People rarely think of taxes, and it’s safe to assume that there are even fewer people that plan for them. However, tax planning is just as important as tax filing.
Tax planning allows you to be more strategic when filing your taxes as an expat while ensuring you’re not paying more than you need in a foreign country or the U.S. On the other hand, putting off tax planning may lead to confusion, mistakes, and missed deductions.
This article will discuss tax planning in-depth to help you better understand the benefits of tax planning and avoid costly mistakes that can lead to tax penalties and more.
What is Tax Planning for Expats?
Tax planning refers to analyzing your financial situation and developing strategies for proper tax management. Here, tax preparation services can help reduce your tax liability and maximize your tax advantages. Tax planning also prevents you from being taxed twice for the same income.
For instance, tax planning can help you qualify for tax exemptions that exclude all or part of your foreign-earned income if you meet statutory foreign residence or physical presence abroad tests.
4 Types of Tax Planning
Tax planning is not a one-size-fits-all strategy. It will ultimately depend on the purpose, income, or assets involved, and tax savings and benefits you may potentially enjoy.
- Purposive Tax Planning
Purposive tax planning involves using tax-saver instruments to obtain the maximum benefit from any investment. The key is making correct investment selections, scouting for suitable replacements for your assets, and diversifying business and income assets based on your residential status.
- Permissive Tax Planning
Permissive tax planning is when you make permissible plans under different laws’ provisions. Your strategy may focus on how to earn income, take advantage of various incentives and deductions, avail of other tax concessions, etc.
- Short-Range Tax Planning
Short-range tax planning refers to the process you undergo at the end of the fiscal year. This is where you legally search for ways to limit your year-end tax liability. Although this method does not cover long-term commitments, it can still provide immediate and considerable tax savings.
- Long-Range Tax Planning
With the long-range tax planning method, you draw your plan at the beginning of the fiscal year and follow it throughout the year. This method will benefit you in the long run. However, unlike short-term tax planning, it does not offer immediate tax benefits.
Tax Planning for Expats 101: How to Be in Control of Your Taxes When Working Abroad
Regardless of your tax planning method, you must follow essential steps to get your taxes done as an expat.
1. Identify the filing requirements
The first step to being in control of your taxes is knowing the tax filing requirements for U.S. expats. American citizens and alien residents in foreign countries must follow the standard rules and tax forms when filing U.S. income tax returns.
You must generally file a return if your gross income exceeds the filing requirements. In addition, remember that all compensation you earn abroad is included in your gross income when determining your tax amount.
Furthermore, you must file a tax return even when your foreign deductions equal or exceed your gross income or when credits, such as the foreign tax credit, eliminate your U.S. tax liability. So, you also have to know what your foreign exclusions are.
2. Special foreign exclusions
- Foreign Earned Income Exclusion: These are wages, salaries, professional fees, or compensation paid to you for personal services you have rendered. These can be excluded from your income up to an amount adjusted for inflation.
- Foreign Housing Expense Deduction: These deductions can be taken from your gross income if your tax home is in a foreign country.
3. Moving and travel expenses
Reimbursements for your move to a foreign country will generally be considered foreign-source income. Hence, it will qualify for FEIE.
In addition, reimbursement for travel expenses to move back to the U.S. can also be considered a foreign-source income. This is possible if a written agreement between you and your employer states that they will reimburse such expenses whether or not you continue working for them.
Furthermore, if you have sold your principal address in the U.S. as a result of being transferred abroad, you may be able to receive additional tax exclusions.
4. Principal residence
If you are unmarried, you can exclude up to $250,000 from your earned income if you have gained from the sale of your principal residence. Your tax exclusion can be up to $500,000 if you’re married.
To qualify for this exclusion, you must have owned and occupied your primary residence for at least two years preceding the sale. However, taxpayers who fail to meet the two-year requirement because of unforeseen circumstances may still be eligible for a portion of the exclusion.
5. Alternative minimum tax
The alternative minimum tax (AMT) prevents taxpayers who earn substantial economic income from using excessive deductions, exemptions, and credits. AMT is considered a separate tax levied on certain income and deductions, and you must pay it if it exceeds the regular threshold.
AMT can significantly affect U.S. expats that exceed the exclusion amounts. This provision may entitle you to a foreign tax credit, which can reduce your U.S. tax dues.
6. AMT credit
Once you pay AMT, it may be allowed as a credit against regular tax in later years, but this will only provide temporary relief on your regular tax.
Furthermore, AMT credits and foreign income tax deductions provide nearly the same tax deduction opportunities. So, in the years you are subject to AMT, it may be better to elect a foreign tax credit.
7. Foreign tax credit
As a U.S. expatriate, you can deduct foreign income taxes when computing taxable income or claim them as a credit against your U.S. income tax. Moreover, using a foreign tax credit often results in lower taxes than deductions from foreign income taxes, as a foreign tax credit permits a dollar-for-dollar offset against U.S. income taxes.
With this provision, you can credit the taxes imposed by a foreign country or its political subdivisions. As a result, you must either deduct all foreign income taxes or take credit for them each year. You could switch between taking deductions one year and then taking credits the following year if you do it before the allowable period lapses.
8. Tax equalization policies
Tax rates significantly vary worldwide. For instance, in Germany, the highest rate for individuals is 45%, while in other countries, the overall rate generally never exceeds 25%. On the other hand, a few nations, such as Saudi Arabia, have no personal income tax at all.
Not knowing the tax policies of a foreign country may increase your uncertainty and indecision when determining whether to accept the assignment or include a deduction or credit.
Fortunately, many U.S. companies with operations abroad have adopted tax equalization policies for U.S. employees on foreign assignments. Under this policy, your employer will assume responsibility for your U.S. and foreign income taxes. However, in exchange, you pay the company a speculative tax equal to the amount you would have paid in U.S. income tax.
Typically, you will pay an amount similar to what you have withheld. However, this rule has notable exclusions, which you can learn by diving into payroll taxes and special situations.
9. Payroll taxes and special situations
Generally, a U.S. employer must withhold income taxes from U.S. citizens regardless of where they perform their services.
5 Benefits of Tax Planning for Expats
Tax planning has multiple benefits. Going through the whole process allows you to see every aspect of your taxes as an expat. Here are some tax planning benefits:
One of the benefits of tax planning is tax deductions. Tax deductions are usually expenses you incur throughout the year. These are expenses you can subtract from your total income, allowing you to reduce your taxable income.
For example, a Foreign Housing Deduction can increase your exempted income by the amount of your qualified housing expenses for U.S. expatriates. Likewise, a Tax Treaty Deduction can prevent the U.S. government from taxing foreign-sources dividends, interest, or royalties income already taxed in your resident country.
Rebates are forms of refunds that transpire after a retroactive tax reduction. For example, Congress occasionally offers rebates to help stimulate the economy during financial recessions or uses rebates to incentivize environmentally friendly company practices.
For example, the U.S. government launched a recovery rebate available for the 2020 and 2021 tax years. They issued this rebate for any amount of Economic Impact Payments or Stimulus Relief Payments you were eligible for but didn’t receive.
Credits will allow you to subtract from the total tax you owe. If you are a student, have children, or are from a low-income household, you may qualify for a tax credit.
An excellent example of credit for expatriates is the foreign tax credit. You can use the foreign tax credit if you work abroad and pay income tax in your local jurisdiction. This will help you avoid paying the same income twice.
A tax concession is when a government reduces the amount of tax a particular group of people owes. Governments usually use these concessions to incentivize specific behavior.
For example, the Saver’s Credit incentivizes people to save money. This provision allows working-class Americans who manage to put together some savings to have a tax break when they fill out their returns.
Exemptions can reduce or eliminate your responsibility to pay taxes. For example, for 2022, the FEIE may exclude up to $112,000 of your foreign earned income if you qualify for the Physical Presence Test or Bona Fide Residence Test for living outside of the U.S.
5 Possible Pitfalls When Tax Planning
For you to have a solid tax plan, keep an eye out for these possible tax mistakes or issues you might encounter:
1. Not maximizing the provided tax deductions
Not maximizing your tax deductions is one mistake you can make when tax planning. Contributions to charity are an excellent example of tax deductions you might forget to consider.
Furthermore, you can track out-of-pocket expenses you incur while doing charitable activities. For example, you can include the cost of food preparation, the cost of delivering your donations, etc. Then, you can add those costs to your cash contributions when computing for your deduction.
2. Thinking that all tax plans are the same
Thinking that all tax plans are the same is not unusual in tax planning. However, falling into this pit may cost you some valuable deductions and exemptions.
For instance, if you plan to maximize the benefits you get from your investments, you could leverage purposive tax planning. This will help you make the proper investment selections, asset replacements, and income diversification to save you plenty in taxes in the long run.
3. Feasibility of the tax plan
The feasibility of your tax plan is among the most crucial factors to the success of your tax planning. If your tax plan is not feasible, chances are you won’t get the benefits of your tax plan. Even worse, it may cost you more.
For instance, if you are leaning toward a permissive tax plan but don’t or can’t qualify for the requirements of the loopholes, then your tax plan is not feasible and may cost you valuable money and time.
Likewise, if you are looking to use a purposive tax plan but are not liquid enough to make suitable investments, you won’t be getting the most benefit from your assets or none at all.
4. Ignoring tax plan loopholes
Some expats ignore tax planning loopholes that can provide them with essential deductions, exclusions, and credits.
Again, you can counter or erase your U.S. income taxes with the following:
- Foreign Earned Income Exclusion
- Foreign Tax Credit
- Foreign Housing Exclusion
As a general rule, don’t pay tax on your income twice! If you get taxed twice on the same income, you could look into possible loopholes that can save you money from taxes.
5. Trying to do it all yourself
It might be tempting to do all your tax duties yourself to save money. You can opt to do everything from tax planning and computing to filing returns and making payments, but if you don’t know the ins and outs, it could cost you exponentially more than what you would save if you were to do it yourself.
Rather than braving taxes yourself, getting tax preparation services can ensure that you have a good tax planning strategy before tax time. That way, you can dodge the possibility of any costly mistakes.
Strategic Saving with Expat Tax Planning
Expats have numerous factors to consider when doing their taxes, and it doesn’t help that these elements are both overwhelming and confusing.
If you’re not used to doing your taxes, it’s easy to miss a deduction or exclusion that could have saved you thousands of dollars. Likewise, it’s also just as easy to make a wrong tax plan and jeopardize your filing for the fiscal year.