The “One Big Beautiful Bill Act” (OBBBA), signed into law on July 4, 2025, is the most sweeping U.S. tax overhaul since 2017. 

While it extends many Tax Cuts, it also introduces new provisions that affect inbound and outbound expatriates. 

Below we summarize key changes and considerations, including new deductions, changes to foreign earned income provisions, reporting obligations, and residency rules.

New Deductions Or Changes For Foreign Nationals Moving To The U.S. (Inbound Expats)

Moving Expense Deduction

Unfortunately for new U.S. residents, OBBBA permanently disallows the moving expense deduction (and the exclusion for employer-paid moving reimbursements) for non-military taxpayers. 

This means foreign nationals relocating for work can no longer deduct their moving costs (which had been suspended under TCJA and now will not return). 

In practice, inbound employees should negotiate tax gross-ups on moving packages, since moving benefits are fully taxable. Only active-duty military (and certain intelligence community members) remain eligible for the moving expense deduction.

Standard Deduction And Dual-Status Issues

OBBBA locked in a much larger standard deduction (now $15,750 single / $31,500 joint for 2025 and indexed) as a permanent feature. 

However, non-resident aliens still cannot use the standard deduction. 

A foreign national who arrives mid-year will file as a dual-status alien, generally paying U.S. tax only on U.S.-source income for the non-resident portion of the year, but with no standard deduction for that part. 

If they qualify, they might elect to be treated as U.S. resident for the full year (under IRC §7701(b)(4)) to claim the standard deduction – but that subjects their full-year worldwide income to U.S. tax. 

These first-year elections rules are unchanged under OBBBA, so careful timing and modeling is needed to decide the optimal filing status.

Tax Treaty Provisions

Inbound taxpayers should also review tax treaty provisions. If a treaty tie-breaker would treat them as resident of their home country for part of the year, they may use that (since they are not U.S. citizens, the treaty saving clause doesn’t bar it), though doing so can be complex. 

OBBBA did not create any new inbound tax exemptions or basis step-ups – meaning new residents receive no automatic step-up in basis for assets they owned before moving. 

Planning Tip. For inbound individuals – consider disposing of highly appreciated foreign assets before becoming a U.S. resident, or to be prepared for U.S. tax on the full gain if sold post-arrival (since U.S. basis will generally be original cost).

“Remittance Tax” On Outbound Transfers

A novel provision imposes a 1% excise tax on certain money transfers from the U.S. to foreign recipients (effective for transfers after 2025). 

This is aimed at cash remittances – for example, an expat worker in the U.S. sending cash to family overseas via a money transfer service would pay a 1% tax, collected by the remittance provider. 

However, transfers from U.S. bank accounts or by U.S. debit/credit card are exempt, so immigrants and foreign workers in the U.S. can plan around this by using bank-to-bank transfers instead of cash remittance services to avoid the fee. 

While not a “deduction,” this new tax is a consideration for inbound expats who regularly send funds abroad.

Other Inbound Notes

OBBBA’s major individual tax cuts (rate reductions, bigger child credits, etc.) generally benefit U.S. residents and citizens across the board, including recent arrivals. 

For example, the Child Tax Credit (CTC) was increased to $2,500 per child (from $2,000). 

However, the act tightened ID requirements. Now at least one parent filing jointly must have an SSN to claim the refundable portion of the CTC. 

This is actually easier than the initially proposed rule that both parents have SSNs – a relief for mixed-nationality couples. 

Children still need SSNs (ITINs don’t qualify) as before. Inbound expats should obtain SSNs for themselves and their U.S.-citizen children as soon as possible to maximize credits.

Finally, note that state tax obligations might still follow a new arrival (if they establish residency in a U.S. state). 

OBBBA temporarily raised the federal state and local tax (SALT) deduction cap from $10k to $40k (through 2029, with AGI phase-outs). This provides some relief if a new resident pays significant state/local taxes. 

However, non-residents and dual-status filers generally cannot benefit from the standard deduction or SALT deduction unless they elect full-year residency, so the practical benefit is limited to those fully subject to U.S. tax.

Changes For Americans Moving Or Living Abroad (Outbound Expats)

Foreign Earned Income Exclusion (FEIE) And Housing Exclusion

The FEIE – a key tax break for U.S. expats – continues unchanged in mechanism, with annual inflation adjustments. 

For 2025, the FEIE cap rises to $130,000 per qualifying individual (up from $126,500 in 2024). 

Married couples who both qualify can exclude up to $260,000 of foreign wage or self-employment income. 

The foreign housing exclusion/deduction was also adjusted. The base housing amount is $20,800 and the general housing cost limit about $39,000 for 2025 (with higher caps for certain high-cost cities abroad). 

Bottom line. Americans abroad can exclude a bit more income due to inflation indexing; OBBBA did not restrict these exclusions. 

Expats should continue to track their bona fide residence or physical presence test status carefully each year to maintain FEIE eligibility – the law did not change the qualification tests (12+ months abroad or 330-day rule).

Foreign Tax Credit (FTC) And Tax Treaties

One initial concern was a provision known as Section 899 (nicknamed the “revenge tax”) that would have penalized Americans in countries with “unfair” taxes (initially aimed at nations with digital services taxes, etc.), effectively limiting the use of foreign tax credits in those cases. 

Good news. After international pushback, Section 899 was removed from the final bill. Thus, U.S. expats retain full access to the FTC* to offset foreign income taxes paid, and no new surtax will apply on income from any particular country. 

The FTC system remains as before, so Americans abroad can generally credit foreign taxes dollar-for-dollar against U.S. tax on the same income (up to limits), helping avoid double taxation in high-tax countries. 

In fact, one tweak in OBBBA actually improves FTC usage for some expats. The act reduces the “deemed paid” foreign tax credit haircut from 20% to 10%. 

This mostly affects those with GILTI (Global Intangible Low-Taxed Income) from controlled foreign corporations – now renamed “Net CFC Tested Income” – where previously only 80% of foreign taxes were creditable. Going forward, 90% of foreign taxes on GILTI/NCTI will be creditable. 

For an entrepreneur abroad who owns a foreign corporation, this could modestly lower U.S. tax on high-taxed foreign earnings (since more of the foreign tax can offset U.S. tax). 

Other international business provisions – like making the CFC look-through rule permanent and restoring certain attribution rules – may ease tax burdens on expats with complex structures.

No Switch To Pure Residency-Based Taxation (Yet)

Despite hopes in the expat community, OBBBA did not end citizenship-based taxation. 

U.S. citizens and green card holders are still taxed on worldwide income regardless of residence. President Trump had promised to “end double taxation” on Americans abroad and supported a residence-based taxation (RBT) proposal, but that was not included in this bill. 

A separate bill (the LaHood RBT Act) was introduced and may be debated later, but as of now nothing has changed: Americans abroad must continue filing annual U.S. tax returns, FBARs, etc., on their worldwide income and assets. 

The FEIE and FTC remain the primary tools to mitigate double taxation. 

Tax treaties also remain in effect, but remember the “saving clause” in U.S. treaties generally prevents U.S. citizens from using treaty residency tie-breakers to avoid U.S. tax. 

OBBBA did not alter any treaty provisions or the saving clause. (In practical terms, a U.S. citizen cannot use a tax treaty to claim non-residency and escape U.S. tax – you’d have to expatriate to do that. For long-term green card holders, using a treaty to be treated as a non-resident can trigger the expatriation rules – see below.)

Foreign Housing, Meals, And Other Deductions

Aside from the FEIE/housing exclusion adjustments noted, OBBBA didn’t take away expat-specific deductions. 

For instance, the housing exclusion formula under §911 remains in place. 

Some expats who work for foreign employers may have access to tax-equalization or housing reimbursement plans – those too are unchanged by the law (though employers might need to recalibrate tax projections given other changes). 

One Item To Note. If an outbound U.S. employee was hoping the moving expense deduction might be restored for their move abroad, that is not the case – as mentioned, moving expense write-offs remain disallowed for civilians. Employers should gross-up any moving allowances for U.S. employees relocating overseas, since those payments will be taxable compensation to the employee.

Estate And Gift Tax Relief

Many Americans abroad worry about U.S. estate tax on worldwide assets. 

OBBBA increased the unified estate/gift tax exclusion to $15 million per individual (up from ~$14M). This high exemption (available through 2030) greatly reduces the number of expats subject to U.S. estate tax. 

It also presents a planning opportunity. Wealthy expats considering renouncing U.S. citizenship can use the large gift exemption now to shed assets and potentially get their net worth below the $2 million “covered expatriate” threshold. 

By utilizing the $15M exemption to gift assets tax-free now, an expat could avoid the exit tax entirely upon expatriation. (For example, an American abroad with $10M net worth can gift, say, $5M to a trust for their children – using up part of the $15M exemption – and thereafter be under $2M net worth, avoiding covered expatriate status if they renounce.) 

Caution. The $15M exemption isn’t guaranteed forever; it’s set to revert (likely to ~$6M) in 2031 unless extended. 

Thus, expats with estate tax concerns might act sooner rather than later. OBBBA did not otherwise change the exit tax regime under §877A – any U.S. citizen or long-term green card holder who expatriates with net worth above $2M (or failing other tests) still faces the mark-to-market exit tax. 

Proper planning (now aided by the high exemption) remains crucial.

New Reporting Burdens And Compliance Changes (And Planning Responses)

A major theme of OBBBA is increased tax compliance and enforcement, including for international filers. 

Key changes that inbound/outbound taxpayers should note:

• Expanded Foreign Asset Reporting – The law authorizes lower thresholds for FATCA Form 8938 and FBAR reporting and even for foreign gift reporting. While the IRS hasn’t yet announced new limits, OBBBA gives Treasury the green light to “lower the bar” for reporting foreign accounts and assets. Currently, U.S. expats must file an FBAR (FinCEN 114) if aggregate foreign accounts > $10,000, and Form 8938 if foreign financial assets > $200,000 (single) at year-end. These thresholds could drop, meaning more expats may have to file these forms going forward.
  
  Foreign gifts/inheritances – Today, a U.S. person must file Form 3520 if they receive > $100,000 from a foreign individual or > ~$18,000 from a foreign corporation/trust.
  
  OBBBA significantly lowers these thresholds (exact new amounts TBD). 
  
  This means more expats will trigger Form 3520 filings for even modest gifts or bequests from abroad. 
  
  While such foreign gifts remain non-taxable, the penalty for failing to report can be 25% of the gift – so this is a serious compliance point. International tax advisors should flag any inbound gift to a client, no matter how small, to see if it now requires a report.
  
• Accelerated Deadlines & Shorter Extensions – The Act directs alignment of some expat filing deadlines closer to domestic deadlines. U.S. taxpayers abroad have traditionally enjoyed an automatic 2-month filing extension to June 15, with further extensions to October (and even December in some cases). OBBBA shortens this window. Expect tighter due dates for international filings, possibly ending the automatic June 15 extension. 
  
  For example, the due date for filing a Form 3520 or Form 5471 might be pulled forward. We await IRS guidance, but practitioners should prepare expats to file earlier and not rely on lengthy extensions. The era of casually filing an expat return in October might be over – timely attention to April 15 (or a nearer date) is advised once rules are clarified.
  
• Stiffer Penalties and Enforcement – Congress has hiked penalties for international non-compliance across the board. Failure to file an FBAR, Form 8938, 5471, 3520, etc., will carry even heavier fines than before, and the IRS is mandated to step up international enforcement (with funding previously allocated to IRS enforcement largely preserved). Also, expect greater data sharing between IRS and foreign tax authorities. 
  
  For expats, this means less margin for error – every foreign account, asset, and entity must be reported meticulously. 
  
  It’s prudent to perform a “compliance check-up”. Ensure all past FBARs and international forms have been filed (the Streamlined Procedures remain an option to clean up past omissions, ideally before penalties hit). 
  
  OBBBA’s message is clear: the compliance net is tightening.
  
• Small Business and Investment Tweaks – Expat entrepreneurs will face some new wrinkles. OBBBA instructs Treasury to limit Section 179 expensing and certain small-business deductions on foreign assets/businesses. 
  
  In practice, if an American abroad owns a foreign business or rental property, they may not be able to immediately deduct equipment purchases (§179) placed in service overseas as liberally as a domestic business. 
  
  There may also be new anti-abuse rules for expats claiming business losses or expenses from abroad. 
  
  Details will emerge in IRS guidance, but tax professionals should be prepared to recalculate assignment cost projections for employers and reassess expat entrepreneurs’ estimated taxes. 
  
  On the investment side, note that no relief was provided from the PFIC rules or the transition tax/GILTI regime that hit many expats after 2017 – those remain in effect. (If anything, as noted, GILTI was slightly modified to be more inclusionary by reducing the §250 deduction to 40%, but high foreign tax credits mitigate its impact for many.) 
  
  Expats should continue to avoid foreign mutual funds (PFICs) or be ready to file Form 8621 annually.

Planning Opportunities

Despite increased burdens, OBBBA opens some planning avenues:

• Use of the Higher FEIE and Credits – With a ~$130k exclusion, expats on the margin might newly avoid all U.S. tax by ensuring salary splits or housing allowances that maximize use of the FEIE + housing exclusion. Also, the slightly larger Child Tax Credit can mean bigger refunds for those with qualifying kids (make sure to claim the Additional CTC if eligible).
• Estate/Gift and Expatriation Planning – As discussed, the $15M lifetime exclusion offers a window for high-net-worth expats to reorganize wealth (gifts, trust funding, etc.) while U.S. estate tax is minimal. It can facilitate an exit strategy or simply provide peace of mind that one’s estate won’t be taxed absent very large assets.
• State Tax Considerations – Expats retaining state residency (or planning a move abroad mid-year) might benefit from the temporary SALT deduction increase if they itemize. For example, an expat who sells a U.S. home or has high state tax in the year of departure can potentially deduct up to $40k of it federally now – factor this into timing (maybe accelerate income/transactions into 2025-2029 to utilize the higher cap).
• Remittance Tax Avoidance – Inbound foreign workers should shift from cash remittances to bank transfers, as noted, to legally avoid the 1% excise.

In short, global tax planning is more critical than ever. 

Expats should coordinate U.S. and foreign tax strategies. For instance, a reduction in U.S. tax by FEIE could expose them to unused foreign tax credits (since you can’t claim credit on excluded income), so one might choose the FTC over FEIE in certain scenarios to maximize overall benefit. Each expat’s situation must be modeled under the new rules to uncover the best approach.

Residency Tie-Breakers, Dual-Status And First/Last-Year Residency Cases

OBBBA did not change the fundamental residency rules for tax purposes – but it adds context:

• Dual-Status Taxpayers – Individuals who are U.S. resident for part of the year and non-resident for part (e.g. the year of arrival or departure) will still file split-year returns as before. One caveat. Because the standard deduction is now permanently high and still unavailable to non-residents, dual-status filers get no standard deduction (and no personal exemption, as exemptions remain $0) for the non-resident portion. 
  
  This can result in higher taxable income in a split year. 
  
  Strategies remain the same – e.g., if arriving late in the year, consider electing to be treated as a full-year resident (if eligible under the first-year election rules) to claim the full standard deduction and credits, especially if foreign income for the pre-arrival part was low or already taxed abroad. 
  
  Conversely, if departing mid-year, one typically does not want to be taxed as a U.S. resident for the full calendar year. In those cases, use the “last-year” residency termination rules (IRC §7701(b)(2)(A)(iii) and (B)) by showing a closer connection to the new country and limited U.S. presence after departure. 
  
  OBBBA introduced no new relief or complexity in these calculations – it’s status quo. 
  
  However, watch the new accelerated filing deadlines. A dual-status taxpayer can’t procrastinate filing until October; if extension periods are reduced, they may need to file by spring with all necessary information on worldwide income ready. 
  
  Early coordination with foreign employers for income statements is advised.

• Tax Treaty Tie-Breakers – Many U.S. tax treaties have residency “tie-breaker” provisions that determine a single country of residence when both countries claim someone as a resident in a given year. 
  
  As noted, U.S. citizens cannot fully escape U.S. taxation via treaty due to the saving clause (the U.S. reserves the right to tax its citizens as if the treaty didn’t exist). 
  
  OBBBA did not amend any treaties or the saving clause. For non-citizens, such as a foreign national who becomes a U.S. resident but remains a tax resident of their home country, the treaty tie-breaker could be invoked to treat them as non-resident in one of the countries. 
  
  That process remains the same – though one should be mindful – if a long-term green card holder uses a treaty to be treated as non-resident of the U.S., that action can be considered a form of expatriation (essentially a surrender of their green card for tax purposes) potentially subjecting them to the exit tax under §877A. 
  
  OBBBA did not change this anti-treaty-shopping rule for long-term residents. 
  
  Thus, dual-status and treaty positions should be taken with caution and full disclosure (Form 8833 is required for treaty-based return positions).
  
• Increased Scrutiny – While the rules haven’t changed, the enforcement environment has. The law’s new reporting and documentation demands could indirectly affect residency determinations. 
  
  For example, more aggressive information reporting might flag an individual who claims to be a non-resident via a treaty tie-breaker but still has significant U.S. indicia. 
  
  In practice, an American abroad who asserts treaty benefits (say, to exempt foreign pension income under a treaty article) might face more IRS questions under the new regime. 
  
  Treaty-based positions should be thoroughly supported by contemporaneous evidence (residency certificates, proof of foreign tax paid, etc.). 
  
  Likewise, first-year and last-year residency cases may see heightened IRS scrutiny – e.g., if someone claims to have left the U.S. for good in June, the IRS may more often request proof of foreign residence for the remainder of the year. It’s advisable to document travel dates and foreign ties more rigorously in anticipation of this stricter oversight.

Bottom line. The residency definitions (substantial presence test, green card test, etc.) are unchanged – no new “residency tie-breaker certificate” or election was created in OBBBA (the mooted RBT proposal would have allowed citizens to elect non-resident status, but it’s not law). 

So the familiar complexities of dual-status returns and treaty tie-breakers remain. 

The difference post-OBBBA is a less forgiving compliance atmosphere. 

Entry and exit dates should be carefully planned, to maximize the use of any available exclusions/credits in split years, and ensure all required statements (e.g., dual-status statement, treaty disclosure) are properly attached to returns. 

Given the new law’s emphasis on enforcement, taking meticulous care with these cases will be critical.

Conclusion

The One Big Beautiful Bill Act of 2025 brings a mix of tax cuts, new rules, and tightened compliance that expats must navigate. 

For inbound expats, there’s relief in the form of permanent lower tax rates and higher credits, but also the loss of any moving expense offset and a new remittance tax to consider. 

For outbound Americans, the status quo of worldwide taxation continues – mitigated by an even larger FEIE and FTC preservation – but accompanied by more reporting obligations and potential penalties. 

Notably, the “worst-case” provisions feared by expats (like the Section 899 FTC surtax) were averted, making this law, in some ways, less punitive than expected. 

In fact, some experts call it expat-friendly due to the higher exclusions and the groundwork laid for future residence-based reform.

Still, the administrative burden on expats will rise. More forms (FBAR, FATCA, 3520) at lower thresholds, stricter timelines, and vigorous enforcement mean taxpayers must be ever diligent. 

There are also subtle planning points – from exploiting the temporarily generous estate exclusion, to adjusting tax equalization policies for employers, to revisiting whether FEIE or FTC yields a better outcome under the new rates. 

Each expat’s scenario will be unique under OBBBA, so personalized analysis is key.

IRS/Treasury Guidance. As of mid-2025, the IRS has begun issuing guidance on implementing OBBBA’s provisions. 

For example, guidance was promised on the new tip and overtime deductions (with transition relief for 2025 reporting), and we anticipate further instructions on international provisions (e.g. how to apply the new excise tax or any changes in reporting thresholds).

In summary, expat taxation in the post-OBBBA era will require careful attention but also presents new opportunities. 

By understanding the law’s changes – higher deductions and credits, preserved exclusions, and new compliance rules – inbound and outbound taxpayers alike can minimize their tax liability while staying fully compliant with both U.S. and foreign laws. 

The 2025 tax year will be a test run for many of these changes, so proactive planning in late 2025 and early 2026 will be essential. 

With thoughtful planning, Americans abroad and foreign nationals in the U.S. can navigate the One Big Beautiful Bill’s provisions to their advantage, or at least avoid its pitfalls, and move forward with greater confidence in their tax positions.

Imagine working remotely from the sunny shores of Australia for a New York-based employer, thinking you’re safely outside the grasp of U.S. state taxes. 

Think again. 

Due to the often-overlooked and widely misunderstood “convenience of the employer” rules, many individuals living abroad who work remotely for American companies are being caught unaware by state taxation. These arcane rules are increasingly relevant in our globalized and remote-first work environment, especially impacting digital nomads and expatriates.

What Exactly Is The “Convenience of Employer” Rule?

At its core, the “convenience of the employer” rule says that if you’re working remotely from another jurisdiction out of personal preference rather than explicit employer necessity, you could still owe state taxes to the state where your company is based. Even if you’ve never set foot in that state, the logic of this rule asserts that you owe state tax because your work location choice was “for your convenience,” not your employer’s.

Which States Enforce This Rule?

The most infamous of these is New York, which aggressively applies this rule and has extensive case law supporting its stance. But New York isn’t alone. 

Connecticut, Delaware, Pennsylvania, and Nebraska (effective from January 1, 2025), as well as Alabama, enforce similar rules. New Jersey imposes it selectively, impacting residents from states with reciprocal rules such as New York and Connecticut. 

Surprisingly, states like California and Oregon have not yet adopted such provisions, preferring instead to tax individuals based primarily on their physical presence within the state.

Why Does This Matter?

The impact of these rules is profound and often expensive. Individuals who believe they’re free from state tax obligations because they physically live abroad may find themselves saddled with unexpected tax bills, penalties, and interest. This creates complexity for international remote workers, especially those who assume they’re safe because of international tax treaties or their physical presence abroad.

Real-Life Implications

Take a recent 2023 Alabama tax court case as an example. 

An individual living outside Alabama was still found liable for Alabama state taxes because the court determined the remote work arrangement was for the employee’s convenience, not the employer’s. Though this was an isolated ruling, it illustrates how aggressive and varied state interpretations can become.

New York courts have also been largely unsympathetic to taxpayers. In the significant “Matter of Devers” case, New York upheld its right to tax a remote employee who seldom visited the state. While a few taxpayers have successfully argued against this rule, most outcomes have favoured the state, further solidifying New York’s tough stance.

Connecticut introduced its own “convenience rule” largely as retaliation against New York’s aggressive taxation of Connecticut residents working remotely for New York companies. The result is an ongoing interstate tension with complex implications for remote workers.

How To Mitigate Risks

To navigate these risks, it’s essential to understand potential “safe harbor” rules. For instance, New York offers limited safe harbors that, if carefully adhered to, might exempt a remote worker from the convenience rule. One such strategy involves structuring employment agreements explicitly requiring the employee to work remotely due to the company’s necessity rather than the employee’s preference.

However, this approach raises another challenge: employment law. A company must verify whether employing foreign nationals (e.g., Australians) directly from the U.S. entity while permanently working abroad complies with both U.S. and local employment regulations. It might lead to unintended legal and corporate exposure if not correctly structured.

Planning Is Key

For global nomads or expatriates working remotely for companies in affected states, advance planning with specialised tax advisors is crucial. Individuals should understand the specific rules and precedents in their employer’s state. This involves not only drafting robust and defensible employment contracts but also documenting the genuine business necessity of remote working arrangements.

Moreover, employees should explore whether structuring their employment via foreign subsidiaries or affiliated entities might insulate them from the direct application of these state rules. Although more complicated structurally, this approach can offer a stronger defence against aggressive state taxation.

Final Thoughts

The “convenience of employer” rule represents a hidden trap for unsuspecting remote workers globally. States like New York, Connecticut, Delaware, Pennsylvania, Nebraska, and Alabama have demonstrated varying degrees of willingness to apply these aggressive rules, creating uncertainty and potential liability for employees worldwide. 

To avoid costly surprises, international remote workers and global nomads must stay informed and engage early with expert tax advice to navigate this complex and evolving landscape.

Navigating U.S. taxes as an American expat living abroad can be confusing, but it’s crucial to understand your obligations. 

The United States taxes its citizens and resident aliens on worldwide income, no matter where they live. 

This article outlines the U.S. tax system for expats covering key terms, filing requirements, common mistakes, deadlines, and practical tips to stay compliant and avoid penalties.

Overview Of The U.S. Tax System For Expats

Unlike many countries, the U.S. follows a citizenship-based taxation model. 

This means if you are a U.S. citizen or a resident alien (more on this term below), you must file U.S. tax returns and potentially pay U.S. taxes even while living abroad. 

In other words, your obligation to the IRS doesn’t end when you move overseas. You are generally required to report all income from all sources worldwide on your U.S. tax return.

To prevent double taxation (being taxed by both the U.S. and your country of residence on the same income), the tax code provides relief in the form of credits and exclusions. 

Two key provisions are the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). 

The FEIE allows qualifying expats to exclude a certain amount of foreign earned income from U.S. tax – for example, up to $126,500 of foreign salary in tax year 2024. The Foreign Tax Credit, on the other hand, lets you offset U.S. tax with taxes paid to a foreign country. These benefits recognize that expats often pay taxes abroad, but you only get them by filing a U.S. return. Even if you owe nothing to the IRS after using exclusions or credits, you still must file to claim these benefits and meet your legal requirements.

Key Tax Terms Expats Should Know

Understanding a few basic tax terms will help make sense of your U.S. filing obligations:

• Tax Return – A tax return is the annual form or set of forms you file with the IRS to report your income, deductions, credits, and calculate any tax owed or refund due. For individual expats, this usually means filing Form 1040 (the U.S. Individual Income Tax Return) each year. In simple terms, it’s your annual report to the IRS on your finances. Even if you live abroad, if your income is above the filing threshold for your status, you need to submit a tax return to remain compliant.

• FBAR (Foreign Bank Account Report) – The FBAR is a separate reporting requirement for foreign financial accounts. If you are a U.S. person (citizen or resident) and the total value of your foreign bank accounts exceeds $10,000 at any time during the year, you must file an FBAR (officially FinCEN Form 114). This is not a tax form per se (no tax is calculated on it), but an informational report to the U.S. Treasury. The FBAR is filed online through the Treasury’s FinCEN system, not with your tax return. Even accounts that produce no income must be reported if the aggregate balance hit the $10k mark. Failing to file an FBAR when required can result in severe penalties, so it’s a crucial obligation for expats with foreign accounts.

• Resident Alien – In tax terms, a resident alien is a non-U.S. citizen who is treated as a U.S. resident for tax purposes. This generally means someone who either has a green card (Lawful Permanent Resident status) or meets the IRS substantial presence test (based on days spent in the U.S.). A resident alien’s U.S. tax responsibilities are essentially the same as those of a U.S. citizen: they must report and potentially pay U.S. tax on their worldwide income. For example, a foreign national working in the U.S. on a long-term assignment may become a resident alien and be subject to U.S. taxes on global income just like an American expat would be.

• Non-Resident Alien (NRA) – A non-resident alien is a non-U.S. citizen who does not meet the green card or substantial presence test for U.S. tax residency. NRAs are generally taxed only on their U.S.-source income (for instance, income from working in the U.S. or investment income from U.S. assets). They do not have to report worldwide income. For expats, this term comes up if, say, you’re an American married to a non-U.S. citizen – your foreign spouse is considered a non-resident alien for U.S. tax purposes (unless they choose to be treated as a resident alien by election). It’s important to know the difference, because U.S. tax rules and filing status options differ depending on whether a spouse is a resident alien or NRA.

Who Must File And What To Report As An Expat

Filing Requirements

All U.S. citizens or resident aliens must file a U.S. income tax return if their income is above certain minimum thresholds, which vary by filing status and age. These thresholds are usually equivalent to the standard deduction (for example, around $14,600 for a single filer under 65 in the 2023 tax year). 

In many cases, expats meet these filing minimums. In fact, if you’re married to a foreign spouse and file separately, you may have to file if you earned just $5 or more in income. The point is, don’t assume you’re off the hook just because your income is below the Foreign Earned Income Exclusion amount or because you owe no tax. Expats still need to file annual returns if their gross income exceeds the normal filing threshold for their situation.

Worldwide Income

When filing, you must report all forms of income from everywhere: salary from a foreign employer, freelance or business income, investment earnings, pensions, rental income, etc. The IRS expects expats to report worldwide income every year—not just U.S. source income. 

If you’ve paid taxes to a foreign government on that income, you can typically claim a Foreign Tax Credit to offset U.S. tax, and if you qualify, you can use the Foreign Earned Income Exclusion to exclude foreign wage or self-employment income up to the limit. But these benefits must be claimed on a filed return; they’re not automatic. 

Failing to report an income source – even if by accident – is a common mistake that can raise an IRS red flag, especially now that under FATCA (Foreign Account Tax Compliance Act), foreign banks report financial info of U.S. account holders to the IRS. In short, the IRS has ways to know about your foreign income, so it’s best to be transparent and report everything truthfully.

Foreign Assets And Accounts

In addition to your tax return, expats need to be aware of separate reporting requirements for foreign assets.

• FBAR – As explained, if your combined foreign account balances exceed $10,000 at any point in the year, you must file an FBAR. This includes not just bank accounts, but also foreign investment accounts, certain retirement accounts, or even accounts where you have signature authority but no ownership (for example, if you can sign on a parent’s or employer’s foreign account). The FBAR is an annual online filing due April 15 (it’s automatically extended to October 15 each year). It’s important to file the FBAR on time – there’s no tax to pay on it, but penalties for missing it can be steep.

• FATCA Form 8938 – Under FATCA, certain expats may also need to file Form 8938 (Statement of Specified Foreign Financial Assets) with their tax return. 

This form overlaps with the FBAR in some ways but has different thresholds and covers a broader range of foreign assets. 

For instance, Form 8938 requires reporting foreign financial assets (bank accounts, investment accounts, foreign stocks or bonds, foreign mutual funds, etc.) if their total value exceeds a higher threshold – for example, a married couple filing jointly and living abroad would file Form 8938 only if their foreign assets exceed $400,000 on the last day of the year or $600,000 at any time during the year (lower thresholds apply for single filers or those living in the U.S.).

The exact threshold varies by filing status and whether you reside abroad or in the U.S.. Not every expat will meet these limits, but if you do, Form 8938 is required in addition to the FBAR. Like the FBAR, failing to report assets on Form 8938 when required can lead to penalties.

In summary, most expats need to report their worldwide income on Form 1040, and if they have foreign accounts or assets, be mindful of FBAR and FATCA Form 8938 requirements. It’s wise to keep records of your foreign income (pay slips, bank statements, etc.) and the highest balances of your accounts so you can report accurately. Remember: reporting does not always mean owing tax, but not reporting can lead to big problems.

Deadlines, Extensions, And Avoiding Penalties

Tax Return Deadlines

The standard deadline for filing a U.S. individual tax return is April 15 of each year (for the prior calendar year’s income).

The good news for expats is that if you are living abroad on April 15, the IRS gives you an automatic 2-month filing extension to June 15 . 

You don’t have to file any form to get this automatic extension, but it’s a good idea to attach a statement to your return noting you were abroad and eligible for the automatic extension.

If June 15 still isn’t enough time, you can request a further extension to October 15 by filing Form 4868 before June 15 . 

In special cases (and with a proper request), expats can even get an extension to December. 

However, be careful: an extension to file is not an extension to pay any tax due. 

If you end up owing U.S. tax for the year, interest starts accruing from April 15 onward, even if you filed for an extension. 

To avoid interest and penalties, it’s best to pay an estimated amount by April 15 if you suspect you’ll owe anything, or as soon as possible.

FBAR Deadline

The FBAR follows a similar schedule – it’s due April 15 as well, but FinCEN grants an automatic extension to October 15 every year. You don’t need to file any form for that FBAR extension; it’s automatic if you miss the April deadline. Essentially, October 15 is the final due date for the FBAR. Mark your calendar and don’t forget this separate filing.

Avoiding Penalties

Missing deadlines or failing to file required forms can result in penalties. 

For the tax return itself, the failure-to-file penalty can be harsh (typically 5% of the unpaid tax per month late, up to 25%), and a failure-to-pay penalty (0.5% of unpaid tax per month) may apply if you don’t pay on time. Even if you can’t pay right away, always file your return (or an extension) on time to minimize penalties. 

The IRS will usually work with you on payment plans, but not filing is seen as more serious. If you owe $0 but file late, you won’t have a failure-to-pay penalty, but a late filing can still trigger a monetary penalty if you were required to file. In short, meet your deadlines – and if you can’t, get the automatic extensions available to expats and pay what you can by April 15.

For the FBAR and other information returns (like Form 8938, or forms for foreign trusts or corporations if those apply), penalties can reach into the tens of thousands of dollars, even if no tax was due, because these are primarily about reporting compliance. 

The FBAR, for example, can carry a civil penalty of up to $10,000 for non-wilful violations, and much more if the violation is found to be wilful. 

The IRS has increasingly enforced these rules, so don’t treat them lightly. 

The safest course is to file all required forms on time and fully disclose what’s required. If you realize you’ve missed something (like forgetting an FBAR in a prior year), consider seeking advice on how to correct it – the IRS has amnesty programs (such as the Streamlined Filing Compliance Procedures) to help expats catch up on late filings penalty-free if the lapses were non-wilful.

Common Tax Mistakes And Risks For Expats

Even well-intentioned expats can slip up on U.S. tax obligations. 

Here are some common mistakes and compliance risks to watch out for:

• Assuming You Don’t Need To File – A pervasive myth is that if you live abroad or your income is under the FEIE limit, you don’t have to file a U.S. return. In reality, all U.S. citizens or residents with income over the filing threshold must file annual returns, regardless of where they live. 

Thousands of expats fail to file each year, often simply because they aren’t aware they need to. Not filing is one of the biggest red flags to the IRS and can lead to problems down the line. Remember, you may not owe tax due to exclusions/credits, but you still need to file to claim those and inform the IRS of your income.

• Reporting Only U.S. Income – Some expats do file U.S. taxes but omit their foreign income, mistakenly thinking that income earned abroad isn’t taxable or doesn’t need to be reported. This is incorrect – as mentioned, the U.S. taxes worldwide income. 

If you earned money overseas (salary, business income, interest, etc.), it must be included on your U.S. return, even if it will be excluded or offset by a credit. Failing to report foreign income can not only negate your eligibility for things like the FEIE, but it also looks like you’re trying to hide money. 

With FATCA in effect since 2010, the IRS often receives information on your foreign accounts and earnings from foreign banks. In short, they likely already know about that overseas salary or bank interest, so don’t leave it off your return.

• Forgetting To File FBAR/8938 – Another frequent mistake is neglecting the FBAR or Form 8938 reporting. 

These forms can be easy to overlook because they don’t involve paying tax, and expats may not even realize they exist until after they’ve missed a deadline. Not reporting a foreign account or asset when required is a serious compliance issue. 

An expat might think, “It’s just a savings account in my country of residence – why would the U.S. care?” But the law is the law: if the thresholds are met, you must file the FBAR and/or Form 8938. 

The IRS and Treasury have cracked down on offshore account reporting in the past decade, issuing hefty penalties to some who wilfully hid assets. Most expats who miss these forms do so by accident, but it’s an expensive accident to make. Always check each year if your accounts crossed the $10k FBAR limit or if your assets require Form 8938, and err on the side of reporting if unsure.

• Missing Deadlines Or Extensions – Life abroad can be busy, and it’s easy for tax deadlines to sneak up on you – especially with different filing dates than the local taxes in your country. Many expats file late or not at all simply due to poor deadline management. 

Missing the April 15 (or June 15 automatic expat extension) deadline without filing an extension can lead to late-filing penalties that add up. Likewise, forgetting the FBAR by October 15 could draw unwanted attention. The risk here is not just fines, but also the stress of knowing you’re behind on compliance. 

Mark your calendar with U.S. tax dates, use reminders, and if needed, get professional help to ensure you meet all deadlines. It’s far easier to file on time than to explain to the IRS later why you didn’t.

• Not Using Available Tax Benefits (Or Using Them Incorrectly) – Expats have access to special tax provisions like the FEIE, Foreign Housing Exclusion, and Foreign Tax Credit. 

A common mistake is not taking advantage of these, which can lead to overpaying U.S. taxes. 

For example, if you paid foreign income taxes, you should claim the Foreign Tax Credit to reduce your U.S. tax bill – otherwise you’re paying tax twice. 

On the flip side, some expats misunderstand these rules and claim something they shouldn’t, or double-dip (for instance, excluding income with FEIE and also claiming a credit on the same income, which isn’t allowed). 

Claiming large exclusions or credits you aren’t eligible for can raise a red flag in the IRS system. 

Always ensure you meet the criteria (like the 330-day presence test for the FEIE ) and fill out the required forms (Form 2555 for the FEIE, Form 1116 for the Foreign Tax Credit) accurately. If done right, these provisions are completely legal and beneficial. 

If done wrong, they can trigger an audit or additional taxes. When in doubt, consult a tax professional to get these right.

• Overlooking Filing Status Options – Expats who are married might not realize how their choice of filing status can affect their taxes and obligations. 

For instance, if you’re married to a non-U.S. citizen (non-resident alien), you generally cannot file jointly unless you make a special election to treat your spouse as a U.S. resident for tax purposes. 

If you don’t make that election, you’ll file as Married Filing Separately – which, as noted, can mean a very low income threshold (often effectively $5) for having to file a return. 

Some expats miss out on beneficial options, like electing to file jointly with a foreign spouse (which can allow a higher standard deduction, but also means your spouse’s income is subject to U.S. tax – a complex decision). 

Make sure you understand your filing status choices and their consequences. Likewise, if you have dependent children abroad, look into claiming the Child Tax Credit or Foreign Tax Credit for any foreign taxes paid on their behalf. Misunderstanding filing status and dependency rules can be a pitfall.

• Assuming The IRS Won’t Notice – In years past, some expats took the approach of “out of sight, out of mind” regarding U.S. taxes. 

This is increasingly risky. 

Not only does FATCA enable the IRS to receive data on Americans abroad, but there’s evidence that Americans overseas are more likely to be audited than domestic taxpayers. 

The IRS knows expat taxes can be complex, and they use automated systems to flag irregularities (like unreported foreign accounts or large exclusions). 

It’s a mistake to assume you can fly under the radar indefinitely. 

If you haven’t been filing because you were unaware of the requirements, the IRS offers programs (like the Streamlined Procedure) to come clean without facing penalties. 

But if you wilfully ignore your obligations and the IRS catches up, the outcome could be much worse – including potential fines or even loss of your passport in extreme tax delinquency cases. The bottom line: take compliance seriously, because the IRS certainly does.

By being aware of these common pitfalls, you can take steps to avoid them. Most mistakes are avoidable with a bit of knowledge and careful record-keeping.

Examples Of Expat Tax Scenarios

Every expat’s situation is a little different. 

Let’s look at a few example scenarios to see how U.S. tax rules apply in practice:

Single Filer Living Abroad

Scenario: Jane is a single U.S. citizen living and working in Australia. She earns the equivalent of $80,000 per year from an Australian employer and pays Australian income taxes on that salary. 

She also has an Australian bank account that at one point held $15,000 in savings.

How U.S. Taxes Apply: Jane must file a U.S. tax return because her income ($80k) is well above the filing threshold (even if it were below, since it’s above about $13k she’d still need to file). On her U.S. return, she will report her $80k salary as income. 

To avoid double taxation, she has options: she could use the Foreign Earned Income Exclusion (FEIE) to exclude $80k (which is under the limit of around $126,500 for the year) from U.S. taxation, or she could claim a Foreign Tax Credit for the Australian taxes she paid. 

She’ll choose the method that benefits her most (often, if the foreign tax rate is higher than U.S., the tax credit works well; if the foreign tax is lower, FEIE might save more). Either way, by using these provisions, she will likely owe little to no U.S. tax – but she still files the return to report everything and claim the exclusion or credit. 

Additionally, because her Australian bank account exceeded $10,000, she needs to file an FBAR by October 15 to report that account . 

If the total value of all her foreign financial assets is below the Form 8938 threshold (which for a single filer abroad is $200k at year-end), she wouldn’t need to file Form 8938. In Jane’s case, only the bank account of $15k is relevant and that is below $200k, so no Form 8938, just the FBAR. By filing these, Jane stays compliant and avoids penalties.

Key Takeaway: Even if you’re a single expat who owes nothing to the IRS due to foreign exclusions/credits, you must file a return and required asset reports. This keeps you in good standing and ensures you legally claim the tax benefits available.

Married To A U.S. Citizen (Both Spouses Abroad)

Scenario: John and Alice are a married couple, both U.S. citizens, living in Australia. 

John works for an Australian company and earned $100,000; Alice is self-employed and earned $50,000. They have two kids (U.S. citizen dependents) and joint foreign bank accounts that peaked at $25,000 during the year.

How U.S. Taxes Apply: John and Alice can choose to file their U.S. taxes as Married Filing Jointly, which generally offers a higher standard deduction and other benefits. 

They will report John’s $100k and Alice’s $50k, plus any other income (if Alice’s self-employment generated any business profit, that counts too). 

Since both are abroad all year, they likely qualify for the FEIE. 

They could each exclude their foreign earned income: John could use the FEIE on his $100k and Alice on her $50k (each spouse can exclude up to the limit, around $126,500 each, so all their earned income can be excluded). 

They would file Form 2555 for each spouse to claim the exclusion. 

Alternatively, if Australia’s income tax on those earnings is higher, they might choose to use the Foreign Tax Credit instead (filing Form 1116) to offset U.S. tax with Australian tax paid. 

They’ll also get to claim their children as dependents and possibly the Child Tax Credit, just as if they lived in the U.S. (note: the refundable Additional Child Tax Credit is available to expats only if they have earned income above a certain amount and taxes paid – this gets a bit detailed, but the key is they follow mostly the same rules).

Because they have foreign bank accounts exceeding $10k combined, they must file an FBAR reporting those accounts. 

Since they file jointly, they can submit one FBAR listing both as joint owners of the accounts. 

They should also check the threshold for Form 8938: for a joint return by a couple abroad, the threshold is $400,000 at year end (or $600k at any time). Their $25k in accounts is way below that, so no Form 8938 needed.

Key Takeaway: Married American expats can file jointly and effectively double the amount of foreign income they can shield via the FEIE (each can claim it) – in this case excluding all $150k of income – but they must file to claim these benefits. They also need to report foreign accounts. Being married doesn’t reduce the FBAR or FATCA reporting duties: those still apply jointly if thresholds are met. By coordinating their filing, John and Alice can minimize U.S. tax (likely to $0 after exclusions/credits) while staying fully compliant.

Working Remotely From Overseas (Digital Nomad)

Scenario: Sara is a U.S. citizen who spent the year moving between several countries in Asia and Latin America, working remotely as a freelance graphic designer. 

She has no fixed employer – she does gig work for clients worldwide, earning about $70,000 over the year. 

She didn’t establish tax residency in any one foreign country (she was traveling), and she did not pay taxes to any foreign government on that income. 

She kept her money in a U.S. bank account and a digital wallet, with only a small foreign bank account in Thailand where she briefly stayed (balance never above $5,000).

How U.S. Taxes Apply: Sara is still fully responsible for U.S. taxes on her freelance income. 

In fact, because she didn’t pay any foreign income tax, the Foreign Tax Credit isn’t applicable (there’s no foreign tax to credit). 

However, she can use the Foreign Earned Income Exclusion if she meets one of the qualifying tests. 

Since she’s a digital nomad, the likely test is the Physical Presence Test – she must show she was outside the U.S. for at least 330 days in a 12-month period that overlaps with the tax year. 

If she meets that (which, if she only had brief visits back to the U.S., she will), she can exclude up to $126,500 of her freelance income. 

Her $70k falls under that cap, so by filing Form 2555 with her 1040, she could exclude it and owe no U.S. income tax on it. 

But importantly, because she’s self-employed, U.S. self-employment tax (Social Security/Medicare) may still apply on that $70k even if income tax is excluded. 

Unless she falls under a Totalization Agreement (agreements the U.S. has with some countries to coordinate Social Security taxes), Sara is supposed to pay self-employment tax to the U.S. (approximately 15.3% of her net self-employment income). 

Some expats overlook this – but the FEIE does not waive Social Security tax. 

If she had instead been paying into a foreign country’s social system and that country had a treaty with the U.S., she might be exempt from U.S. self-employment tax. 

It gets technical, but she should be aware of this aspect. 

From an income tax perspective though, Sara can likely eliminate U.S. income tax via the FEIE.

Since Sara’s foreign bank account never exceeded $10k, she does not need to file an FBAR in this scenario. 

And her foreign financial assets are minimal, so no Form 8938 either. Her main task is to file her U.S. tax return reporting the $70k and then excluding it with FEIE. 

If she doesn’t file, the IRS doesn’t know she qualifies for the exclusion – they might assume she owes tax on $70k and could flag her for not filing. 

By filing and using the FEIE, she stays on the right side of the law and avoids a surprise IRS notice.

Key Takeaway: Even “digital nomads” and remote workers with no fixed address abroad must file U.S. taxes. In some ways, they need to be extra careful: without a foreign tax home, the Physical Presence Test is their ticket to the FEIE. Planning travel to ensure 330+ days abroad is crucial. Also, remember U.S. self-employment tax can still bite. Always evaluate both income tax and social tax obligations when working for yourself abroad.

Practical Tips For Staying Compliant And Avoiding IRS Scrutiny

Filing U.S. taxes from abroad doesn’t have to be a nightmare. 

Here are some practical tips to ensure compliance and keep the IRS happy while you enjoy life overseas:

• Stay Organized And Keep Good Records – Maintain a file (digital or physical) with all relevant documents each year. 

This includes W-2s or 1099s from U.S. payers, but also foreign pay slips, records of foreign taxes paid, bank statements showing year-end balances (for FBAR/FATCA), and any other proof of income or deductions. 

Good records make it much easier to file accurately and defend your figures in case of any questions. 

For example, if you claim the Foreign Housing Exclusion, keep receipts of rent and utilities.

If you claim the Physical Presence Test, keep travel logs or passport stamps as evidence of your days abroad. 

Having documentation ensures you can substantiate your claims and avoid trouble if audited.

• Mind Your Dates And Plan Ahead – As mentioned, mark your calendar with the key deadlines: April 15 (tax payment due), June 15 (expat return due if not extending), October 15 (extended return due and FBAR final due). 

If you know you’ll need more time, file Form 4868 by June 15 to push to October. Set reminders a month before to gather documents or reach out to a tax preparer. 

If you’re expecting a refund, filing earlier is better; if you think you owe, at least calculate and pay by April to stop interest. 

Also, if you move frequently, consider setting up a U.S. mailing address (like a family member’s or a mail forwarding service) or ensure you update your address with the IRS, so any correspondence reaches you. Missing an IRS letter because it went to an old address can escalate an issue unnecessarily.

• Don’t Skip Reporting Requirements – Make It A Checklist Item Every Year: “Do I need to file an FBAR? Form 8938? Any other forms?”. 

If you had any non-U.S. financial accounts, total their max balances to see if you cross $10k – if yes, do the FBAR. If you owned shares in a foreign corporation, or a foreign mutual fund, or you’re the beneficiary of a foreign trust, research the forms (Form 5471 for foreign corps, Form 8621 for PFICs like foreign mutual funds, Form 3520 for trusts/gifts, etc.). 

These can be complex, but they’re important. When in doubt, consult a tax professional versed in expat issues; they can identify which extra forms apply to you. It’s much better to file an informational form that might not end up being needed than to ignore it and face a penalty. Compliance is key – the more transparent you are with the IRS, the less likely they’ll have reason to scrutinize you.

• Use Direct Deposit And Online Tools – If you expect a refund, set up direct deposit to a U.S. bank account (it’s faster and more secure, and yes, you can receive a refund while abroad). Create an account on the IRS website to access your tax transcripts and notices electronically. 

This can be helpful to track your filing history or any communications. 

The IRS also has an Interactive Tax Assistant and many online FAQs that can clarify common questions for expats. And remember, you can electronically file (e-file) your return from abroad – you don’t have to mail paper forms across the ocean. E-filing is typically faster and reduces errors.

• Leverage Tax Treaties And Professional Advice If Needed – The U.S. has tax treaties with many countries that can affect how certain income is taxed (for example, a treaty might exempt certain pension income, or clarify residency in dual-resident situations). 

• Voluntary Compliance And Amnesty – If you realize you’ve missed filings in past years, don’t panic. The IRS offers pathways to get back on track. The most common for expats is the Streamlined Filing Compliance Procedures, which is essentially an amnesty program for those who failed to file or report foreign assets due to non-wilful neglect. It generally requires you to file the last 3 years of tax returns and 6 years of FBARs, and the IRS will forgive the penalties. 

Taking advantage of this can wipe the slate clean. 

What you shouldn’t do is continue ignoring the issue or attempt a “quiet disclosure” (just sending in old forms without noting you’re in a program) – that can backfire. 

Show good faith by coming forward under the proper procedures. 

The IRS is usually much harsher on those who wilfully evade taxes than those who genuinely didn’t know and then corrected their mistakes.

• Be Truthful And Thorough – This may sound obvious, but always be honest on your tax forms. 

Overstating deductions, underreporting income, or hiding accounts isn’t worth the risk. 

The IRS has become quite sophisticated in detecting discrepancies. With data sharing between countries (FATCA) and improved technology, trying to outsmart the system could lead to an audit or investigation. 

Most expats who file properly and pay what’s due (or legitimately owe nothing) will not hear from the IRS aside from maybe a refund check or a confirmation. Those who cut corners, however, might invite extra scrutiny. It’s simply not worth it. 

If you make an honest mistake, that’s one thing – the IRS can be understanding – but if you intentionally omit things, the penalties can be severe if discovered. Play it safe by filing complete and accurate returns.

By following these tips and staying informed about your responsibilities, you can significantly reduce the likelihood of IRS problems. Being an expat is exciting and comes with many life changes; by handling your U.S. taxes diligently, you’ll have one less thing to worry about.

Final Thoughts

U.S. tax obligations don’t disappear when you move abroad, but with knowledge and preparation, they become just another manageable aspect of expat life. 

To recap, always remember that U.S. persons abroad must report their worldwide income and often their foreign accounts. 

Take advantage of provisions like the FEIE and Foreign Tax Credit to avoid double taxation – these exist to help you, but you must file to use them . 

Keep an eye on deadlines (utilize that automatic expat extension to June 15, but pay by April if you owe) and don’t ignore additional forms like the FBAR. 

Common mistakes like not filing or failing to report something can lead to penalties or audits, especially since the IRS has increased its focus on international compliance. 

The good news is, if you stay compliant and informed, you can avoid penalties and IRS scrutiny while fulfilling your civic duties as an American abroad.

Navigating U.S. tax rules can be complex, especially for foreign-owned U.S. businesses. One key form to know about is Form 5472. This guide explains who needs to file it, deadlines, and tips to stay compliant.

Who Needs To File Form 5472?

If your business fits any of these categories, you need to file Form 5472:

• 25% Foreign-Owned U.S. Corporation – If a U.S. corporation is at least 25% foreign-owned and has reportable transactions with its foreign shareholder(s), it must file Form 5472. A “25% foreign-owned” corporation means one or more foreign shareholders directly or indirectly own at least 25% of the company during the tax year.
• Foreign Corporations Operating In The U.S. – A foreign corporation conducting trade or business in the U.S. must file Form 5472 for reportable transactions with related parties. “Related parties” include direct and indirect 25% foreign shareholders or entities connected through ownership or control.
• Disregarded Entities (DEs) – If a U.S. disregarded entity (e.g., a single-member LLC) is fully owned by a foreign person, it must file Form 5472, even if it doesn’t need to file an income tax return.

Deadlines For Filing Form 5472

• Calendar-Year Corporations – If your corporation’s tax year ends on December 31, Form 5472 is due April 15 of the following year.

Example: For a tax year ending December 31, 2024, the filing deadline is April 15, 2025.

• Fiscal-Year Corporations – For businesses operating on a fiscal year (e.g., ending June 30), Form 5472 is due on the 15th day of the third month after the tax year ends.

Example: If your tax year ends on June 30, 2025, the filing deadline is September 15, 2025.

Important: Missing these deadlines can result in penalties.

Need More Time? Extension Options

You can request a 6-month extension by filing Form 7004. This moves the deadline for Form 5472 to October 15 (for calendar-year filers). However, keep in mind:

• Taxes owed are still due by the original deadline (e.g., April 15 for calendar-year taxpayers).
• Extensions only apply to filing, not payments.

Special Rules For Foreign-Owned Disregarded Entities

• Filing Requirements – Even if a foreign-owned U.S. disregarded entity (DE) doesn’t owe income tax, it must still file a pro forma Form 1120 with Form 5472 attached. The pro forma return acts as a cover page and only requires basic details like the entity’s name and address.
• Submission Method – Unlike most forms, DEs cannot file electronically. You must send Form 5472 by fax or mail to the IRS at the designated address or number (available on the IRS website).

Penalties For Non-Compliance

Failure to file Form 5472 or maintain proper records can lead to penalties of $25,000 per failure, with more added if non-compliance continues. To avoid these costs, stay on top of deadlines and keep detailed documentation.

Conclusion

Filing Form 5472 correctly and on time is essential for foreign-owned U.S. businesses. Know your deadlines, request extensions if necessary, and ensure compliance to avoid penalties.

Managing taxes can be challenging, particularly when living overseas. 

Many Australian expats in the USA wonder, “What happens with taxes on Australian shares I still own back home?”

If you’re an Australian expat in the USA, there are a few things to know about the tax implications of holding Australian shares. 

You may already be aware of how the franking credit system in Australia works and how tax credits are tied to dividends. 

However, the US doesn’t have an equivalent system. 

Here’s how taxes on your shares work when you’re a US tax resident.

What It Means To Be A US Tax Resident

Let’s assume you’ve moved to the USA and are now a US tax resident. 

When you lived in Australia, you paid tax on all your worldwide income. 

Now, as a US tax resident, you’ll only need to pay Australian taxes on assets with a direct link to Australia.

However, the USA also taxes worldwide income, so income from both Australian and US sources must be reported. US tax rates vary by income type—ordinary income, capital gains, and qualified dividends, each with its own rate.

Owning Australian Shares

If you own shares in Australian companies, here’s how taxes apply to dividend income from those shares.

• Franked Dividends: In Australia, franking credits are added to dividends to reduce double taxation. For expats, these credits usually cover Australian taxes, so you won’t pay additional Australian taxes on franked dividends. However, no tax refund is provided for these credits, even though they offset your Australian tax obligation.
• Unfranked Dividends: Unfranked dividends don’t come with franking credits, so they’re taxed differently. Under the Australia/USA tax agreement, Australia caps the tax on unfranked dividends for US residents at 15%. Be sure to notify the share company that you’re a non-resident so they can apply the correct withholding tax; otherwise, you may need to report it later your tax return.
• Reporting in the USA: The USA considers dividends from Australian shares as taxable income. However, you may be able to claim the franking credit or tax withholding as a foreign tax credit, which reduces your US tax bill.

Inheriting Australian Shares

Australia doesn’t have an inheritance tax. So, when you inherit shares, they’re either valued based on their market price on the date of death or the original cost base paid for the asset. It depends on when the asset was acquired by the deceased. This amount becomes your “cost base,” which you’ll use later to calculate any capital gains tax if you sell the shares.

In the US, while beneficiaries aren’t directly taxed on inherited assets, an estate tax could apply to the estate if it’s large enough. The fair market value on the date of inheritance serves as your cost base for capital gains. 

Buying & Selling Australian Shares

Purchasing shares in Australia as a non-resident doesn’t trigger any immediate tax consequences. In usual cases non-residents don’t pay tax on the sale of Australian listed shares.

There is a narrow category of share sales that would be taxable in Australia, however. Generally, these relate to shares in companies that have Australian real estate.

The US imposes a capital gains tax, with different rates for long-term and short-term holdings. You may claim the Australian tax paid as a credit against any US tax due on the same capital gain to avoid double taxation.

Understanding Double Taxation

Australia and the USA have a tax agreement to prevent double taxation. 

This means that while you’ll need to report your income in both countries, you can usually apply tax credits for Australian taxes paid against your US taxes on the same income.

Using The Check The Box Election To Simplify Tax Treatment

For Australian expats with ownership stakes in Australian companies or entities, the Check the Box Election can offer significant tax flexibility and may simplify your US tax obligations.

The Check the Box election is a choice US taxpayers can make to treat an Australian business entity (such as a private company) as either a corporation or a pass-through entity for US tax purposes. 

If you choose to treat the company as a “disregarded entity” (for a single-member entity) or a partnership (for a multi-member entity), the income flows directly to you as the individual taxpayer. 

This may allow you to avoid some of the more complex reporting and potentially double-taxation issues that can arise with foreign corporate ownership.

However, if you opt to treat the Australian company as a corporation, it will be taxed separately, which can sometimes be advantageous but will introduce reporting requirements (such as filing Form 5471). 

Please consult with us further so we can better advise you of your position.

Holding Shares Through a Passive Foreign Investment Company (PFIC)

If your shares are held through a Passive Foreign Investment Company (PFIC), special US tax rules apply, which could increase your tax bill. 

The IRS defines a PFIC as a foreign corporation earning mostly passive income or holding mostly passive income assets.

US shareholders of a PFIC may face complex tax rules. 

To reduce tax, you might consider specific elections like the Qualified Electing Fund (QEF) or mark-to-market options, but these require filing IRS Form 8621.

Controlled Foreign Corporation (CFC) Rules

Under CFC rules, the US may tax you on undistributed income if you own a significant stake in a foreign corporation. If, along with other US taxpayers, you own more than 50% of an Australian company, the company may qualify as a CFC, requiring you to report certain types of income in the US.

Seek Professional Advice

International tax can be complex, and tax rules change often. It’s wise to speak with a CST tax advisor as we provide advice in both US and Australian tax advice.

Whether you have already moved to the United States or are planning to, there are tax implications for Australian expats to consider. 

For example, how does the Australia-US tax treaty apply to capital gains on the realization of assets, and what will your Australian and US tax obligations be? 

These are just a few questions this article will answer for you.

What Is Capital Gains Tax?

To begin, it is crucial to have a comprehensive understanding of capital gains tax concerning Australian expats. 

Capital Gains Tax or CGT is a tax on the profit made from selling an item classified as an asset. In Australia, as in the United States, CGT is complex and different from other taxes. Let us review both Australian and US CGT and then bring them together.

Australian CGT Tax

In Australia, CGT applies to any asset acquired after 20 September 1985. 

Selling an asset for more than it costs means you have a capital gain and must pay CGT. If an asset is sold for less than it cost, this results in a capital loss that can offset against current or future capital gains.

Generally, if an Australian tax resident makes a capital gain and the asset sold was held for at least 12 months, the 50% capital gain tax discount will apply. This results in half the capital gain being included in assessable income and being assessed at marginal rates of tax – which may vary between financial years. See the ATO website for the current individual tax rates. 

There are potential exemptions from the capital gains tax regime, including the main residence exemption.

A person’s main residence, which was moved into as soon as practicable after purchase and continues to be a person’s main residence for the entire ownership period, and on sale, if still a tax resident of Australia, will be exempt from CGT.

In relation to the main residence exemption, new laws passed in 2019, which came into effect 1 July 2020 now mean a total loss of this exemption if the property is sold while the taxpayer is a non-resident of Australia. There are some exceptions known as life events but careful planning is required to ensure the preservation of this exemption.

US CGT Tax

Under US law, the tax rate applied to capital gains depends on the asset’s holding period.

For assets held more than a year, you pay long-term capital gains tax, usually lower than the tax on ordinary income.

For assets held for less than a year, short-term capital gains tax rates apply, equal to your normal income tax rate.

Your income also determines the percentage of CGT you pay in the United States.

Your US CGT rate will depend on your taxable income. It is best to check the IRS website for the most current income thresholds for which CGT rate applies. 

There are also special circumstances under which your capital gains might be taxed at a higher rate. For example, net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.

Australia-US Tax Treaty And Its Impact On Capital Gains Tax

For Australian expats in the US, the Australia-US Tax Treaty is particularly important to understand. First signed into law in 1982, the treaty has been updated several times since then to address changes in areas such as superannuation and non-US investments.  

The Australia-US Tax Treaty determines where your tax obligations lie between the two countries. The overarching goal of the treaty is “avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income.” 

As we explain in this article, the Australia-US Tax Treaty, allows the tax paid in one jurisdiction to be claimed as a tax credit in the other jurisdiction, in the event that the income is assessable in both.  

For example, if the US sourced income is first taxed in the US and the income is then assessed in Australia, the tax first paid in the US will be taken up as a foreign tax credit against the tax assessed on the income. If the foreign tax credit covers the Australian tax, then any excess foreign tax credits are lost. If there is a shortfall after the foreign tax credit is applied to the assessed Australian tax, then extra tax will be required to be paid.

Tax Obligations When Selling A Former Main Residence In Australia

Let us look at an example to demonstrate how the Australia-US Tax Treaty affects Australian expats when selling their former main residence. 

An Australian couple moves to the US and lives there for eight years. They have decided to sell their former main home in Australia (purchased in 2015 for AUD1,000,000 and now worth AUD3,000,000).

Australian Tax Considerations

This couple would be classified as foreign residents and would not qualify for the CGT main residence exemption. As such, they will pay Australian CGT tax on the AUD2,000,000 (AUD3,000,000-AUD1,000,000) capital gain. 

However, if this Australian couple moves back to Australia and are considered residents for tax purposes and they reestablish the home as their main residence, depending on the length of their absence from Australia and whether they rented the property out or left it vacant, will determine whether a full or partial main residence exemption exists.

This example makes it clear that planning the timing of the sale of your former primary residence can and will have material tax implications. With that in mind, it is critical to get professional tax advice to optimize any potential or upcoming CGT liabilities.

It is important to note Australia also offers certain life event exemptions if they occurred during the time this family lived abroad, which could make them eligible for the CGT main residence exemption. 

The life events this includes are:

• You, your spouse, or your child under 18 had a terminal medical condition
• Your spouse or your child under 18 died
• The CGT event happened because of a formal agreement following the breakdown of your marriage or relationship

USA Tax Considerations

Any income earned, including employment income and realized capital gains, is subject to US tax. Australians who have become US tax residents, including green card holders and those in the US for over 183 days in the last two years, are taxed on worldwide income. This would include the AUD2,000,000 capital gain.

However, the U.S. allows a foreign tax credit for U.S. residents on US taxes owed against any tax already paid to Australia or vice versa. 

The Australia-US Tax Treaty requires that the combined taxes paid in both countries cannot exceed the total tax that would otherwise have been payable in the country where the sale occurs.

Australia And USA Combined Tax Considerations

If the Australian couple decided to sell their former main residence in Australia while being a non-resident for tax purposes, they will need to declare this income on both the Australian and US income tax return. 

As the property is situated in Australia, the first taxing rights reside with Australia. Tax will be applied at non-resident marginal rates on their AUD2,000,000 capital gain.  

For the US CGT, the tax on their AUD2,000,000 capital gain would be calculated depending on their combined income and the CGT rate applicable. 

Thankfully, this couple would not have to pay both the full amount of tax in Australia and the US, as the tax treaty allows taxpayers in each jurisdiction to avoid double taxation. In this case as Australia has the first taxing rights, the US would give the couple a tax credit for the tax paid in Australia and the excess tax paid will be carried forward.

CGT On Selling Shares Originally Purchased In Australia

Let us assume an Australian citizen moves to the US for a period of five years. During this time, they decided to sell the shares purchased while they resided in Australia.

The first aspect to consider is what their choice was when then became a non-resident of Australia. If an Australian tax resident moves to the US and becomes a non-resident and they hold a share portfolio, the choices on cessation of residency with respect to the share portfolio is either to take a deemed disposal or ignore the deemed disposal and treat the shares as Taxable Australian Property. 

A deemed disposal involves comparing the purchase price of the shares to the market value of the shares on the date that residency ceased. Importantly, there is no cash received with respect to this type of CGT happening and so if there is a large accumulated capital gain, then there will be a tax bill that requires payment from other funds. 

If the latter option is chosen (ie. they choose to treat the shares as Taxable Australian Property), any future sale of these shares are connected with Australia and a capital gain or capital loss requires calculation and reporting in the Australian income tax return, even as a non-resident.

Fortunately, the treaty provides a paragraph where future sales of this portfolio can be subject to tax solely in the US. If a choice is made to have future sales subject to tax solely in the US, then the deemed disposal on cessation of residency is ignored.

CGT On Inheritance In Australia

If an Australian citizen has lived in the US for 15 years and inherits an investment property and shares, what are the tax implications in both Australia and the US?

Inheriting Property

The original property was purchased for AUD500,000 and has a current market value of AUD2,500,000. If the property was sold on when inherited, there will be a capital gain of AUD2,000,000 (AUD2,500,000-AUD500,000). As Australia has the first taxing rights, tax will be applied at non-resident rates.

If they had no other Australian sourced income for the year in which the property was sold, tax on the capital gain of AUD2,000,000 would be AUD875,350.

The USA CGT tax on their AUD2,000,000 capital gain would be calculated depending on their combined income and the CGT rate applicable.

The Australian citizen would not have to pay both the AUD875,350 Australian CGT and US CGT as the treaty allows taxpayers in each jurisdiction to avoid double taxation. In this case, the US would give the person a tax credit totaling AUD875,350.

Inheriting Shares

If they inherit shares, they can choose to have any future sales solely taxed in the US under the Australia-US Treaty.

Get Help Navigating CGT For Australian Expats

There are many intricacies and challenges to navigating tax laws between countries. The information in this article may not cover some variables relevant to your circumstances and as such it is recommended you seek tax advice for your specific situation.

The U.S. government’s crackdown on offshore tax evasion has placed the Report of Foreign Bank and Financial Accounts (FBAR) in the spotlight. Many U.S. taxpayers with foreign accounts may not fully understand their obligation to disclose these accounts, and even fewer realize the severe penalties that come with failing to comply. For U.S. citizens, residents, and entities with foreign financial accounts, the stakes are high.

Understanding FBAR requirements and the line between non-willful and willful violations, including recklessness, can mean the difference between a reasonable penalty or a financial disaster. A key case illustrating this legal battlefield is Bedrosian v. United States, a cautionary tale for those who might be unaware—or choose to remain unaware—of their filing obligations.

FBAR Reporting Requirements And Penalties: An Overview

U.S. citizens, residents, and certain entities are required to file an FBAR if the aggregate value of their foreign accounts exceeds $10,000 at any point during the calendar year. This requirement applies even if the accounts don’t generate taxable income. The FBAR is filed annually with FinCEN, separate from tax returns.

Penalties for failing to comply are steep:

• Non-Willful Violations: Penalties for non-willful violations are generally capped at $10,000 per violation unless the taxpayer can show reasonable cause.
• Willful Violations: For willful violations, penalties can be far more significant, often up to 50% of the account balance or $100,000, whichever is greater. In some cases, criminal charges can also be brought.

The difference between willful and non-willful violations is central to determining penalties, and recent court cases and IRS guidance have clarified that recklessness can meet the standard for willful conduct.

Bedrosian Case: Recklessness Redefined

In Bedrosian v. United States, the issue of recklessness in the context of FBAR penalties took center stage. Arthur Bedrosian, a successful businessman from Pennsylvania, had held foreign accounts with UBS in Switzerland. Despite being aware of his FBAR obligations, he failed to report one of his accounts in 2007. The IRS imposed a $975,789 penalty, citing willful failure to file.

Initially, the district court sided with Bedrosian, ruling that his actions were non-willful, and reduced the penalty to $10,000. However, on appeal, the 3rd Circuit Court found that the district court had applied an incorrect standard of willfulness, specifically underestimating the role of recklessness in FBAR violations. The 3rd Circuit clarified that recklessness can indeed qualify as willfulness, and remanded the case for further review. Upon reconsideration, the district court determined that Bedrosian’s failure to report the account demonstrated at least reckless disregard, and the original penalty was reinstated.

Key Case On Recklessness: McBride And FBAR Penalties

A landmark case discussing recklessness in FBAR violations is United States v. McBride. In this case, the taxpayer, Michael McBride, failed to file an FBAR for his offshore accounts. The court found that McBride acted with reckless disregard of the filing requirements, even though he claimed ignorance. The court emphasized that recklessness could be inferred from a taxpayer’s knowledge of the law and his failure to comply with it, even if there wasn’t a clear intent to break the law.

The McBride decision underscored that a taxpayer doesn’t need to knowingly violate FBAR obligations to be penalized severely. Acting recklessly—such as choosing not to learn the rules or ignoring clear indications that filing is required—can be sufficient to trigger the harshest penalties.

IRS’s Approach To Determining Willfulness: The Role Of Evidence

The IRS takes a broad approach when assessing whether an FBAR violation was willful or reckless. In doing so, the agency looks at various forms of evidence to determine whether a taxpayer’s failure to file was due to deliberate intent, recklessness, or negligence. Key factors include:

• Prior Filings And Disclosures: The IRS may review past tax returns and FBAR filings to assess whether the taxpayer has consistently disclosed foreign accounts. A pattern of non-disclosure could suggest willfulness.
• Foreign Bank Communications: Correspondence between the taxpayer and their foreign bank can provide clues about willfulness. For instance, if the bank warned the taxpayer about FBAR requirements, and they still failed to comply, this could indicate recklessness.
• Education and Background Of The Taxpayer: The IRS will also take into account the taxpayer’s background and sophistication. For instance, someone with a high level of financial literacy, such as a business owner or an individual working in finance, is more likely to be held to a higher standard of knowledge regarding their obligations. In Bedrosian, for example, his years of financial dealings and awareness of offshore accounts contributed to the court’s determination of recklessness.
• Taxpayer Behavior: Deliberate concealment, such as moving funds to different jurisdictions or closing accounts after learning of an investigation, can be viewed as willful.

The Internal Revenue Manual also provides guidelines for IRS examiners to follow when assessing willfulness. The IRS is particularly focused on patterns of behavior that demonstrate a conscious choice to disregard the law.

What Does This Mean For Taxpayers?

Taxpayers who hold foreign accounts must be aware of the serious consequences of failing to comply with FBAR requirements. The distinction between willful and non-willful violations is often determined by the taxpayer’s behavior and the totality of the circumstances, not just their direct knowledge of the law. The IRS will scrutinize the individual’s past filings, communications, and behavior to determine whether their failure to file was reckless or deliberate.

As seen in McBride and Bedrosian, recklessness doesn’t require overt intent to evade the law. Simply failing to act on information, or ignoring a known legal duty, can lead to penalties amounting to 50% of the account balance. The IRS’s focus on recklessness means that taxpayers cannot afford to be passive about their foreign accounts. They must actively ensure compliance or risk facing substantial financial penalties.

Conclusion

With the growing focus on offshore tax evasion, the U.S. government has ramped up its enforcement of FBAR penalties. The Bedrosian and McBride cases highlight the importance of understanding the broad definition of willfulness, which includes reckless conduct. Taxpayers who fail to disclose foreign accounts may face severe penalties, even if they claim ignorance. Staying informed and seeking expert advice is critical for anyone with international financial interests.

Declaring Foreign Business Interests

Navigating the U.S. tax code can feel like tiptoeing through a minefield, especially when you throw in international dealings. 

If you’re a U.S. person or corporation with foreign business interests, two forms in particular—Forms 5471 and 5472—might already haunt your dreams. 

Dubbed the “Terrible Twosome” by some beleaguered taxpayers, these forms come with stringent filing requirements and draconian penalties for non-compliance. 

Here’s why you should never forget to file these forms, what the consequences of forgetting are, and some recent developments that might surprise you.

What Are Forms 5471 And 5472?

Form 5471 is essentially an information return that must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations. 

The form requires detailed disclosure about the foreign corporation’s income, assets, and shareholders.

Form 5472 on the other hand, is used by U.S. corporations that are at least 25% foreign-owned, or by foreign corporations engaged in a U.S. trade or business. 

This form requires disclosure of reportable transactions between the reporting corporation and related foreign parties.

While both forms may seem like just another piece of paperwork, failure to file them—or filing them incorrectly—can lead to massive penalties.

The Fines:

Staggering and Unforgiving The IRS takes non-compliance with Forms 5471 and 5472 very seriously, with penalties that could make even the most seasoned tax veteran wince. 

For Form 5471 the penalty starts at $10,000 per year per foreign corporation. 

If the taxpayer fails to correct the omission within 90 days of being notified by the IRS, additional penalties of $10,000 accrue every 30 days, up to a maximum of $50,000. 

Form 5472 penalties are even harsher, starting at $25,000 for each accounting period the form is not filed. 

After the IRS sends a notice of failure, an additional $25,000 penalty kicks in for each subsequent 30-day period of non-compliance, with no cap on the penalties. 

These penalties apply whether the non-compliance was willful or due to an innocent mistake, although options for relief exist in cases of non-willful conduct. 

However, this relief is often difficult to obtain and requires demonstrating reasonable cause for the failure. 

No Statute Of Limitations? Yes, You Read That Right

One of the most terrifying aspects of failing to file these forms is that it can leave your entire tax return open to scrutiny indefinitely. 

Normally, the IRS has three years from the date you file your return to audit it. 

However, if you fail to file Forms 5471 or 5472, that statute of limitations does not apply. The IRS could theoretically go back and audit that return 10, 15, or 20 years later. 

Recent Developments: A Small Ray of Hope?

A recent Tax Court case, Farhy v. Commissioner, had thrown a wrench into the IRS’s penalty regime. 

In April 2023, the court ruled that the IRS did not have the statutory authority to assess penalties under Section 6038(b) for failing to file Form 5471. 

The IRS had been enforcing these penalties for years, but the court found that there was no legal basis for these assessments.

However this Tax Court Ruling was subsequently overturned by the United States Court of Appeals, District of Columbia Circuit on  3 May 2024.

Conclusion: Don’t Tempt Fate

If you have foreign business interests and think you might need to file Form 5471 or 5472, the best advice is simple: file them. 

Even if the forms are a headache and the rules seem complex, the potential costs of non-compliance—financial and otherwise—are simply too high to ignore. 

And as the Farhy case shows, while there may be occasional victories against the IRS, they are the exception rather than the rule. 

So, stay vigilant, keep those forms in mind, and avoid becoming another cautionary tale in the annals of tax non-compliance. 

The “Terrible Twosome” might be formidable, but with careful attention and professional guidance, they don’t have to be your undoing.

For many people the United States is a major investment jurisdiction.

Whether that investment is made into stocks, bonds, managed funds, real estate or shares in US private companies – the size and scale of the US market is often irresistible for international investors.

One of the downsides of investing directly into the US can be that non-residents of the United States who own U.S. assets can be subject to U.S. estate tax.

This can significantly impact their estate planning strategies by imposing a significant cost on their estate.

This article discusses the exposure of non-residents to U.S. estate tax, the benefits of estate tax treaties, the relevance of international wealth in estate tax calculations, and the formalities required to transfer U.S. assets to beneficiaries. 

U.S. Estate Tax for Non-Residents

Non-residents of the U.S. are subject to estate tax on their U.S. situs assets, which include real estate, tangible personal property located in the U.S., and certain intangible assets such as stocks of U.S. corporations. 

The tax rates range from 18% to 40%.

Importantly the exemption amount is significantly lower for non-residents than for U.S. citizens and residents, currently only $60,000.

Estate Tax Treaties

The U.S. has estate tax treaties with several countries, including Australia, Canada, France, Germany, Italy, Japan, the Netherlands, South Africa, Switzerland, and the United Kingdom. 

These treaties can provide several benefits, including:

Unified Credit

Some treaties allow non-residents to use the unified credit available to U.S. citizens, which can significantly reduce the estate tax liability. 

Exclusions And Deductions:

Treaties may provide for exclusions of certain types of property or deductions for debts, taxes, and expenses.

Relief From Double Taxation:

Treaties can prevent double taxation by providing rules for the allocation of taxing rights between the U.S. and the treaty country.

Relevance Of International Wealth

For non-residents, the U.S. estate tax is generally limited to U.S. situs assets.  

However, the international wealth of foreigners can still be relevant in certain situations.

For example, under some treaties, the U.S. may consider the decedent’s worldwide assets to determine the allowable unified credit or to apply pro-rata deductions. 

Example Calculation (Singapore Resident: No Estate Tax Treaty With US)

The non-resident owns a $1,000,000 U.S. property and has no debts or other deductions: 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Exemption Amount: $60,000 

3. Taxable Estate: $940,000 

Using the U.S. estate tax rates, the estate tax liability would be calculated based on the progressive rates. 

For simplicity, assume the effective tax rate is around 34% for this taxable estate size: 

Estate Tax Due: $940,000 x 34% = $319,600

This is major cost on a deceased estate and something that can be planned for ahead of time.

They key point here is to be aware of strategies to minimize or eliminate US estate tax.

Example Calculation (Australian Resident: Estate Tax Treaty With US)

The U.S.- Australia Estate Tax Treaty can provide relief and reduce the tax liability. 

Consider an Australian resident who owns a $1,000,000 U.S. property and has $5,000,000 in worldwide assets. 

The unified credit for U.S. citizens in 2024 is $13,000,000. 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Worldwide Estate: $6,000,000 

The proration of the unified credit is calculated as follows: 

Prorated Unified Credit = U.S. Situs Assets/Worldwide Assets  X Unified Credit

Prorated Unified Credit = 1,000,000/6,000,000 x 13,000,000 = 2,166,66 

The effective exemption amount is $2,166,667. 

 3. Taxable Estate: 

Since the U.S. situs assets ($1,000,000) are less than the prorated unified credit ($2,166,667), the taxable estate is reduced to zero. 

 4. Estate Tax Due: 

 With a taxable estate of zero, the estate tax liability is also zero.

Formalities For Transferring U.S. Assets

For those beneficiaries of deceased estates that have to deal with the transfer of U.S. assets from a deceased resident to a beneficiary, the following steps are required:  

1. Obtain A Transfer Certificate: 

The IRS requires a Transfer Certificate (Form 5173) to release the U.S. assets. 

This certificate ensures that all applicable estate taxes have been paid or secured. 

2. File Form 706-NA: 

The executor must file Form 706-NA, U.S. Estate (and Generation-Skipping Transfer) Tax Return, to report the U.S. situs assets and calculate the estate tax due. 

3. Pay Estate Tax: 

Any estate tax due must be paid. 

In the above examples, in Singapore the estate tax due is $319,600. Whereas in the case of the Australian estate no tax is due. 

4. Submit Documentation: 

Provide the IRS with necessary documentation, including the death certificate, will or trust documents, and appraisals of the U.S. assets. 

 5. Transfer of Title: 

Once the Transfer Certificate is obtained, the executor can proceed with the transfer of title of the U.S. assets to the beneficiaries as per the deceased’s will or trust documents. 

Conclusion

Other strategies exist to manage this exposure, including the formation of trusts in certain US states to hold assets.

The key point here is to plan the way you hold your U.S. assets as early as you can.

Indeed, those people who are non-residents of the U.S. holding US assets from countries that do not have an Estate Tax Treaty with the U.S. have the most severe exposure.

Please contact us to discuss any concerns or questions you might have with respect to holding US assets.

The United States tax code presents a labyrinth of rules and regulations, particularly for U.S. residents with investments in foreign corporations. These complexities are magnified when dealing with Controlled Foreign Corporations (CFCs) and the associated immediate taxation of foreign earnings under Subpart F or the Global Intangible Low-Taxed Income (GILTI) regime. This article delves into Section 962 of the Internal Revenue Code (IRC), explaining its significance and utility for U.S. tax residents in managing their foreign investments more effectively.

The Challenge: Immediate Taxation of Foreign Earnings

For U.S. tax residents with investments in foreign corporations, including those held through pass-through entities such as partnerships and S corporations, immediate taxation of foreign earnings is a significant challenge. This taxation arises annually under the Subpart F or GILTI regimes, compelling taxpayers to include foreign income in their U.S. taxable income, often leading to double taxation without relief mechanisms available to corporate taxpayers.

Corporate vs. Individual Taxpayer Treatment

The tax burden disparity between corporate and individual taxpayers under the GILTI regime is stark. U.S. corporations benefit from a reduced federal income tax rate of 21 percent, a Section 250 deduction that allows them to deduct up to 50 percent of GILTI, and the ability to claim up to 80 percent of foreign taxes paid as a foreign tax credit. This combination of benefits significantly mitigates the impact of GILTI on corporate taxpayers.

Conversely, U.S. resident individuals are generally taxed at a federal income tax rate of up to 37 percent on GILTI, without access to the Section 250 deduction or foreign tax credits for GILTI. This discrepancy creates a substantial tax burden for individual taxpayers, necessitating a strategy to level the playing field. This is where Section 962 of the IRC comes into play.

How Section 962 Election Works

A Section 962 election allows U.S. individuals to elect to be taxed on their GILTI and Subpart F income at corporate tax rates. When an individual makes this election, they are effectively treated as if they own their CFC through a hypothetical domestic corporation. This election provides several advantages:

1. Corporate Tax Rate: The taxpayer is subject to the 21 percent corporate tax rate instead of the higher individual rates.
2. Section 250 Deduction: The taxpayer can avail the Section 250 deduction, reducing GILTI by 50 percent.
3. Foreign Tax Credit: The taxpayer can claim an indirect foreign tax credit for taxes paid on the CFC’s net income in the foreign country, up to 80 percent of the foreign taxes paid.

Practical Example Of Section 962 Election

Consider a U.S. individual who wholly owns a CFC in Germany with net tested income of $1,000 for GILTI purposes, having paid $150 in foreign taxes. Without a Section 962 election, the individual faces a 37 percent tax rate on GILTI, resulting in $370 of U.S. tax, without any foreign tax credit or Section 250 deduction.

However, with a Section 962 election:

• The income is taxed at the corporate rate of 21 percent.
• The individual can deduct 50 percent of the GILTI under Section 250, reducing the taxable income to $500.
• Adding back the $150 foreign tax paid (gross-up), the taxable income becomes $650.
• Applying the 21 percent corporate tax rate results in $136.50 of U.S. tax.
• After claiming 80 percent of the $150 foreign tax as a credit ($120), the U.S. tax liability is reduced to $16.50.

Future Distributions And Tax Implications

The tax advantages of a Section 962 election extend to future distributions. In the example above, when the taxpayer eventually receives a distribution of $1,000 from the CFC, it will be taxed at the qualified dividend rate of 20 percent plus the 3.8 percent Net Investment Income Tax (NIIT), resulting in $238 of U.S. tax. Without the election, distributions would typically be subject to ordinary income tax rates, leading to higher tax liabilities.

When To Make A Section 962 Election

Despite its benefits, a Section 962 election is not always advantageous. Some scenarios where the election might not be beneficial include:

1. Same-Year Repatriation: If the CFC’s earnings are repatriated in the same year, the benefits of the election may be negated.
2. State Tax Considerations: Not all states follow the federal tax treatment. States like California do not tax Subpart F or GILTI until a distribution is made, meaning the Section 250 deduction and foreign tax credits may not be available for state tax purposes.
3. Future Tax Increases: Future distributions from previously taxed earnings under a Section 962 election might be taxed at higher rates, potentially offsetting the initial benefits.

Conclusion

Section 962 of the IRC offers a powerful tool for U.S. tax residents with investments in foreign corporations to manage their tax liabilities more effectively. By allowing individuals to be taxed at corporate rates and claim deductions and credits typically available only to corporations, this election can significantly reduce the tax burden associated with GILTI and Subpart F income. However, the decision to make a Section 962 election should be based on a careful analysis of individual circumstances and potential future implications. Consulting with a tax professional is essential to navigate the complexities and determine the best tax strategy.