Income Tax Question: US citizen working abroad

[Algernon]

I’m pretty sure there is a factual answer to this question. Here is the situation.

My daughter just out of college, has landed her dream job – being a tour coordinator for an international travel company based in London. She’ll be working in various countries, multiple per year. For example, she spends July and August in Croatia, then September to November in Greece, then on to somewhere else not yet defined. Could be anywhere from Russia to Rawanda; Mongolia to Mexico; Iceland to Antarctica.

She’ll be out of the US more than 180 days per year, and she will only carry US citizenship.

Since she is getting paid from a UK company, will she have to pay taxes in the US and the UK? How is the split determined? What if she decides she likes a particular tour location and decides to spend significant time there – for example, she could potentially spend an entire year in Botswana. Would she have to pay Botswana taxes? UK taxes?

I will be managing her investments while she is abroad, so she will have some US based income to report, though probably not enough to pay taxes on.

Anyone have experience or knowledge on this question?

[Desert_Nomad]

If she spends more than 330 days in a foreign country (international waters don’t count) and her tax home is not in the US (ie she has to actually move out of the US and maintain a foreign home), then she can exclude from federal tax, the fist $85,700 in income earned abroad.

She will have to pay local tax in which ever country she is in, but usually only after spending 183 or more days there in a year. She may be able to avoid UK tax if she is not actually working there.

PM me and I can give you the name of my US tax guy for foreigners. He is based in Eastern Europe.

[Algernon]

Thanks Desert Nomad.

a) What if she spends less than 180 days in each country she works in over the course of a year?

b) She will not have any permanent foreign home – if you mean a physical location or dwelling.

While she’ll be employed by a UK company, she won’t be spending any time there except between assignments for debriefing – perhaps a week or two at a time.

[PS - I’ll PM you for the name of your tax advisor.]

[C_K_Dexter_Haven]

The rules are governed by tax treaties among the countries involved. There’s no going to be a simple answer, I’m afraid, because it may well depend on the individual countries. And I disagree with Desert Nomad: she may be liable for tax as a part-year resident if she spends more than 90 days there but less than 180 days.

I agree with Desert Nomad that you’ll need a tax advisor.

[Algernon]

@C K Dexter Haven

The rules are governed by tax treaties among the countries involved. There’s no going to be a simple answer, I’m afraid, because it may well depend on the individual countries. And I disagree with Desert Nomad: she may be liable for tax as a part-year resident if she spends more than 90 days there but less than 180 days. I agree with Desert Nomad that you’ll need a tax advisor.

Drat. I was hoping it’d be more straightforward than that, to avoid paying for someone to do her tax return.

[Balthisar]

Hopefully her employer does this all the time, and will provide her free of charge the services of a tax specialist that’s familiar with international tax equalization. You could avoid US taxes by being out of the country, avoid foreign taxes despite being there, and try to make a lot of money tax free. Or with your employer tax equalization program, you don’t worry about anything; you pay exactly what you would pay in your home country, and the tax people worry about all the details.

[mhendo]

I’m not sure if it’s still the same, but a friend of mine worked as a tour guide with a London-based company in the early 1990s.

While she spent time in multiple countries, just like the OP’s daughter, all of the official tax stuff was done AS IF she were in the UK for the whole time. Because the British company was the one paying her, and her pay checks went into a UK account, the fact that she was physically in the other countries for parts of the year did not matter.

I’m not sure if this company was playing fast and loose with the rules, or if things have changed, but that’s how she reported her experience to me.

[intention]

I’m a US citizen who occasionally works as a US tax preparer. I’ve also lived outside the US for about 16 of the last 25 years. In addition to what Desert Nomad said so well, I would add:

The basic rule of thumb is that if your daughter lives outside the US for 330 days/year, or is a “bona-fide resident” of another country, she is exempt from tax on the first $85,700 of her foreign earnings. (The earnings can actually be paid in the US, but must be earned overseas.) If she is a bona fide resident who is there for a part of a year (not uncommon, I’m on two year contract now that stretches across three years), she is only entitled to exempt that portion of her income for the year in proportion to the time she spent overseas.

From the US Tax point of view, I am a bona-fide resident in this tiny and exquisitely lovely country for one reason. I have a residence permit and a work permit from the Government. That’s what makes me a bona-fide overseas resident for tax purposes.

Absent that, she’s got to do the full 330 daze to get the credit, with one exception. If she is taxed overseas on her income in one or more countries, she can in most cases offset that against her US taxes. If that’s the case, then get the tax man’s name from Desert Nomad.

The underlying theory is that income is only taxed once. If it is made overseas and taxed overseas, in most cases the home country reduces taxes accordingly.

I use TurboTax (Mac version 'cause that’s what I’m on, there’s a PC version as well) tax software to prepare my own and others taxes. It asks you all of the questions to determine the circumstances and fills out and prints all of the forms, takes all the mystery out of it, checks for errors, you or your daughter could do it.

I would also be very curious about the exact details of her employment. It seems to me that someone in Britain hiring Americans to work in Croatia is not very visible on anyone’s radar … Workers Compensation? Oh, no, none for me thanks, they’re overseas “Independent Contractors” from Britain’s point of view, and they’re not working in Britain … or are they (working in Britain)?

My guess is that she won’t really be on anyone’s books, that the whole deal will go on in that lovely gray area that is in between countries and businesses, the mysterious foggy Eurozone, where nobody really either lives or works in one country, for goodness sake, that’s so 20th century …

I have a seventeen year old daughter. If she were going on such a quest, I’d want her to have some kind of workmen’s compensation insurance, I’ve seen the traffic in Rome and Paris … but hey, what do I know? I’m just the dad.

w.

[China_Guy]

@Balthisar

You could avoid US taxes by being out of the country.

This is not correct. If you are an American citizen or permanent resident, you ARE liable for US taxes. Heck, Uncle Sugar reserves the right to go after you if they suspect you’ve given up US citizenship to escape US taxes.

Of course, I am not a tax lawyer, advisor or accountant and you should not take anything written here as advice.

That said, you have to file for the tax exemption to qualify for it. Eg, there’s a form that you have to fill out and file.

Second, you are liable for the US tax but can credit any income tax paid in another country. For example, you make $100k, and pay $20k in UK taxes. First you claim the $85k exemption, and you’re liable for US tax on the balance. My understanding, you pay tax on the US equivalent as if you only made $15k in the US. Say that US equivalent amount is $5k. You can then credit up to the $20k in UK tax paid. Net net, you would pay UK tax and zero US tax.

**Intention’s ** way is easier and works too. Frankly, it’s easier than the hoops on of the Big 4 put me through to calculate my taxes.

[TokyoBayer]

@Balthisar

You could avoid US taxes by being out of the country, avoid foreign taxes despite being there, and try to make a lot of money tax free.

No. No. No. No. No.

This is illegal and should not be followed. The IRS does not take tax evasion lightly and recommending people break the law should be avoided, even on an anonymous board.

You do not avoid US taxes simply by being in a foreign country, although there are cases where you are allowed exclusions and credits. Regardless if you do or do not pay income taxes to a foreign country, you * still are* responsible for reporting this income to the IRS.

I’ve done a fair amount of research on US taxes after I fired the guy who did mine and started filing my own.

I’d start off with Pub. 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, which explains the eligibility requirement, with a number of examples. It goes through form 2555 and 1116.

The US part of the taxes is simple. If she meets the Tax Home Test

@Tax home test

To meet this test, your tax home must be in a foreign country, or countries (see Foreign country, later), throughout your period of bona fide residence or physical presence, whichever applies. For this purpose, your period of physical presence is the 330 full days during which you were present in a foreign country, not the 12 consecutive months during which those days occurred.

and either the Bona Fide Residence Test, in which she acknowledges a residence in a foreign country or counties for the full tax year, or the Physical Presence Test in which she in physically out of the US for 330 days or more in period of 12 continuous months, she is allowed to take the income and housing exclusions. (Form 2555)

She is also allowed to take credit for taxes paid to foreign governments on taxes earned abroad. (Form 1116) If she has the Foreign Income Exclusion, there are calculations to the amount of the foreign taxes eligible for credit to US taxes which can make it tricky when you are first figuring it out.

Note that this is not dependent on the length of time abroad. If she’s only abroad for 180 days a year, she may not be eligible for the foreign income exclusion, but she can still apply the credit for taxes paid in the UK (and everywhere else).

Also note if she is sent on a tour back to the US or to a US territory, (where she’s working on not on vacation) she will be responsible for US taxes for the amount of time she’s in the States. Mostly likely she’s also have to pay UK taxes for this income as well, but she can apply the US taxes (or a percentage of the taxes) she pays for that portion as a credit toward her UK taxes.

[Balthisar]

ChinaGuy and TokyoPlayer, having accumulated many years working out of the USA, I know the law – really! I suppose the italicized “or” wasn’t enough to indicate that avoiding taxes was not the way to go about things. The implication was, don’t do a; you should do b.

[TokyoBayer]

@Balthisar

I suppose the italicized “or” wasn’t enough to indicate that avoiding taxes was not the way to go about things. The implication was, don’t do a; you should do b.

That may have been clearer if “b” were a valid option.

IANATE (tax expert) but it seems that your “b” is incorrect. It doesn’t seem that your suggested alternative, international tax equalization, which you present as the only alternative, is applicable to local hires, which is the case for the daughter of the OP.

cite

Tax equalization is a process where a U.S. employer makes a U.S. employee whole for any differential in taxes resulting from a foreign assignment. It allows the employee to take the risk of higher or lower taxes out of the decision making process of whether to take the foreign assignment.
Under a tax equalization program, a U.S. employee would be reimbursed by his/her employer if the employee’s taxes are higher then if he or she stayed in the U.S. Alternatively, if the taxes were lower, the employee would reimburse the employer.

[Algernon]

Wow. I leave for a business trip for a few days (no Internet access) believing I left behind a dead thread, and return to find not only a lively thread, but also a plethora of advice. Some comments to your responses are below. Given the level of uncertainty of her tax liabilities, she needs to first get further information and guidance from her employer. They must deal with these questions all the time.

@Balthisar

Or with your employer tax equalization program, you don’t worry about anything; you pay exactly what you would pay in your home country, and the tax people worry about all the details.

@TokyoPlayer

[via cite]Tax equalization is a process where a U.S. employer makes a U.S. employee whole for any differential in taxes resulting from a foreign assignment.

Hmmm. Well, my daughter’s employer is a UK company, not a US company. We’ll have to find out if tax equalization applies.

@intention

The basic rule of thumb is that if your daughter lives outside the US for 330 days/year, or is a “bona-fide resident” of another country, she is exempt from tax on the first $85,700 of her foreign earnings. (The earnings can actually be paid in the US, but must be earned overseas.) If she is a bona fide resident who is there for a part of a year (not uncommon, I’m on two year contract now that stretches across three years), she is only entitled to exempt that portion of her income for the year in proportion to the time she spent overseas.
Absent that, she’s got to do the full 330 daze to get the credit, with one exception. If she is taxed overseas on her income in one or more countries, she can in most cases offset that against her US taxes. If that’s the case, then get the tax man’s name from Desert Nomad.

@TokyoPlayer

I’d start off with Pub. 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, which explains the eligibility requirement, with a number of examples. It goes through form 2555 and 1116.

@China Guy

Second, you are liable for the US tax but can credit any income tax paid in another country. For example, you make $100k, and pay $20k in UK taxes. First you claim the $85k exemption, and you’re liable for US tax on the balance. My understanding, you pay tax on the US equivalent as if you only made $15k in the US. Say that US equivalent amount is $5k. You can then credit up to the $20k in UK tax paid. Net net, you would pay UK tax and zero US tax.

Ah. These clarifications and explanations are exactly the type of insight I was looking for. Excellent!

@intention

I use TurboTax (Mac version 'cause that’s what I’m on, there’s a PC version as well) tax software to prepare my own and others taxes. It asks you all of the questions to determine the circumstances and fills out and prints all of the forms, takes all the mystery out of it, checks for errors, you or your daughter could do it.

I’m a TurboTax user myself. I think I’ll take some time to create a few hypothetical scenarios using my 2007 software and see where it leads me.

@intention

I would also be very curious about the exact details of her employment. It seems to me that someone in Britain hiring Americans to work in Croatia is not very visible on anyone’s radar … Workers Compensation? Oh, no, none for me thanks, they’re overseas “Independent Contractors” from Britain’s point of view, and they’re not working in Britain … or are they (working in Britain)?

My guess is that she won’t really be on anyone’s books, that the whole deal will go on in that lovely gray area that is in between countries and businesses, the mysterious foggy Eurozone, where nobody really either lives or works in one country, for goodness sake, that’s so 20th century …

Heh, heh. Yep. And to make it even foggier, she isn’t exactly an employee of the UK company. Technically she’ll be self-employed and working as a subcontractor on contracts of varying duration. For example, her Croatia contract starts in July and is only for two months because that tour is a family tour which goes on hiatus in September when kids have to be back in school. After each contract she returns to the UK for a week for debriefing and then heads out to her next contract. In this case she already knows it’ll be Greece.

@intention

I have a seventeen year old daughter. If she were going on such a quest, I’d want her to have some kind of workmen’s compensation insurance, I’ve seen the traffic in Rome and Paris … but hey, what do I know? I’m just the dad.

Trust me, as the dad of my lovely, talented, and adventurous daughter I know how you feel. I was, like every dad, pretty nervous about her first trip abroad, but I’m a bit immune to it by now. She’s studied abroad in Egypt and Thailand. She’s circled the globe on Semester At Sea with independent excursions at each port. She climbed Kilimanjaro a couple months ago. And she just got back from Ireland. I’m used to it now and no longer worry excessively. In fact, my main emotion is envy.
Thank you all for your input.

[Koxinga]

@Algernon

Heh, heh. Yep. And to make it even foggier, she isn’t exactly an employee of the UK company. Technically she’ll be self-employed and working as a subcontractor on contracts of varying duration.

That makes a big difference, at least according to my own experience. I once held on to the misguided belief that working abroad meant that everything I earned was exempt . . . only to be bitten in the rear later by hundreds of dollars in US self employment tax.

[TokyoBayer]

@China Guy

Second, you are liable for the US tax but can credit any income tax paid in another country. For example, you make $100k, and pay $20k in UK taxes. First you claim the $85k exemption, and you’re liable for US tax on the balance. My understanding, you pay tax on the US equivalent as if you only made $15k in the US. Say that US equivalent amount is $5k. You can then credit up to the $20k in UK tax paid. Net net, you would pay UK tax and zero US tax.

You are also allowed to deduct housing costs, up to certain limits which depend on the country you like in. (More in Hong Kong or Tokyo, less in Tanzania, for example). You’re taxed if your employer supplies housing, so it’s a wash unless they are supplying a very expensive place to live. If you supply your own housing, then it also helps reduce your US.

The foreign tax credit is a little more complicated. There is a ratio of how much credit you can use, which depends on what percentage of your income you are excluding. This is called the Tax Reduction Percentage and it’s the ratio of the amount of your foreign income excluded to your total income. In this case, you have to reduce $3,000 of UK taxes and you have $17,000 available. Note that this credit can’t be used against income from US.

Not to worry, in this example, you would still have your standard deduction, so your taxable income is only $6,550 (using the deductions fromm 2006, the figures I happened to have on hand). Tax on that is $653, which is completely offset by the UK taxes.

@Algonon

Hmmm. Well, my daughter’s employer is a UK company, not a US company. We’ll have to find out if tax equalization applies.

I’d be surprised if they provided that for your daughter. The system is set up for US companies sending their employees overseas, and foreign companies would not do this for their hires.

Heh, heh. Yep. And to make it even foggier, she isn’t exactly an employee of the UK company. Technically she’ll be self-employed and working as a subcontractor on contracts of varying duration.

Now you run into something which I don’t know the answer. As she will be self-employed, you will need to know how her social security (rather, the equivalent in the UK) is handled and how the affects her US social security obligations.

[Algernon]

@TokyoPlayer

Now you run into something which I don’t know the answer. As she will be self-employed, you will need to know how her social security (rather, the equivalent in the UK) is handled and how the affects her US social security obligations.

Hmmm. That raises another interesting question which I never even considered. Social Security. I’ve been focused on income taxes.

So would the UK equivalent of SS deductions be taken from her paycheck I wonder? Does the UK even have an equivalent system? If so, would that qualify her for benefits someday? And would she need to pay SS in the US while she earns salary abroad?

[fortytwo]

@Algernon

Hmmm. That raises another interesting question which I never even considered. Social Security. I’ve been focused on income taxes.

So would the UK equivalent of SS deductions be taken from her paycheck I wonder? Does the UK even have an equivalent system? If so, would that qualify her for benefits someday? And would she need to pay SS in the US while she earns salary abroad?

The equivalent in the UK is National Insurance. By paying NI I think your daughter should then be able to access our NHS.

If she does end up paying it there is also a reciprocal agreement between EEC countries which entitle you to free or reduced emergency health care. You can apply for a European Health Insurance Card to do this.

I really don’t know all the details of this but it may be worth investigating.

[TokyoBayer]

(I’ll use SS for social security, and this can be assumed to mean the equivalent in other countries.)

Some, but not all, countries have agreements which allow benefits paid into one country’s SS to count toward the other country’s SS program. Japan and the US started this a few years back. This allows me to count my total contributions to both counties when I retire. I presume that if I were to go back to the States to retire I would collect US SS and would collect Japanese SS if I stay here. I’m sure they have some system to ensure that people don’t collect both, but I’m still 20 years away, so I’ll cross that bridge when I get there.

I’ve been told that self-employed US citizens working abroad are responsible for SS contributions the same as if they were in the States, but I don’t know how this would be affected if they are paying into their local country’s SS program. If there is anyone on the Dope who meets this condition, I’d be interested in finding out.

Income taxes for citizens working abroad is mostly a US issue. Most countries do not require their expatriated citizens to file or pay income taxes on foreign income.

[intention]

Algernon, how funny, my guess about her being a 'independent contractor in the Eurozone" was spot on.

That changes everything. I have works a good portion of my life overseas as an independent contractor, so like others here, I speak from experience.

She won’t pay tax in Britain or Bahrain, she’s not on anyone’s books anywhere as an employee. Her tax home is the US, and she has to pay US income tax (unless she passes the 330 day test).

As an independent contractor, she files a “Schedule C - Business Income”. Bad news is that she has to pay both sides (employer 7.5%, employee 7.5%) of her own Social Security. This has to be paid even if she passes the 330 day test.

Good news is, because of the business she is in, once she leaves her home for the larger world virtually everything she pays for is a legitimate business expense. She needs to ASK FOR RECEIPTS and SAVE EVERY RECEIPT.

(There are exceptions. Clothing that is suitable for “street wear” is not deductible. Jewelry, no. Camera, yes, she uses it for work.)

As the owner of a “sole-proprietorship” business, she is not an employee of the business. She has no salary or wage, she receives no 1040 Form. It’s all done on the Schedule C.

Finally, just like the IRS requires businesses to withhold taxes from employees, it requires the self-employed to file “Estimated Taxes” quarterly (Mar-Jun-Sep-Dec). TurboTax handles that as well, prints out the 1040-ES forms. Basic rule here is that at the end of a tax year, she has to have paid the full amount of taxes or thereabouts due for that year.

All the best,

w.

[TokyoBayer]

@intention

As an independent contractor, she files a “Schedule C - Business Income”. Bad news is that she has to pay both sides (employer 7.5%, employee 7.5%) of her own Social Security. This has to be paid even if she passes the 330 day test.

OK, that’s a confirmation of what I’ve heard.

@TokyoPlayer

Not to worry, in this example, you would still have your standard deduction, so your taxable income is only $6,550 (using the deductions fromm 2006, the figures I happened to have on hand). Tax on that is $653, which is completely offset by the UK taxes.

This is incorrect. I posted it late last night and was tired. The rules have changed and the method of calculating tax has changed. However, since it’s not relevent to this case, I won’t get into it.