If you’re a US citizen working abroad as an expat and you’re paying taxes in a foreign country, you shouldn’t have to pay taxes to the US, right? Yup, you’re right, for the most part, but you still have to file your US taxes and file them correctly!
Avoiding double income tax
It just doesn’t seem fair to have to pay taxes twice on your money, and the US tax code has some rules for helping you out. Generally for individuals, you can either take a Foreign Tax Credit or a Foreign Earned Income Exclusion, but you can’t take both!
I’m currently living in the Manila right now with my wife and we will both soon have to pay taxes for 2017. I don’t have any foreign income, but my wife is a teacher here and she will have to file her US taxes and report her foreign income.
Foreign Tax Credit
A Foreign Tax Credit is a credit on your US taxes for taxes paid to a foreign country. You must fill out Form 1116 to calculate receive this credit.
Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion only is applicable to Earned Income. That’s basically when you work for your money rather than passively earning money through investments. The amount changes a bit year to year but for 2017 you can exclude up to $102,100. You must fill out Form 2555 or 2555-EZ for this exclusion. Also you must meet ONE of the following requirement for living abroad:
- Bona Fide Residence Test – You have living abroad for an entire tax year
- Physical Presence Test – Within a consecutive 12 month period overlapping the tax year in question, you have lived aboard for 330 days.
Foreign Tax Credit vs Foreign Earned Income Exclusion
So if you can’t choose both, which do you choose? With everything about our absurdly overly complicated tax code, it depends. Generally speaking if you paying more taxes in the foreign country, then the Foreign Tax Credit is better. If you’re able to take both possibly, run through both forms and see which one gives you the better tax break. That’s the fun part to me trying to find a way I can get a few hundred dollars more in savings.