Election Day often brings out the wanderlust in people dissatisfied with the results; the 2020 election is no different. After a tough year, Americans are once again looking into living abroad.
There are currently 9 million U.S. expats living all over the world, a number that stands to grow after this election season as online searches on expat life surge 300 percent above the average. With rising coronavirus numbers in the U.S., combined with the new flexibility offered by remote work, Americans are more inclined than ever to give expat life a try.
While living abroad brings a new lifestyle and a rush of opportunities, it’s important to do the proper research, and consider the logistics and the tax consequences of living abroad, according to Katelyn Minott, a CPA, managing partner of Bright!Tax and currently a resident of Rio de Janeiro.
“The pandemic has created a situation in which many are finding they can work from wherever their computer might be,” she said. “And it’s created a global business environment that allows people to travel and follow their heart’s desire to live abroad. But beyond the lifestyle implications of a move abroad, there are financial and tax considerations of a move that many don’t plan for before they pull the trigger on moving.”
The most common misunderstanding is the idea that you don’t have to file a tax return from abroad, according to Minott. “Many who live abroad assume that leaving the U.S. and living outside its jurisdiction means no tax returns,” she said. “But once they have the basic understanding that U.S. taxes are going to follow them wherever they may be, there are certain mechanisms to reduce and often eliminate U.S. tax. It’s also important to consider that the new country may also have local tax requirements that need to be met.”
Many of the countries that are attractive to those looking to relocate have little to no tax, making for significant tax savings overall, Minott observed: “Someone in the British Virgin Islands or the Cayman Islands will be able to take advantage of the low taxes to achieve overall tax savings.”
There is quite a bit of recordkeeping involved in properly preparing a U.S. tax return, Minott indicated. “For example, one of the mechanisms utilized to lower U.S. taxable income is the requirement that the taxpayer report their travel to and from the U.S. each year,” she said. “There are a couple of ways to qualify for the foreign earned income exclusion. One involves being absent from the U.S. for 330 days during the year. It’s important to keep track of travel, foreign housing expenses, and income earned stateside versus offshore."
A big issue, with possible extremely negative unexpected consequences, is the obligation to report the maximum account balance held in foreign bank and financial accounts to the Treasury Department. The report is made on a Report of Foreign Bank and Financial Accounts, or FBAR, on FinCEN Form 114. A United States “person,” including a citizen, resident, corporation, partnership, limited liability company, trust and estate must file an FBAR.
“There are big penalties for failure to do this,” said Minott. "The penalties start at $10,000. There’s no reason to miss filing — it’s just a disclosure, it doesn’t yield a tax liability.”
State residency is an issue that needs to be carefully examined, according to Minott. “Every U.S. state has different rules surrounding what would be a tax residence,” she said. “Some, like California and New York, make it very challenging to break state residency when you’re moving abroad.”
“As a result, many taxpayers choose to relocate to a different U.S. state before moving abroad,” she said. “Many taxpayers relocate to a non-income-tax state prior to relocation abroad. Texas and Florida are the most popular as interim relocation states.”
Not every taxpayer moves to a low or no-tax jurisdiction such as the British Virgin Islands or the Caymans, Minott observed. “Many taxpayers find themselves moving to countries where they do, in fact, have a tax obligation. In those circumstances where they do have a foreign tax obligation, there are also mechanisms to reduce U.S. tax, based on the foreign tax they already paid. More often than not, they won’t be in a double-tax situation thanks to the foreign earned income exclusion, foreign tax credit or a tax treaty in effect with their country of residency.”
But for the many freelancers that are taking advantage of the ability to work from anywhere, the self-employment tax does not go away, Minott cautioned. “Unless the country has a totalization agreement with the U.S., the U.S. taxpayer will continue to pay self-employment tax to the IRS,” she said.
“Many taxpayers choose to set up a business in their new country,” Minott remarked. “This can generate a number of international disclosure requirements with the IRS. Holding a foreign corporation or a partnership interest can create a complex filing situation on the U.S. side. It’s vital that the expat understand the implications of those business interests prior to incorporating or setting up a foreign entity."
