Tax Implications of Life Abroad

Posted on June 16, 2007
Filed Under Cost of Living, Expat Tips, Taxes | 10 Comments

The US is one of the few countries that taxes its citizens based on their world income. This means that you need to file a tax return whether you live in the US or not. There is some debate as to whether this policy should be revised, however it is not likely to change soon. Countries wishing to attract foreign nationals, like Uruguay, usually only tax income earned in the country. Others like Brazil, tax on world income, but only if you are a resident for more than 6 months of the year.

The truth is that few countries have the muscle to even attempt to enforce collection of taxes on worldwide income. The US, however, is one of those countries and the IRS is not organization to be toyed with. Paradoxically, even gains from illegal activities are subject to taxes in the US. Al Capone, for example, went to jail not because of the crimes he committed, but because he did not pay taxes on his very illegal activities. So if you are an American citizen and plan to live in Uruguay you should pay close attention to the IRS rules regarding life abroad. Since an exhaustive treatment of the subject would fill a few books and would bore you to tears, I’ve dug up only a few important points. (Keep in mind I am not a legal or tax expert and it is best to consult with one.)

Foreign Earned Income Exclusion (FEIE) – After you are living in Uruguay for a complete tax year, i.e. Jan 1 to Dec 31st, you may qualify for the FEIE (see comments below for an alternative method for qualifying). The exclusion is currently US$ 82,400, but only applies to earned income. If you are married and reside abroad and both have foreign earned income, the exclusion amount is $164,800. But the exclusion does NOT apply to any income from interest, dividends, capital gains, pensions, annuities and Social Security benefits. It can be used however by people doing business in Uruguay and earning money while there. See this publication for more details. Please note that it can only be used AFTER you have lived a whole tax year in Uruguay. So you may want to plan your “move” for December rather than January.

After you have lived abroad for a full tax year, you can file an amended tax return for the prior year to take advantage of the year you have lived abroad only partially. The exclusion amount is scaled by a factor equal to the number of days lived in the country that year divided by 330.

If you have other income that is not excluded (or income above the exclusion amount), the taxes you pay on those amounts are as if you had not claimed the exclusion. For example, if you earn 100,000 while working in Uruguay, you have an exclusion of 82,400, you must pay taxes on the 17,600. However, the tax rate on the 17,000 corresponds tax rate for income of 100,000, say 25%, instead of 15%. These numbers are for illustration only, the real worksheet can be found here. Also, please note that the U$S82,400 exemption is an IRS only thing and has nothing to do with Social Security. So if you are self employed, you will still need to pay 15.3% of your pay to Social Security. You do that by filing the SE schedule with your 1040.

Social Security Benefits – Social Security benefits can be taxable depending on your total income. If your income + ½ of your Social Security benefits is below 32,000 for married couples or 25,000 for singles, the Social Security income is not taxable. If your income is above that amount, you need to use a worksheet to find the taxable amount. For higher incomes, up to 85% of the Social Security benefit payments may be taxable.

Foreign Tax Credit - If you pay income taxes in Uruguay (not VAT) or in another foreign country, you can use the Foreign Tax Credit provision. This can be used to prevent double taxation issues, but the amount of credit received will depend on the percentage of total world income that is actually earned in that country. But the Foreign Tax Credit cannot be used for incomes covered by the US$ 82,400 exclusion.

Now that I put you to sleep, you’ll need to drink a lot of mate to wake up.

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10 Responses to “Tax Implications of Life Abroad”

urufish on June 16th, 2007 10:47 am

Great post… for non americans, like me, it’s very interesting to see how we (Canadians) differ from the US. Each of us has different pros and cons…
Canada is also one of those ‘world income’ countries. If we are out of the country for 6 mohths, and give up all of our ties to Canada (close bank accounts, cash in our retirement plans, cancel our credit cards, cancel social memberships, etc), we can apply to our IRS to be labeled a non-resident. If they approve, we do not have to pay any taxes to Canada on any income earned from anywhere, but we still must file. Even though we live outside of Canada for more than 6 months a year, if we do not cut all ties with the motherland, we can not be non-residents in the eyes of the CRA (our IRS) and we must report all income and pay full tax on it.. We don’t have any exemptions like you have.

Someone told me that if US citizen becomes resident elsewhere, becomes a non-resident of the USA, you still have to pay taxes (based on your above formulae) for the following 10 years? Is this true?

Canada will also you to credit taxes paid in another country but ONLY if that country has a reciprocal agreement with Canada. Unless Uruguay has entered into such an agreement with Canada, a Canadian working for a company in Uruguay, paying income taxes in Uruguay, will be double taxed.
Brazzie on June 16th, 2007 11:33 am

I am glad you explained the tax implications for Canadian residents. I was tempted to research that but got lazy.

If you are an American citizen and live abroad, the only way not to be taxed permanently is to renounce your citizenship. However, the US will automatically assume that you are doing it to evade taxes and will continue to tax you for the next 10 years. By renouncing the citizenship, when traveling to the US, you will need to apply for a visa like everybody else and may be denied entry.

So it is not something to decide on a whim.
Chuck Stull on June 16th, 2007 1:10 pm

Interesting topic!

For US citizens living abroad, the earned income exclusion doesn’t require a Jan 1 - Dec 31 period. As long as someone is physically our of the country for 330 days (out of 365) they would be able to exclude the $82 thousand of earned income. For example, many professors leave for an academic year (typically September - August) and they are eligible for this tax exemption.
Brazzie on June 16th, 2007 1:21 pm

Thanks Chuck for catching that. You are right, I only mentioned one of the two possibilities to qualify as living abroad. The second one is called Physical Presence Test and you qualify if you are outside the US for whatever reason (could be on vacation) for 330 days out of 365. See details here:
http://www.irs.gov/publications/p54/ch04.html#d0e2807
urufish on June 16th, 2007 4:06 pm

Ok Chuck… Does the 82k deduction apply if the income came from a US employer or does it only apply if it comes frm a non US employer?
I assume it must be the latter or a lot of IT staff would be moving south.
urufish on June 16th, 2007 4:09 pm

Oh yah.. and for you other Canucks out there scheming to avoid taxes, you also can not come back to Canada on a regular basis. If you come back on what looks like a vacation or homesickness take a quick boo basis, you’re OK. But if you come back regularly. like every few months, it will look like you’ve got some business to take care of and you’ll become a resident (for tax purposes) again.
Brazzie on June 16th, 2007 4:15 pm

urufish, the link provided in the article explains the income source issue in detail.

To summarize it: it does not matter where your payment comes from, as long as the work is done abroad while you are living abroad.
Urufish on June 16th, 2007 6:12 pm

wow.. now there’s a business.. wooing American programmers to Urugay to work tax free at half the cost of living from back home.. that’s like a 2-3 fold increase in standard of living.
kcwinkleman on June 23rd, 2007 8:25 pm

Be aware that if you work for an American company as a private contractor outside of the USA, you are still liable for paying Social Security tax. They consider you to be self-employed. No U$S82,400 exemption for SS tax if self-employed.

If you are employed by a foreign corporation you are not subject to Social Security tax.
Brazzie on June 23rd, 2007 8:52 pm

Hi kcwinkleman, good point.

The U$S82,400 exemption is an IRS only thing and has nothing to do with Social Security. So if you are self employed, you will still need to pay 15.3% of your pay to Social Security. You do that by filing the SE schedule with your 1040.

I will add this info to the text.

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