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Although not an accountant, the writer has regularly assisted parties during matrimonial proceedings where these issues have had to be dealt with. The United States is one of the few countries that imposes taxes on its citizens regardless of where they reside, indeed the IRS can be quite relentless in pursuing expats. The issue of taxation for US nationals living overseas is a multifaceted and often perplexing topic.
Citizenship-Based Taxation: The United States employs a citizenship-based taxation system, which means that US citizens are required to file tax returns and potentially pay taxes on their global income, regardless of where they live. This is in stark contrast to the majority of countries that use a residency-based system, taxing individuals only on income earned within their borders.
Foreign Earned Income Exclusion (FEIE): Whilst the IRS allows expatriates to exclude a certain amount of foreign-earned income (up to $120,000 as of 2023) from US taxation through the Foreign Earned Income Exclusion, many expatriates find that they still owe taxes on income that exceeds this threshold. Additionally, certain types of income, such as investment income, may not qualify for exclusion.
Foreign Tax Credit (FTC): To alleviate double taxation, expatriates can claim a Foreign Tax Credit for taxes paid to foreign governments. However, the complexities of calculating eligible foreign taxes and understanding the nuances of tax treaties can be overwhelming, leading to potential errors in filings with specialist advice often being required.
Filing Requirements: US citizens living abroad must file annual tax returns and, in many cases, additional forms such as the Foreign Bank Account Report (FBAR) if they have foreign bank accounts exceeding $10,000. The plethora of forms and the constant updates to tax laws can create confusion. Many expatriates either miss deadlines or fail to file the correct documents, leading to penalties and potentially substantial interest. In naturally makes sense that any tax return and other forms i.e. the FBAR are completed at the same time.
Banking Difficulties: Many banks outside the US are reluctant to handle accounts for US citizens due to the compliance burdens imposed by the Foreign Account Tax Compliance Act (FATCA). This law requires foreign financial institutions to report information about accounts held by US nationals, causing some banks to refuse service to US citizens altogether. As a result, expatriates (depending on the country they are living in) may face difficulties in accessing banking services, which can complicate their financial lives.
Retirement Accounts: US citizens living abroad often find it challenging to manage their retirement accounts. For instance, contributions to US retirement accounts like a 401(k) or IRA may not be feasible if they are working for a foreign employer onsite who are likely to have their domestic pension arrangements. Additionally, the tax implications of withdrawing funds from these accounts while living abroad can be difficult to navigate, leading to unexpected tax liabilities. In the event of a separation/divorce if the parties residing abroad are dividing a US based retirement account then often they will be required to obtain a mirror order in the US to give effect to the agreement/order from a third country.
Social Security and Healthcare: Expatriates may also encounter challenges concerning Social Security benefits. While US citizens are entitled to Social Security benefits based on their contributions, the complexities of working abroad can complicate eligibility and benefit calculations. Moreover, expatriates often have to navigate foreign healthcare systems, which may not align with US insurance coverage, leaving them vulnerable to unexpected medical expenses.
Taxation of Foreign Investments: US citizens are generally required to report and pay taxes on foreign investments, such as property or business interests. The IRS has specific rules regarding foreign investments, and failure to comply can lead to severe penalties. Moreover, expatriates may face complications in understanding the tax implications of selling or renting foreign properties. It is very important that they seek suitably qualified advice if they wish to do this.
Legal and Cultural Barriers: Navigating the tax laws of a foreign country can be daunting, especially when cultural differences and language barriers come into play. Expatriates may not fully understand the tax obligations in their host countries, leading to unintentional non-compliance and potential legal repercussions.
The strict taxation arrangements for US nationals living outside of the United States stem from a combination of historical precedent, legislative choices, and the desire to ensure compliance among citizens regardless of their location. While the Foreign Earned Income Exclusion and Foreign Tax Credit provide some relief, the complexities of the US tax system create numerous challenges for expatriates. From filing requirements to banking issues and the management of retirement accounts, US citizens abroad must navigate a labyrinth of regulations that can lead to significant stress and financial implications. As such, it is essential for expatriates to seek professional tax advice to ensure compliance and optimise their financial situations while living overseas.
Aziz Malik has considerable experience in helping clients navigate these issues during matrimonial proceedings or putting people in touch with suitably qualified experts to help clients navigates this complex area.
To discuss any of the above further, please contact Aziz: azizmalik@bexleybeaumont.com | 07966 375115
