Let’s start with a definition of what an expat actually is.
An expat is someone who lives outside their native country. It’s somewhat similar to an immigrant with one big difference. An immigrant intends to stay in their new location. An expat may stay or may go back to their home country.
Some countries, like England, have a long history of citizens who live the expat lifestyle in other countries. This however, is a fairly new phenomenon for Americans. With the rising cost of living and especially the very high cost of medical care, more and more retirees are choosing to live their golden years outside the US.
And that leads to a big question regarding their US taxes. Simply put, do they still need to file and pay US taxes if they live outside the US?
The answer is that it depends on the income, if any, they make. If their only income is Social Security, they need to check whether their total income is below the current filing requirements. If below, they don’t need to file personal income tax returns.
However, they may still have filing requirements if they are an owner, signer or beneficiary of a foreign bank account or investment account. This also includes foreign cryptocurrency accounts. There are very stiff penalties for failure to file to disclose these accounts. The civil penalties are $10,000 or more, per occurrence and there can be criminal charges with penalties of 6 months or more in jail.
If the expat additionally has passive income, such as interest, dividends and capital gains and/or rental income from the US, they will likely need to file a US tax return.
Additionally, if the expat earns income, as contrasted to passive income which is not called “earned” by the IRS, they will also likely need to file a US tax return. However, there is a difference in the way these two different types of income are treated for tax purposes. The tax treatment depends on the type of income. Here are some examples.
Let’s start with Joe’s case. Joe has Social Security income, pension income, some portfolio income, and a rental house back in Arizona. He lives in Costa Rica.
He will need to file both a US tax return and an Arizona tax return. The Social Security income, pension income, and portfolio income will not be subject to Arizona income tax. However, the rental property income is subject to Arizona tax because there is Arizona nexus (connection) to Arizona for this income. He would file a non-resident Arizona income tax return and possibly pay Arizona tax on any net income from the rental.
Now let’s look at the case of Beverly. Beverly lives in northern Baja California, Mexico.
She has Social Security income and has found it’s not enough for her to live on. So, she has taken a part-time job in California (US). She commutes across the border on the days she works.
She will need to file a federal return and a California return to report the California income.
Finally let’s look at the case of Michael. Michael is also retired and like Beverly, found he needed to supplement his income. He has started an online business. Depending on the country in which he’s now living, he may decide to declare that income from the online business as income within his new home country. Or, he may decide that it is income inside the US. Or, he may set up a corporation in still another country that has no income tax in order to run his online business.
Each of those scenarios would have a different tax implication. For example, if he has the online business set up in his new home country and he pays taxes there, the income may still need to be reported to the US and he would pay tax on it. He would get a credit for the tax paid to the foreign government. Or, it’s possible that the income would not be taxable in the US. It would depend on the foreign country’s tax treaty with the US, the type of income earned by the company, the location of the sales from the company, and that entity type in the foreign country. And, he may qualify for the FEIE (foreign earned income exclusion) for US income.
Since every case is different, expats with businesses need to talk to a qualified tax expert. I am on a few online forums, such as Facebook, expats. And frankly, I’m appalled at the incorrect and sometimes down right horrible advice given in these groups.
In the interest of saving some money on consultations with true experts, expats are risking thousands of dollars in excess tax and even more thousands of dollars in penalties and interest because they don’t want to pay for advice from a qualified professional. Yikes!
The biggest risk of all is assuming you are invisible. You’re not. In fact, the new number one focus of IRS audits now is on foreign income and non-reporting of income in these cases. If you’re concerned that you’re not compliant now with the tax law and haven’t been for several years, there are amnesty programs available. However, if they catch you first, all hope of amnesty is gone. You have to come through voluntarily and in the proper way. And you need to do it before they catch you.
Once you get a notice from the IRS or state, your chances for a negotiation diminish severely.
You don’t need to hire me for the consultation. In fact, I am definitely one of the more expensive choices. That’s because this is what I do. It’s not a sideline to a regular business. It IS my business.
I have years of experience doing it and connections that help us make it work more efficiently for our clients. But whether it’s me, my firm or someone else you hire, please make sure you are talking to a qualified expert and not just some random person you meet online.
If you’d like to find it out more information about what we do, you can Contact Us.