This post is intended for a specific target audience: American citizens who reside outside the USA and its territories. Not one of those? Go find something else to read, preferably on this blog.
There is a further refinement to my audience: I am assuming that, like me, you are not wealthy. You do not earn more than the equivalent of US$ 100,800 per year, you have no hidden offshore accounts, no substantial savings or a complicated financial portfolio. You are like the majority of Americans abroad that I know: artists, students, freelancers, church workers, etc. who make enough to get by (most years) and just happen to like living where they do. If you do have money and a complex financial portfolio, you can afford a tax attorney to think about these things for you. This post isn’t for you either.
Finally, nothing I write here should be construed as legal advice. I’m not qualified to give it. I am simply going to share with you what I do every year, and why, and give you hyperlinks to original government documents to back it up. However, those documents are open to various interpretations and you may come up with a different approach.
Okay, here we go… I’m going to number the paragraphs so you can work through them one by one.
1) First of all, don’t panic; just bite the bullet. As long as you remain an American citizen you are going to have to give one day per year, at least, to keeping the US government happy. Get over it. My suggestion is to set aside a day – reserve it in your diary! – as soon as you have gathered all the written evidence of your income and financial dealings of the previous year, but certainly before June 15 of each year (p 7; the normal filing deadline is April 15, but if you live abroad you get an automatic two-month extension; just claim it in your cover letter). The sooner you can get this done, the better; it won’t be hanging over you, spoiling your Spring.
2) Which Americans, living overseas, should file US tax returns every year? The IRS provides an overview of who MUST file a return (pp 7-10), but my short answer is: if you are living abroad, you should do it. If you are like me, you will not actually have to PAY any taxes but it is wise to FILE every year and have the confidence that you are up-to-date with the IRS. You don’t want something coming back to bite you later. And besides, if you ever entertain giving up your US citizenship, the IRS will have to be told so that you can meet any outstanding obligations (different links either side of the comma; for the latter one see: “Documents” section, and the very last paragraph). Best to have things tidy and not be trying to file back-taxes at that point.
3) So, gather your financial information: collect all the income-related forms from your employers and financial institutions, and any information you have about taxes you paid to other nations. Essentially, anything that pertains to your income, investments, bank accounts, etc. And of course you will need to know your US Social Security number (or “TIN” as it is now referred to – Taxpayer Identification Number).
Make a list of ALL your financial accounts anywhere, any personal accounts that you have authority over: include the account number, institution name and address, the maximum balance during the year for the account in its local currency, plus the equivalent in US dollars (using an exchange rate approved by the US government, important: see my *Note at the bottom of this article about using these numbers). Aside from giving you a good picture of where you’re at financially, it will be necessary to help you know if you need to file FBAR or FATCA statements (we’ll get to that).
4) In fact, let’s go ahead and get FBAR out of the way. This has nothing to do with taxes but it is required anyway. It is part of the US Treasury’s attempt to hem in money laundering. Who must file FBAR? “A United States person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year.” So, if the total of your foreign accounts together went over US $10,000 at any time during the previous year, you need to file this document. And you need to do it by June 30 of each year, no exceptions. The whole thing is done online on a fairly straightforward form with instructions in the menu to the right (from which the quote above is taken).
5) Back to filing taxes with the IRS. Depending on your investments or assets you may need a variety of IRS forms and schedules but these are the ones I’ve been getting by with: Form 1040, Form 2555-EZ, Form 8965 (Obamacare exemption!), Form 8938 (FATCA!), and if you are self-employed Schedule SE and Schedule C. Just buy some extra printer ink and paper and print out the forms you need in duplicate (one for you, one for the IRS) and the instructions, if you don’t want to read them online (but don’t print out the instructions for Form 1040; that would be ridiculous). Form 1040 is the main form that draws all the bits and pieces together from the others, so have it in front of you but plan to complete it last of all.
Now we’ll look at the forms one by one:
6) Form 8965. Might as well start with the easiest one; you probably don’t need this form at all, but you should know what it is: The chances are really good that you already have some kind of health insurance coverage, likely through private coverage or a national medical coverage plan. So, if you want to make sure you don’t get bothered with the Affordable Care Act (Obamacare) and you’ve been covered by another plan for all 12 months of the previous year then all you have to do is tick the little box on Form 1040, line 61 (and leave the amount blank). If for whatever reason you need to clarify or specify the nature of your exemption (or you simply enjoy doing redundant paperwork) submit Form 8965. Most Americans abroad will have an exemption based on code “C”. (See instructions.)
7) And now a form many of my (poor) friends can ignore: Form 8938. This has to do with the much hated FATCA and is the IRS’s version of tracking your foreign financial assets. Fortunately their threshold for Americans abroad having to file this form is considerably higher than the US Treasury’s FBAR above. For example: “If you are not married, you satisfy the reporting threshold only if the total value of your specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.” (The threshold is the same for married individuals filing a separate return from their partner.) Remember, US dollars, not Canadian ones. So, if the value of your foreign financial assets is less than the amounts specified above you “get out of jail free” and can skip this step entirely. Refer to the Form 8938 instructions to be sure. And keep in mind that when you DO have that amount of money, you’ll need to start filing this form.
At this point you’ve probably started daydreaming about joining a religious order and taking a vow of poverty, or keeping all your assets in the form of gold coins in a sock under your bed. Or, if you completely trust your non-US-citizen partner, let them hold all the assets until they die. Okay, focus…
8) This next step is only for self-employed people (you do have income from work but you don’t have an employer taking taxes from your pay check). Do Schedule C, Profit and Loss from a Business, and then do Schedule SE, Self-Employment Tax. See, here’s the thing: if nobody is taking taxes from your pay check then it is quite likely that you are not putting anything aside for a state-run old age pension. So you’ve got to pay that tax to the US government. However, there is also a likelihood that the country you are living in has a social security agreement with the USA and you might be covered simply by virtue of being a legal resident in that country. If so, you might ask your local social security office (of the country where you reside) for a document showing you are covered. If you can do that, you may not be liable for any American self-employment tax and can skip this step too. Research it.
So far, so good. If you are like me, you haven’t had to do anything yet except tick the box on Line 61 of Form 1040. Now for some serious work…
9) Form 2555-EZ. This one is important. It establishes that you are a legitimate resident of a foreign country and thus provides you with an exclusion: the first big chunk of your income will not be taxed by the US. In 2015, that amount is up to US$100,800, if you haven’t spent any days in the USA on business in the past year. You may need to use the regular Form 2555, but most of the people I know can use the EZ version and qualify as “Bonafide Residents” of a foreign country.
Really important: when you finish this form and get to 2555-EZ’s line 18 you will have an amount of income you can exclude from US taxes (in my case, all of my income). You need to take that amount and put it in parentheses on the main tax form, Form 1040, on line 21. Next to it write “2555-EZ.” The parentheses makes it a negative value.
10) We’re almost there now; on to the big one: Form 1040. The first sections are fairly simple. Then comes the record of your Income. If you did Form 2555-EZ and carried the amount over to Form 1040 (above) then all your foreign earned income is already accounted for and marked down as a negative value (in parenthesis) on line 21. You should not re-enter those same wages again on a different line (for instance line 7). Fill in the other income lines as necessary, leaving them blank if you have nothing. I never have any, so the total of my income (Line 22) is always a Big Fat “0”. In fact, the next sections are also all blanks for me, so I end up with “0” at lines 37, over the page at 38, 56, 63, 74 and 78. But your situation is likely to be different. Just go line by line, looking up the instructions if you need help. Don’t get bogged down by stuff that only applies to people living in the USA. Make sure to tick the box at Line 61 if you had a full 12 months of medical coverage. Don’t forget to sign and date Form 1040 and you’re done.
11) Finally (yeah!), write a cover letter to the IRS. Very simple; the less words, the better. You want to claim – if necessary – the automatic two-month extension given to those whose tax home is abroad and who were living outside the USA on the normal filing deadline (April 15). Further, you trust that all is in order with the enclosed forms. Sign off, and give your Social Security Number and your full address. Keep a copy of your forms and your letter for yourself! Put everything in a safe place (you’ve got some serious personal information here).
Send your letter and your completed tax forms with enough postage to the proper address. Put your feet up and have a drink.
I know, I know, it is totally ridiculous that American citizens living abroad – all 6.3 million of us – have to go through this every year. Taxation without representation, anyone? But, it’s the law and to make life easier you need to be on the right side of it. Good luck!
I have tried to keep this short and simple, and make sure the hyperlinks are correct. However,if there are any mistakes, please let me know and I will update it. Again, this is not legal advice; this is my experience. Americans living abroad can find more helpful information and resources here.
*Note about using the Treasury historical exchange rates (point 3 above): these rates are given in the configuration of US$ 1.00 = x foreign currency. However, if you earned money outside the USA, you want the opposite configuration, or Foreign Currency 1.00 = x US$? Do this with your calculator: enter 1.00 (for US dollars) and divide it by the number given on the chart for your foreign currency. Then multiply your foreign income by that number. Here’s an example using Canadian dollars, using the Treasury rate given for 30 September 2015: 1.00 divided by 1.3410 (the number on chart) = 0.7457. That’s how much 1.00 Canadian dollar was worth in US dollar amount; so now multiply your Canadian income by .7457 to get the US dollar equivalent. If you had C$ 10,000 in income, it would be equivalent to US$ 7,457. Got it?