If you’re living abroad or even taking an extended trip and still working, your tax return may be a little more complicated. Here’s how to navigate filing your taxes while overseas.
When I moved to Germany a few years ago, taxes weren’t on my mind: I’m planning to move back to the States eventually, I freelance for U.S. companies, and I’m not trying to get any benefits from the German government, so why wouldn’t I just continue paying taxes as normal?
As is typical of taxes, it’s not that simple.
According to the German accountant I spoke with, any work I’m doing while physically in Germany is subject to German taxes—even if the work I’m doing is for American companies.
One of the biggest problems the IRS encounters with U.S. citizens living abroad is they don’t realize that they have to file a tax return—even if they’re filing a return and paying taxes in another country. (For expatriates, different rules apply.)
While this doesn’t necessarily mean you’ll be paying double, it does mean you’ll need to do double the filing. The good news is you’re allowed an automatic two-month extension from the regular due date of your return.
And while nothing beats going to a expert to help you retain the most cash and make sense of all the tax speak, there are a few steps you can take on your own to ensure that you’re setting yourself up for an easier tax season.
Take the Bona Fide Residence or Physical Presence Test
There are two ways to determine if you qualify for exclusions and deductions when living and working abroad.
The first is the bona fide residence test. It’s a little bit of a gray area: You’ve established a residence in a foreign country, though you may have a home in the states you intend to return to after an indefinite work assignment is complete. Brief trips to the U.S. are OK as long as you intend to return to your foreign residence. And you must reside abroad for an entire tax year (January 1 through December 31).
The physical presence test is a bit more straightforward: You meet this test if you are physically present in a foreign country or countries for 330 days over 12 consecutive months. This applies if you’re on vacation for 330 days or more outside the U.S.
Keep Tabs on the Exchange Rate
If you earn all or part of your income in a foreign currency, or even pay some of your expenses in something other than U.S. dollars, you must convert these amounts when filing your tax return. The IRS “accepts any posted exchange rate that is used consistently.” Taxpayers often use a yearly average exchange rate for regular income, though having proof of the exchange rate on days you receive payments may help maximize your return (or minimize your payments).
Decide on Exclusion or Credit
The Foreign Earned Income Exclusion allows you, if qualified, to exclude some of your foreign earnings from your income. The amount is adjusted annually. If you pay taxes to a foreign country, you can choose the Foreign Tax Credit, which reduces your U.S. tax liability on that same income.
You must choose one or the other, and though you may change your mind in a subsequent tax year, if you do so more than once within five tax years things get complicated.
Contact IRS Customer Service
While the IRS shut down the last of its overseas taxpayer assistance centers once attached to embassies and consulates, its International Taxpayer Service Call Center can answer your specific questions. Unhelpfully, its number is not toll free and operates on East Coast hours (though the hours are, thankfully, long).
Armed with some background knowledge, you can ask your accountant the right questions to ensure you’re making choices that will set you up for financial success both in your current tax year and subsequent ones, too.
Kate Sitarz is a freelance writer living in Germany. Her work has been featured on Yahoo Travel!, The Huffington Post, and USAToday, among other outlets.
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