All U.S. citizens are required to pay tax on all their income. As a result, expats typically not only have to file and pay taxes in the United States but also in the country where they work. Expat taxes are much more difficult to compute than those of regular taxpayers. This is because they must additionally consider their host country’s policies and procedures. Among all regulations, foreign currency is arguably the most complicated aspect that impacts tax.
It might be tough to manage the filing procedure due to varying tax laws and currency fluctuations. With that, learning how foreign currency affects how you pay expat tax can help you better grasp the process and pay your taxes correctly.
Read this article to learn more about how foreign currency affects your taxes.
What is Currency Exchange Rates?
Currency exchange rates are the rates at which you can convert one currency into another. The Internal Revenue Service (IRS) maintains no official exchange rates and instead accepts any listed exchange rate used globally.
When evaluating an exchange rate with several listed conversions, the IRS recommends selecting the exchange rate that best suits your needs and is most applicable to your situation.
For instance, you can use the exchange rate on record for a particular day if you’re declaring a single transaction that took place on a specific date (such as the acquisition of stock). Conversely, if you’re reporting revenue distributed equally throughout the year, you might want to use the annual average rate of exchange that the IRS published annually for many currencies.
4 Ways Foreign Currency Affects Expat Tax
As an expat, you have to convert the foreign currency you’re using to U.S. dollars. It can be tricky, especially with fluctuations in exchange rates. For this reason, learning how foreign currencies can affect your taxes can help you mitigate risks. It would also make you understand how to calculate your tax better.
Currency fluctuations can affect an expat’s take-home pay
If you get your paycheck in a foreign currency, there may be some inconsistencies during conversion. Your financial health may turn upside down by a shift in exchange rates. Particularly if you earn in one currency but spend in another.
There’s not much of a problem if your pay’s base currency is the same as your home country. However, suppose the value of your host country’s currency fluctuates dramatically while you are working there. In that case, you may need to adjust your cost of living budget in order to cope with the low payout you receive.
Income tax is computed in one’s functional currency, not in the local currency
Businesses and freelancers are subject to IRS rules. According to the IRS, the U.S. dollar is the functional currency for all taxpayers (except for some Qualified Business Units).
If the IRS receives foreign currency tax payments, they use the exchange rate on the day the foreign amount is translated to U.S. dollars by the institution handling the transaction – not the date the IRS collects the disbursement.
Hence, to avoid potential losses upon conversion due to currency fluctuations, you must calculate your taxes by converting local currency to U.S. dollars.
Expats have trouble determining the right currency exchange rate when computing tax
You should do all income tax calculations in your functional currency, which is the U.S. dollar. That means you must promptly convert any items of income, expenditure, and taxes from a foreign currency to dollars. You should also translate the outcomes (such as revenue or loss) into U.S. dollars to declare on your tax return.
When you receive, pay, or accumulate an item using a foreign currency, use the current exchange rate.
The base and mid-market rates can affect how you convert money and compute tax
Many banks and exchange offices provide expats with a rate that surprises them because it is not the same as the rate they obtained when they exchanged their money.The base rate is the market’s current exchange rate, so it will vary depending on prevailing market conditions. This may include economic or political events.
Simply put, the base rate is the actual exchange rate with no impact whatsoever from external factors. However, one exception is that the rate may change once you exchange your money with banks or exchange companies.On the other hand, the mid-market rate is closer to the amount you’ll get since it averages the amounts being exchanged in a particular currency. However, you will always get less than the mid-market rate since the exchange service you select will deduct exchange fees of about 5% before converting.
A Simple Solution to Expat Tax Computing
Given the potential benefits and drawbacks of currency exchange, being in charge of your taxes and comprehending how to compute them may boost your chances of benefiting from fluctuating exchange rates.
If you’re unsure of how to compute expat tax, hiring a reliable tax resolution company can be of great help. Tax Samaritan has been providing professional-quality tax resolution services to expats since 1997. Get a Free Tax Quote →