Filing U.S. Taxes from Abroad: FTC vs. FEIE (+ Promo Rate with TieTax)
February 12, 2023
International School employers often promote overseas postings with the promise of ‘tax-free’ income. For U.S. teachers working abroad, this can be a bit deceptive. U.S. international school teachers are required to file a tax return reporting all income from all sources if the taxpayer’s income exceeds the filing threshold. However, the Foreign Earned Income Exclusion and the Foreign Tax Credit help to avoid double taxation and in many cases may result in no tax being due when filing your U.S. tax return.
The Foreign Earned Income Exclusion or FEIE allows the taxpayer to exclude up to a given amount of earned income from income taxes; however, there are a few items to keep in mind. First, this only applies to earned income – the income you earn from your job as an employee or the income you generate from self-employment while living abroad. Second, this only applies to income tax. If you owe Social Security taxes on self-employment income, you must still pay that. Social Security or self-employment tax cannot be excluded using either the FEIE or form 1116 the Foreign Tax Credit.
To claim the FEIE you must first qualify as an overseas resident. This means that either you were in the United States for no more than 35 days during any 365-day period or qualify as a bona fide overseas resident. Assuming you meet one of these requirements, you must then calculate the portion of the exclusion for which you qualify. If you were an overseas resident or a bona fide resident for the entire tax year, you qualify for the entire amount. If you moved overseas during the tax year or moved back to the United States during the tax year then you qualify for a percentage based on your qualifying days of overseas residency. Form 2555 accurately completed and included with a timely filed tax return allows the taxpayer to claim the FEIE.
The Foreign Tax Credit provides another means of avoiding double taxation. This credit allows you to apply income taxes paid to your host country against the income tax owed to the United States on the same income. This requires the filing of form 1116 with your annual tax return. Again, this only applies to income tax and this credit can only be applied to income earned while you were physically present overseas. If you work for a foreign company while residing in the United States, the Foreign Tax Credit is not permitted.
If your income exceeds the FEIE and you pay income tax to your host country, you may be able to apply any taxes allocable to the difference to your US tax bill by using Form 1116 in addition to the FEIE. For example, if you earned $150K with an FEIE allowance of 108,700 that would leave $30,700 of taxable income. The income tax paid to your host country on that $30,700.00 could be applied to your US tax obligations on a pro-rata basis.
While at first glance it may seem better to utilize the FEIE, especially if your income falls below the exclusion limit, there are times when the FTC may prove more advantageous. Using the FEIE automatically excludes you from certain child tax credits. Also, by exempting all of your earned income you become ineligible for IRA/Roth contributions. There may be state considerations as well with one method or the other so a holistic view is needed.
The important thing to remember is that once you stop using the FEIE you must wait 5 tax years before you are eligible to use it again. You cannot switch back and forth each year. Working with a tax preparer who is experienced in helping US expats will enable you to make the decision that is best for you right now and help you to determine if and when a change may be beneficial.
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