The frequently asked questions about British Expats living and paying tax in the United States
As property accountants, we are regularly asked about British Expat Tax in the United States. We will look to answer the below questions in this Article.
“Are you paying too much Expat Tax?”
“What are the basics of Expat Tax?”
“Who has to pay Expat Tax?”
“When do I have to pay Expat Tax?”
“What is the Foreign Earned Income Exclusion (FEIE)?”
“How can I use the Foreign Tax Credit allowance?”
“Can I use a tax treaty to prevent double taxation in the US?”
“Must ex-pats declare rental income on a US tax return?”
“When am I considered a US resident for tax purposes?”
“Does living abroad mitigate US taxes?”
“How can I avoid paying Expat Tax?”
“How does this affect our UK readers?”
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Are you paying too much British Expat Tax in the United States?
As US/UK Expat Tax experts, we know that many of our clients find the subject of ex-pat taxes complex and confusing.
It is an area that can be further complicated when property investment in the US is included.
There are many reasons why British people living in the United States pay far more Expat Tax than they need to. This is because:
-They do not know what they do not know.
-They have not spoken to a tax specialist that knows all the UK and US tax laws.
-Their accountants in the UK are not knowledgeable when it comes to the US tax laws under the IRS.
-Their CPAs are not knowledgeable when it comes to the UK tax laws under HMRC.
Have a question about property investments, tax or being an expat?
There are a number of free events that will help you build investments/businesses with more comfort and move forwards with confidence.
What are the basics of Expat Tax for Brits living in the US?
As UK/US Expat Tax experts, we help 100s of monthly-retained clients reduce or mitigate Expat Tax in the US.
We also help ex-pats with property investment interests in the US to reduce their tax liability in the US.
An expatriate is an individual living and/or working in a country other than their country of citizenship.
This can be temporary and is often for work purposes.
An ex-pat can also be an individual who has given up citizenship in their home country to become a citizen of another.
Once classified as an ex-pat, you will be taxed only on US-based income.
This could include property investment income or stock revenue that is based in the US.
To meet the Physical Presence Test, you must be able to demonstrate to the IRS that you have been physically present in the US for 330 days or more during a 12-month period.
US citizens and resident aliens are subject to income tax on worldwide income.
If you are a US citizen or resident alien the rules set down by the IRS for filing income are generally the same whether you are in the US or abroad.
Your worldwide income is subject to US income tax, regardless of where you reside.
The Federal Earned Income Exclusion (FEIE) allows qualified taxpayers to exclude from taxable income up to $107,600 of earned income. More is written about FEIE in this article below.
The IRS has provided useful inputs on US citizens and resident aliens abroad which is worth reviewing.
Do British Expats have to pay US tax to the IRS?
British expats must pay US tax if they have income, received certain credits, or other specific situations apply.
If your worldwide income exceeds the filing threshold which varies by filing status, you must file an annual tax return to the IRS.
Income is included as wages or salary, interest, dividends and rental income.
If you are self-employed and filing as a single person, the taxable threshold is $12,400, regardless of filing status.
Other situations such as owing special taxes may lead to a requirement to file accounts.
Most ex-pats do not pay US Expat Tax because of the Foreign Earned Income Exclusion and Foreign Tax Credit benefits.
Ex-pats with gross worldwide income over the filing threshold will still need to files taxes annually.
In this situation even if you do not owe any tax to the IRS, you may still need to file.
Foreign income for ex-pats normally includes their ex-pat salary, meaning income earned as an employee abroad.
The income filing threshold is based on the standard deduction of each tax filing status as determined by the IRS.
The IRS has published a helpful guide to frequently asked questions about international individual tax matters that provides useful insight and information.
When do I have to pay British Expat Tax to the IRS in the United States?
A US citizen or resident alien residing overseas are allowed an automatic two-month extension to file a tax return and pay any amount due, without requesting an extension.
For a calendar year tax return, the automatic two-month extension is to 15 June.
If you qualify for the two-month extension but are unable to file a tax return to the IRS by the automatic extension date, you can request an additional extension to 15 October by filing a Form 4868 before the automatic two-month extension date.
If you are allowed extensions to 15 June and/or 15 October, you will owe interest on any unpaid tax from the original due date of the tax return.
Outline your filing requirements so you can meet them, including filing the FBAR to report foreign bank accounts, filing a state tax return in the US if required to do so, or filing a tax return for your business.
If you’re behind on ex-pat taxes, make arrangements as soon as possible to get up-to-date.
Once you know the filing requirements, handling ex-pat taxes becomes much easier.
What is the Foreign Earned Income Exclusion (FEIE)?
The Foreign Earned Income Exclusion (FEIE) is an Expat Tax benefit allowing qualifying ex-pats to exclude up to $107,600 from their taxable US income.
Ex-pats should use the FEIE if they pay low to no income tax in their host countries.
Income earned in the US is not classified as foreign earned income, and cannot be excluded from US taxation using the FEIE.
If you are required to pay taxes on that income in another country, you could be eligible to use the Foreign Tax Credit as a dollar-for-dollar credit to offset US taxes owed.
The FEIE is the most common way ex-pats reduce or completely mitigate their US tax liability.
It is also possible to exclude specific housing expenses such as rent and utilities by using the FEIE.
Once you elect to use the FEIE it remains in effect and you will need to include it on your annual tax return every year thereafter.
Should you decide that you no longer want to use it, you cannot claim the exclusion for five years without IRS approval.
The Physical Presence Test requires that you are physically present inside a foreign country for 330 of any 365-day period.
You must have lived overseas for one calendar year and have no intention of moving back to the US to qualify under the Bona Fide Residency Test.
Those on temporary assignments and temporary overseas contractors won’t qualify.
How can I use the Foreign Tax Credit allowance?
If you live in a high-taxation country or your income exceeds the FEIE, the Foreign Tax Credit allowance may help to offset or mitigate your US tax liability.
The Foreign Tax Credit is a dollar-for-dollar credit on the taxes paid in a foreign country.
You must file Form 1116 to elect it.
Some taxpayers are eligible to utilise both the Foreign Tax Credit and FEIE.
– claim the child tax credit, choosing the Foreign Tax Credit over the FEIE will often yield better tax savings.
– exclude some of your income using the FEIE you cannot use the Foreign Tax Credit on that excluded income.
– exclude $107,600 of your income and have $30,800 left you can only offset the taxes paid on that remaining income.
– are not able to claim the full amount of foreign income taxes paid or accrued, these can be carried over for the next 10 years.
Can I use a British tax treaty to prevent double taxation in the US?
Income tax treaties help to prevent double taxation for Americans living in foreign countries by reducing or mitigating US taxes on certain types of income.
The US currently has tax treaties in place with 68 countries.
Tax breaks vary greatly country-to-country.
Ex-pats need to review the treaty with their host country to find out more about how they will be taxed.
Tax treaties can be complex legal documents to understand.
Must British ex-pats declare rental income on a US tax return?
British ex-pats must report all rental income (both foreign and domestic) to the IRS.
The good news is that many expenses related to the property can offset ex-pat tax liability.
Repairs carried out on an investment property are tax-deductible, but property improvements are more complex.
Repairs are classified as restoring the property to its original state, whilst improvements are deemed to increase the value of the property.
For tax purposes, we recommend that you keep records of both repairs and improvements to your rental property in the US.
Repairs can be included as tax deductions.
Property improvements will have an impact on how you calculate capital gains or losses on your ex-pat taxes after the property is sold.
When am I considered a US resident for tax purposes?
A British ex-pat will be considered a US resident for tax purposes when meeting the Substantial Presence Test.
To meet this, you must be physically present in the US on at least 31 days during the current year, 183 days during the three-year period that includes the current year and the two years immediately before that.
Does living abroad mitigate US taxes?
If you qualify as an American citizen living abroad there are two methods by which you can reduce your US tax by a significant amount. These are the FEIE and Foreign Tax Credit already discussed n this Article.
You will need to demonstrate to the IRS that you have lived for at least one year abroad.
Neither the FEIE nor Foreign Tax Credit means you cannot file if your income is above the filing threshold.
Whether or not an ex-pat needs to file a state tax return largely depends on whether they intend to return.
Every US state has different rules regarding domicile and permanent place of residency.
These rules need to be factored into whether you will be considered a resident and need to therefore file.
If your income was taxed by a foreign country you can subtract that tax from your US tax to substantially reduce your US tax bill by using IRS Form 1116 and applying for Foreign Tax Credit.
However, you can only claim a Foreign Tax Credit for foreign taxes on the same income that the US is taxing.
How can I avoid paying Expat Tax?
Most American ex-pats don’t owe US taxes, because as highlighted in this Article the IRS has put in place important deductions, exclusions and credits in place to ensure double taxation on the same income doesn’t occur.
Most ex-pats can offset all of their foreign earned income with the FEIE and Foreign Tax Credit.
Some frustrated ex-pats may consider renouncing their citizenship to avoid the burden of filing US taxes.
Be aware that before doing this, the IRS will require you to prove compliance on all US taxes for the five years before the date of renunciation.
Depending on your income and net worth, you might also be liable to an exit tax from the IRS.
You may be interested in services where we help Americans move to the UK with tax in mind. There are a number of legal matters and tax issues that you need to consider. We have also written a useful article about people moving from the US to the UK and getting a VISA.