“The nuances of US tax filings for overseas US citizens and permanent residents” by Josephine L. Adalem (April 26, 2010)

SUITS THE C-SUITE By Josephine L. Adalem
Business World (04/26/2010)

In recent years, the world has seen a great deal of mobility involving people who are willing to relocate outside their home countries when presented with opportunities for career growth, expatriate lifestyles, or some other personal or professional reasons.

People who are not citizens of the countries where they work or reside must be aware of the income tax laws of both their home and host countries.

Most countries impose income tax on non-residents (citizens or aliens) based on the source of the income, that is, where the income was earned or derived. Specifically, with respect to performance of services, income tax is imposed only on compensation earned for services performed in the taxing country.

Under Philippine laws, for instance, while resident Filipino citizens continue to be taxed on their global income, non-resident Filipino citizens are subject to Philippine taxes only on income derived from Philippine sources. Similarly, aliens, whether residents or non-residents, are subject to Philippine income tax only on their income from Philippine sources.

But still, there are a few countries that do not adhere to this principle. The United States is one of them.

Thus, citizens and lawful permanent residents (or green card holders) of the United States should not assume that once they leave the United States, they no longer have the obligation to pay US federal taxes or have to file US tax returns.

A US citizen or green card holder living in a foreign country is subject to the same US income tax laws applicable to US citizens and green card holders living in the USA. In short, they may still owe the Internal Revenue Service (IRS) federal taxes each year. This is because they are subject to US federal taxes on their worldwide income. Hence, if a US citizen or a green card holder does not file a US tax return, the statute of limitations on tax assessments will not run.

Those living outside of the US for some time, and have never filed tax returns for all those years that they were away, may be assessed by the IRS if they decide to return and re-establish residence in the US. The IRS can assess the income tax liability based on a mere estimate of the individual’s income. Without knowing it, the interest and penalties may already have exceeded the amount of the original taxes owed.

A US citizen or a green card holder who is employed (or self-employed) outside the US can claim foreign earned income and housing exclusions or deductions if he qualifies as a bona fide resident of a foreign country or if he lives in that foreign country for 330 days out of any consecutive 12-month period. The maximum foreign earned income exclusion for 2009 is $91,400.

It should be noted that these exclusions are not automatic and can be claimed only if the taxpayer files Form 1040 (Individual Income Tax) with Form 2555 (Foreign Earned Income) where the exclusions are claimed.

Failure to file these forms can cause a taxpayer to lose the benefit of claiming the exclusions.

Another exclusion is called “foreign housing exclusion.” This allows the taxpayer to claim an additional amount in excess of the $91,400 foreign-earned income exclusion, if the rent, utilities, etc. he pays for his residence abroad and other living expenses exceed $14,624, an amount established by the IRS. Note that this housing exclusion can be claimed only if earnings are in excess of the $91,400 foreign-earned income exclusion.

In addition, the IRS enacted new laws starting in 2006 that limit housing expenses that could qualify for the housing exclusion.

Claiming the exclusions must be made with (1) a timely filed return, (2) a return amending a timely filed return or (3) a late-filed return filed within one year from the original due date of the return.

US income tax returns are due for filing with the IRS on April 15 after the close of the taxable year, which is the calendar year. US citizens and green card holders are given an automatic extension of up to June 15 to file their tax returns if they maintain their tax home and residence outside of the United States on Apr. 15.

The individual can choose the exclusions on a return filed after the periods described above, provided he owes no federal income tax after taking into account the exclusions. If he owes federal income tax after taking into account the exclusions, he can choose the exclusions on a return filed after the deadlines but hopefully, before the IRS discovers that he failed to do so. If the IRS finds out that he owes federal income tax after taking into account the foreign earned income exclusion and that he failed to choose the exclusion, he must request the IRS for a private letter ruling.

Claiming foreign tax credit

A US citizen or a green card holder may claim foreign tax credit (FTC) for taxes paid in a foreign country. He cannot, however, claim any credit for taxes paid on any income for which he claimed the foreign-earned income exclusion and/or foreign housing exclusion.

FTC attempts to reduce or eliminate any double taxation of income by both US and the foreign country by allowing credits for foreign income taxes incurred while living outside the US against US income taxes. This credit may totally offset any US tax that may be owed on worldwide income in the US, provided this is all from foreign sources.

The global economy has seen an increase in cross-border employment in the past several years. Better social programs, a healthier lifestyle pace and enhanced living standards have also prompted some US citizens and permanent residents to settle abroad. While the benefits of working and even settling overseas might be very attractive to many, one must remember that many countries enforce their tax laws on both their citizens and foreign residents. In the same token, one should be cognizant of the tax laws of their country of citizenship and be responsible for fulfilling their tax obligations. One cannot always have their cake and eat it too.

(Josephine L. Adalem is a Tax Executive Director of in the Human Capital group of SGV & Co.)

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.