Which IRS forms are needed to claim Tax Deductions & Tax Credits? For Tax Deductions, you can claim the Standard Deduction on Form 1040. But if you want to Itemize your Tax Deductions, you must fill out Form 1040 and Schedule A. Claiming Tax Credits requires you to complete Form 1040. Understanding the double tax treaty between the United States and the United Kingdom is essential to ensure you do not pay twice. You will most likely benefit from a US tax credit for the UK tax. Foreigners in the United States must ensure they have a tax identification number, also called an ITIN. It will be necessary for Americans living abroad to understand the nuances of Foreign Earned Income Exclusion (FEIE) vs Foreign Tax Credit (FTC). What are the basics of Tax Deductions & Tax Credits? As UK/US tax specialists, we appreciate that understanding the basics of Tax Deductions and Tax Credits can be time-consuming and challenging. There are different reasons to apply for Tax Deductions compared to Tax Credits, and it is essential to get the right tax advice before proceeding with either tax-reducing strategy. A tax Deduction can only lower your taxable income and the tax rate used to calculate your tax. This can result in a larger refund of your withholding. A Tax Deduction reduces the income you pay taxes on, so you pay less in taxes. You subtract Tax Deductions from your income before calculating how much tax you owe. How much a deduction saves you depends on your actual tax bracket. To calculate how much a deduction could reduce your tax bill, multiply the deduction amount by your tax rate. For example, if a deduction is worth $5,000 and you are in the 10% tax bracket, the deduction would reduce your taxes by $500. You can benefit from a Tax Deduction if you pay a higher tax rate. If you take a $5,000 deduction but are in the 35% tax bracket, that would equal a £1,750 tax saving. Tax Deductions lower a person’s tax liability by reducing their taxable income. Because a deduction lowers your taxable income, it reduces the amount of tax you owe by decreasing your taxable income, not by directly lowering your tax. Some consider tax Credits to be better than Tax Deductions because they directly reduce the amount owed. The effect of a Tax Deduction on your tax liability depends on your tax rate. A Tax Credit reduces your tax, giving a larger refund of your withholding. Certain Tax Credits can provide a refund even if you have no withholding. A Tax Credit is a dollar-for-dollar reduction in the amount of income tax you owe. If you qualify for a $1,000 Tax Credit and owe $5,000 in taxes, that credit will reduce your tax bill to £4,000. A Tax Credit can be non-refundable or refundable. The IRS has also provided clear guidance on Tax Deductions & Tax Credits is worth reviewing. What are the benefits of Tax Deductions? Tax Deductions are designed to offset the amount of income you’ll pay tax on by writing off expenses like tuition and healthcare, contributions to retirement and any self-employed or capital gains losses you incur. Claiming a Tax Deduction ensures you don’t pay tax on certain income you’ve already spent, invested or lost. Many US taxpayers claim a Standard Deduction as outlined above as it can be simpler than individually itemizing all of their deductions. How much you can deduct using this method depends on your tax filing status and age. If you pay interest on a qualified student loan, you may be eligible to deduct up to $2,500 on student loan interest. Qualified medical and dental costs are tax-deductible if they exceed a set percentage of gross income. You may be allowed to deduct state, local and foreign income taxes. If you pay taxes for the property, that may be deductible. They may also be tax-deductible if you pay mortgage insurance premiums or interest on a mortgage. Contributions to a traditional 401 (k) or an IRA are often eligible for deductions. If you have a high-deductible health plan and contribute to an HSA in conjunction with that plan, your HSA contributions are usually tax-deductible. What are the benefits of Tax Credits? In addition to reducing the amount you pay in tax or increasing a refund amount, some Tax Credits can be claimed even if you have no tax liability. Common Tax Credits include: Earned Income Tax Credit (EITC) is a refundable Tax Credit for those working and earning a low to moderate income. Be aware that claiming this credit could delay any tax refund you are owed because federal law requires the IRS to hold the refunds of anyone who claims this credit until mid-February. Lifetime learning credit – depending on your gross income, you may get a credit of up to $2,000 for qualified tuition and education-related expenses for yourself, a spouse or a dependent. Saver’s tax credit helps individuals who meet adjusted gross income requirements save for retirement. Residential energy-efficient property credit – as a homeowner, if you are investing in making your home more energy-efficient, you may be able to deduct those investments. What is the Foreign Earned Income Exclusion (FEIE)? You may read this article as you complete a 1040 expat tax return and wish to submit it to the IRS in the United States. Remember, for an expat to complete a 1040 return, they will need a Social Security Number (SSN) or an Individual Tax Identification Number (ITIN) The Foreign Earned Income Exclusion (FEIE) is an Expat Tax benefit allowing qualifying expats to exclude up to $107,600 from their taxable US income. Expats 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 expats reduce or completely mitigate their US tax liability. It is also possible to exclude specific housing expenses such as rent and utilities 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 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 days. 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 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. If you – 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 from your income and have $30,800 left. You can only offset the taxes paid on that remaining income. – Cannot claim the total 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 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.
