonable to expect that at be withheld is made on Form W-4 adjusted annually for inflation and the least 80% of the remuneration Employee’s Withholding Certificate. HI base is unlimited. Accordingly, all paid to a US citizen during the wages will be subject to HI. The tax Social Security Taxes calendar year will be for services rates and limitations for the current The social security program is performed in a US possession. year are shown in Appendix A. financed primarily from taxes paid by (For this purpose, Puerto Rico is employers, employees, and the self- An additional Medicare tax of 0.9% is not considered a possession.) employed under the provisions of the imposed on employment wages for Under the second exception listed Federal Insurance Contributions Act certain higher-income taxpayers above, an employer may presume that (FICA) and the Self-Employment (income of more than $250,000 for an employee will meet the physical Contributions Act (SECA). A US citizen married couples filing jointly or presence or bona fide foreign or resident alien employed by a US surviving spouse, $125,000 for residence test if the employee submits employer is covered by social security married couples filing separately, and a statement to the employer and the and subject to social security tax, $200,000 for all other taxpayers).

28 2020 Tax Planning for US Individuals Living Abroad | Chapter 8: Payroll Taxes and Special Situations

Employers have an obligation to Totalization agreements are bilateral To obtain a US exemption, an withhold this additional tax for any agreements covering social security. employer or a self-employed employee whose wages exceed They have provisions that deal not individual must obtain specific $200,000, regardless of the filing only with the tax on employers and information from an authorized official status of that individual. An employees but also with the way an of the foreign country. A self- overpayment is reconciled on the employee who has worked in two employed individual must attach the actual tax return if the individual is countries can qualify for benefits. information to his or her US tax subject to additional Medicare These agreements: return; an employer must keep the withholding in excess of the correct information in its files. Foreign • Determine which country’s social threshold confirmed by the actual tax procedural rules about exemptions security tax applies in normal return filing status. For example, if too from foreign social security taxes must foreign assignments much additional Medicare tax was be reviewed. Some residual double withheld from the employee during • Determine where a person taxation may occur, depending on the year, the excess is credited back to qualifies for benefits when he or how the foreign social security the individual on their tax return. she has worked in both countries system works. Conversely, if a deficiency exists, an and paid tax to both social security additional payment is charged on the systems Unemployment Tax tax return to account for any shortfall. Generally, payments under the • Provide for a continuation of US Federal Unemployment Tax Act (FUTA) Additional Medicare applies only to social security coverage in some are required for US taxpayers working the employee, not to the employer. cases for a US employer outside the United However, as noted, the employer has • Provide administrative rules, such States. A US employer for FUTA an obligation to withhold amounts of as automatic applications for purposes, however, does not include excess Medicare tax from the foreign pensions when the US the US government or its employee’s wages. This tax applies for employee applies for social instrumentalities. Furthermore, any employee who is otherwise security services performed by a US taxpayer subject to US social security tax, for a US employer in Canada need not including nonresident aliens covered Totalization agreements let US be covered for FUTA purposes. There by the US social security program. employees who work overseas keep is no FUTA equivalent of the extension US social security coverage on most Employees on assignment in the of FICA coverage to employees of temporary foreign assignments United States who are exempt from foreign affiliates of American (usually less than five years long). But US social security tax due to a corporations. Therefore, while these they eliminate only dual coverage; totalization agreement between the companies are able to extend FICA United States and their home country they do not grant total exemptions coverage to their employees, they are are also exempt from this additional from social security. If an employee is not subject to FUTA coverage for the Medicare tax if a valid certificate of not subject to US coverage, he or she otherwise uncovered employees of cannot be exempt from foreign coverage is in place with the employer. their foreign affiliates. coverage under a totalization Totalization Agreements agreement. In fact, totalization Each state should be reviewed for The United States has entered into agreements go to some lengths to determining the application of the totalization agreements (social confirm that an employee will be State Unemployment Tax Act (SUTA). security treaties) with many countries covered by at least one system. Some states request that the (See Appendix F for a complete list) employer continue to contribute to its Totalization agreements usually apply that eliminate dual social security state unemployment fund if the only to pension or disability coverage, coverage and dual taxation for employee’s last US location was within individuals who work in the United not medical insurance. However, the that state. Other states require that States and in those foreign countries. foreign country often will exempt a US the employer contribute to that state’s Both the employer’s and the employee from medical coverage. This fund for all employees on foreign practice can make medical insurance employee’s contributions come within assignment if the company’s US for a foreign assignment worth a totalization agreement, when one headquarters are within that state. investigating applies. This requirement applies regardless of where the employee had been last

29 2020 Tax Planning for US Individuals Living Abroad | Chapter 8: Payroll Taxes and Special Situations

working or to which state the In the last case, the individual may be instruments or commodities; and (3) employer was contributing before the considered a resident if he or she net gain recognized on dispositions of employee took the assignment. retains an intent to return to the property. home state on completing an Qualified Retirement Plans assignment. Finally, some states tax The rules regarding the NII are A US citizen or resident who is an the gain on the sale of a residence detailed and complex. A taxpayer employee of a foreign subsidiary of a even if the seller is considered a should consult with a tax adviser US parent company may continue to resident abroad. Certain local specializing in this area if their income participate in most US employee jurisdictions may follow similar rules is higher than the above thresholds benefit plans. The contributions will with respect to determining residence. and the taxpayer would like to discuss not be taxable to the employee for US As each state has its own unique set planning opportunities regarding this tax purposes. of rules for determining residency, the tax. state residency position should be Estate and Gift Taxes reviewed on an individual basis prior Affordable Care Act US citizens and US resident aliens As part of the Patient Protection and to the start of the foreign assignment. living abroad are generally subject to Affordable Care Act (ACA), individuals estate and gift taxes under the same Net Investment Income Tax and their dependents are required to rules that apply to those living in the Certain US taxpayers may be subject maintain minimum essential United States and should therefore to an additional net investment healthcare coverage throughout the undertake estate planning to limit income tax (NII). The tax is in addition year. Failure to maintain coverage will potential tax consequences related to to regular federal income tax and result in a penalty known as a shared wealth transfer. US citizens married to intended to reach certain higher responsibility payment, which is non-US citizens should pay particular income taxpayers’ unearned income. calculated on the individual income attention to this area due to tax laws tax return. Medical insurance that severely limit the availability of For individuals subject to tax on NII, tax provided through a US employer will marital deductions when property is imposed at 3.8% on the lesser of: generally qualify as minimum essential passes to a non-citizen spouse. coverage. In addition, there are • the individual’s net investment specific exceptions from this income for the tax year, or In addition to US and state laws requirement for individuals residing affecting estates and gifts, foreign • the excess of the individual’s outside of the US or for gaps in the country laws imposing estate and gift Modified Adjusted Gross Income period of coverage of less than three taxes may affect US taxpayers residing over the threshold amount (the months. A taxpayer should consult there. Although the United States has MAGI threshold amount is with a tax adviser specializing in this concluded several treaties providing $250,000 for individuals filing a area for further details regarding the for relief from double taxation of joint return, $125,000 for married ACA healthcare requirements and estates and gifts (see Appendix F), in taxpayers filing a separate return exceptions. some cases, both US and foreign and $200,000 for all other estate taxes will apply. Double individuals). After December 31, 2018 there will be taxation can sometimes be avoided or no penalty imposed for failing to minimized by appropriate planning, Modified Adjusted Gross Income maintain minimum essential coverage. but tax and legal advisers should be (MAGI) generally means Adjusted consulted before any action is taken in Gross Income as adjusted (increased) Passive Foreign Investment this area. for the allocable amount of foreign Company earned income exclusion recognized A US individual who owns stock in a State and Local Taxes on the return. company classified as a passive An individual residing abroad may still foreign investment company (PFIC) be subject to state income taxes. Such An individual’s Net Investment Income may be subject to an interest charge liability can occur when the person includes three general categories of on “excess” distributions from the returns to work in that state on income: (1) gross income from company. In general, a foreign business trips, continues to maintain a interest, dividends, annuities, rents company is a PFIC if 75% or more of home in that state, or, under some and royalties; (2) income derived from its income consists of passive income state laws, is considered by the state a passive activity or a trade or or 50% or more of its assets produce to retain his or her residence there. business of trading financial passive income. An excess distribution

30 2020 Tax Planning for US Individuals Living Abroad | Chapter 8: Payroll Taxes and Special Situations

is, in general, the amount of deemed Non-U.S. Trusts and Additional Form 3520, Annual Return to Report distributions occurring during the US Reporting Requirements Transactions with Foreign Trusts and reporting period (generally the Under U.S. tax law, certain types of Receipt of Certain Foreign Gifts, is filed calendar-year) that exceeds 125% of foreign accounts or entities are annually by an owner of a non-U.S. the average amount of deemed classified as non-U.S. trusts. If a U.S. trust to report ownership of the trust. distributions on that stock in the citizen or resident is considered the In addition, the form must be filed by preceding three calendar years. It may beneficiary, trustee, or owner of one an individual for the year they make a be advantageous to make a special of these trusts, they may be required contribution or loan to a foreign trust, election to report the shareholder’s to file certain information reporting receive a distribution or loan from a current share of earnings to avoid the forms with respect to the trust. These foreign trust, or receive gifts over a interest charge and complexity information reporting forms are filed certain value from non-U.S. persons associated with excess distributions. separately from an individual’s or entities. The form must be filed by personal tax return and may have the due date, including any Further, distributions occurring within separate filing deadlines. Applicable extensions, of the individual’s tax the fund need not be paid or received penalties and interest may be due for return. to be taxable. Foreign mutual funds failure to file timely any required paying dividends automatically forms. In recent years the IRS has Form 3520-A, Annual Information reinvested are considered a increased scrutiny around timely and Return of Foreign Trust with a U.S. distribution and subject to tax under accurate filing of these forms, so care Owner, is filed annually by the trustee the PFIC regime, regardless of the should be taken to proactively identify of a foreign trust with a U.S. owner. In right to receive cash in lieu of the any applicable filing requirements for contrast to the Form 3520, the original automatic reinvest. A sale of a PFIC foreign accounts considered non-U.S. due date of the Form 3520-A is fund during US residency, in most trusts. generally March 15th for a calendar instances, is deemed an excess year trust. A six-month extension may distribution and also subject to tax A few common types of foreign be requested by March 15th to extend and interest under the PFIC excess accounts or entities that are classified the due date of the form. distribution regime. Additional as non-U.S. trusts are the Canadian considerations outside the US tax cost Tax-Free Savings Account (TFSA), associated with holding PFICs also Canadian Registered Education merit attention. The administrative Savings Plan (RESP), some family trusts burden of gathering the necessary and certain Superannuation funds, information for US compliance though many other accounts could reporting can be burdensome. The also be considered a non-US trust. non-US financial institution or entity Determination of what is classified as where the PFIC is maintained may not a non-U.S. trust should be made provide readily available access to the based on the full facts and specific fund information on a circumstances of each account or calendar-year basis. This burden is entity. It is possible for an entity to be amplified when multiple funds are classified as a trust for U.S. tax maintained in a single account purposes when it is classified because each require separate differently in the foreign jurisdiction. disclosure on the US return Classificiation under U.S. tax law will irrespective of whether tax may be drive the U.S. filing requirements, even assessed. if it is inconsistent with the requirements in the non-U.S. jurisdiction.

31 2020 Tax Planning for US Individuals Living Abroad | Appendix A: Key Figures

Appendix A: Key Figures

1. Standard deduction

Filing Status 2020

Single 12,400

Married filing jointly 24,800

Married filing separately 12,400

Head of household 18,650

2. Kiddie Tax

• For children under age 19 (or certain full-time students under age 24) with unearned income consisting solely of interest, dividends and capital gain distributions, the child’s income may be reported on the parent’s return using Form 8814, provided the child’s gross income is less than $11,000 in 2020.

• If the child files their own return, the first $1,100 of unearned income has no tax applied. The next $1,100 of unearned income it taxed at the child’s marginal rate. Unearned income in excess of $2,200 will be taxed according to the brackets applicable to trusts and estates.

3. Private Delivery Services

The following private delivery services are currently designated by the IRS, as of this publication:

• Federal Express (FedEx): FedEx First Overnight, FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2 Day, FedEx International First Next Flight Out, FedEx International Priority, FedEx International First, and FedEx International Economy; and

• United Parcel Service (UPS): UPS Next Day Air Early AM, UPS Next Day Air, UPS Next Day Air Saver, UPS 2nd Day Air, UPS 2nd Air A.M., UPS Worldwide Express Plus, and UPS Worldwide Express; and,

• DHL Express: DHL Express 9:00, DHL Express 10:30, DHL Express 12:00, DHL Express Worldwide, DHL Express Envelope, DHL Import Express 10:30, DHL Import Express 12:00, DHL Import Express Worldwide.

4. Estimated Tax Payments

Payment dates for 2020 are 15 April, 15 June, 15 September 2020 and 15 January 2021.

5. Foreign Earned Income Exclusion & Housing Cost Exclusion

• A qualifying taxpayer may elect to exclude foreign earned income up to $107,600 for 2020.

• The maximum housing expenses allowable are capped at 30 percent of the maximum foreign earned income exclusion limitation for 2020, $32,280 ($107,600 x 30%)).

• The base housing amount is calculated as 16 percent of the maximum foreign earned income exclusion discussed above. For 2020, the base housing amount is $17,216 ($107,600 x 16%) ($47.04 per day).

• As a result, the maximum 2018 housing exclusion allowable will be capped at $15,064 ($32,280– 17,216).

32 2020 Tax Planning for US Individuals Living Abroad | Appendix A: Key Figures

6. Income Bases for OASDI and HI 2020

Income Subject to OASDI Income Subject to HIC Tax Rate Maximuma Rate Maximum FICA (employee) 6.2% $8,537.40 1.45% Unlimited SECA (self-employed) 12.4% $17,074.80b 2.9% Unlimited

a. OASDI wage base = $137,700; $137,700 x 6.2% = $8,537.40; $137,700 x 12.4% = $17,074.80.

b. Self-employed taxpayers are allowed a deduction equal to one-half of their SECA tax liability when computing adjusted gross income.

c. Subject to additional 0.9% medicare tax on income in excess of predefined amounts.

An individual is liable for Additional Medicare Tax of 0.9% if the individual’s wages, compensation or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individuals filing status for 2020:

Filing Status Threshold Amount

Married filing Joint $250,000

Married filing separate $125,000

Single $200,000

Head of Household $200,000

33 2020 Tax Planning for US Individuals Living Abroad | Appendix B: Sample of the Increased Section 911 Housing Exclusions that have been published by the IRS

Appendix B: Sample of the Increased Section 911 Housing Exclusions that have been published by the IRS

The table below provides a sample of the increased section 911 housing exclusions that have been published by the IRS for the 2020 tax year. The IRS published Notice 2020-13 which listed over 100 locations in which increased housing exclusions are allowed. This notice also provides an option to apply these limitations to 2019 as well. We have provided a sample of cities around the world.

City Country 2020 Amount City Country 2020 Amount

Buenos Aires Argentina 56,500 Tel Aviv Israel 50,800

Sydney Australia 67,900 Rome Italy 46,200

Rio de Janeiro Brazil 35,100 Tokyo Japan 93,200

Montreal Canada 52,100 Mexico City Mexico 47,900

Beijing China 69,000 Amsterdam Netherlands 52,900

Paris France 69,400 Auckland New Zealand 35,700

Frankfurt Germany 35,500 Singapore Singapore 82,900

Hong Kong Hong Kong 114,300 Dubai UAE 57,174

New Delhi India 56,124 London U.K. 71,500

34 2020 Tax Planning for US Individuals Living Abroad | Appendix C: 2020 US Federal Rates

Appendix C: 2020 US Federal Rates

Single From To Amount Excess $0 $9,875 $0 10.00% 9,875 40,125 987.50 12.00% 40,125 85,525 4,617.50 22.00% 85,525 163,300 14,605.50 24.00% 163,300 207,350 33,271.50 32.00% 207,350 518,400 47,367.50 35.00% 518,400 156,235.50 37.00% Head of Household $0 $14,100 $0 10.00% 14,100 53,700 1,410.00 12.00% 53,700 85,500 6.162.00 22.00% 85,500 163,300 13,158.00 24.00% 163,300 207,350 31,830.00 32.00% 207,350 518,400 45,926.00 35.00% 518,400 154,793.50 37.00% Married Filing Joint $0 $19,750 $0 10.00% 19,750 80,250 1,975.00 12.00% 80,250 171,050 9,235.00 22.00% 171,050 326,600 29,211.00 24.00% 326,600 414,700 66,543.00 32.00% 414,700 622,050 94,735.00 35.00% 622,050 167,307.50 37.00% Married Filing Separate $0 $9,875 $0 10.00% 9,875 40,125 987.50 12.00% 40,125 85,525 4,617.50 22.00% 85,525 163,300 14,605.50 24.00% 163,300 207,350 33,271.50 32.00% 207,350 311,025 47,367.50 35.00% 311,025 83,653.75 37.00% Estates and Trusts $0 $2,600 $0 10.00% 2,600 9,450 260.00 24.00% 9,450 12,950 1,904.00 35.00% 12,950 3,129.00 37.00%

35 2020 Tax Planning for US Individuals Living Abroad | Appendix C: 2020 US Federal Rates

2020 Long Term Capital Gain and Qualified Dividends Rates for Taxpayers with taxable income in the specified ranges

Married Filing Joint $0 $80,000 0.00% 80,000 496,600 15.00% 496,600 20.00%

Married Filing Joint $0 $40,000 0.00% 40,000 248,300 15.00% 248,300 20.00%

Head of Household $0 $53,600 0.00% 53,600 469,050 15.00% 469,050 20.00%

Single $0 $40,000 0.00% 40,000 441,450 15.00% 441,450 20.00%

Estate and Trusts $0 $2,650 0.00% 2,650 13,150 15.00% 13,150 20.00%

Additional 3.8% tax imposed on the lesser of the individual’s net investment income or the excess of the individuals modified gross income over certain thresholds ($250,000 for married couples filing jointly or surviving spouse, $125,000 for married couples filing separately, and $200,000 for all other taxpayers).

36 2020 Tax Planning for US Individuals Living Abroad | Appendix D: Decisions Checklist

Appendix D: Decisions Checklist

Page

To obtain filing extensions, taxpayers outside the United States must file Form 4868 (an automatic four-month 2 extension) or Form 2350 (an extension based on expectation of qualifying for the exclusions) by 15 June.

Cash flow may be enhanced if the taxpayer files an initial return before qualifying for the foreign income exclusions 3 and subsequently claims them in an amended return.

Important exceptions to the US withholding tax requirements apply to expatriates. However, expatriates may be 3 required to make US estimated tax payments.

Foreign financial accounts create additional filing requirements. 4

The foreign earned income exclusion and the housing cost exclusion are each elective, and spouses filing joint returns 5 can compute the housing amount separately or jointly.

To qualify for the foreign earned income or housing cost exclusion, the taxpayer must have a foreign tax home (and 5 abode).

A taxpayer meets the bona fide residence test only if he or she has established a foreign residence for at least an entire 8 tax year.

The physical presence test may be more beneficial in the first and last years of a foreign assignment. 9

The foreign camp exclusion may prevent taxation on the value of meals and lodging provided by the employer. 11

Taxpayers receiving deferred income have options for purposes of the exclusions. But to qualify for the exclusions, the 12 foreign earned income must be received no later than the year after it is earned.

Under some circumstances, it may be advantageous for a taxpayer to maintain a US tax home and forgo the exclusion 12 in exchange for claiming “away from home” deductions for foreign business trips.

A taxpayer must review the tax consequences of any decision relating to his or her personal residence (for example, buying or renting a foreign residence, selling or renting the US residence, or converting the US residence to income- 15 producing investment property).

A taxpayer with significant foreign tax payments or with foreign tax credit carryovers may not want to elect one or both 20 of the foreign exclusions, so as to avoid or decrease the disallowance of the foreign tax credit.

Even after returning from a foreign assignment, a taxpayer may use foreign tax credit carryovers by increasing foreign 23 earnings and certain other forms of foreign-source income.

If foreign tax credits are claimed, either the cash or accrual method could prove more beneficial. 23

37 2020 Tax Planning for US Individuals Living Abroad | Appendix E: Forms and Statements Location Information

Appendix E: Forms and Statements Location Information

The current versions of all forms can be obtained from the IRS website:

http://www.irs.gov

38 2020 Tax Planning for US Individuals Living Abroad | Appendix F: US Income Tax, Estate Tax, and Social Security Treaties and Agreements

Appendix F: US Income Tax, Estate Tax, and Social Security Treaties and Agreements

Income Tax Treaties (as of February 2020) Armenia1 Iceland Philippines Australia India Poland Austria Indonesia Portugal Azerbaijan1 Ireland Romania Bangladesh Israel Russia Barbados Italy Slovak Republic Belarus1 Jamaica Slovenia Belgium Japan South Africa Bulgaria Kazakhstan Spain Canada Korea (Republic of) Sri Lanka China (People’s Republic of)2 Kyrgyzstan1 Sweden Cyprus Latvia Switzerland Czech Republic Lithuania Tajikistan1 Denmark Luxembourg Thailand Egypt Malta Trinidad and Tobago Estonia Mexico Tunisia Finland Moldova1 Turkey France Morocco Turkmenistan1 Georgia1 Netherlands Ukraine Germany New Zealand United Kingdom Greece Norway Uzbekistan1 Hungary Pakistan Venezuela

1 The Department of the Treasury announced that the income tax treaty with the Soviet Union will continue in effect for these countries until separate agreements are concluded and come into effect; this position was confirmed in the 2016 IRS Publication 901. However in practice the convention is not consistently applied between all countries. 2 The U.S.– China income tax treaty does not apply to Hong Kong.

39 2020 Tax Planning for US Individuals Living Abroad | Appendix F: US Income Tax, Estate Tax, and Social Security Treaties and Agreements

Estate Tax Treaties Australia Germany South Africa Austria Greece Switzerland Canada1 Ireland United Kingdom Denmark Italy Finland Japan France Netherlands

Social Security Agreements (Totalization Agreements) Australia Germany Norway Austria Greece Poland Belgium Hungary Portugal Brazil Iceland Slovak Republic Canada Ireland Slovenia Chile Italy Spain Czech Republic Japan Sweden Denmark Korea (Republic of) Switzerland Finland Luxembourg United Kingdom France Netherlands Uruguay

1 The United States and Canada do not have a separate estate tax treaty. However, provisions for taxes upon death are covered within the articles of the US-Canada Income Tax Treaty.

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