Wednesday, July 9, 2008
The U.S. tax laws offer one huge tax break to Americans working abroad. If you qualify, you can earn up to $87,600 overseas without paying income tax—or up to $175,200 income-tax-free if you have a working spouse.
Depending on your circumstances, you can legally avoid most (if not all) of your annual income taxes using this strategy.
To qualify for these benefits you must:
1. Establish a “tax home” in a foreign country.
2. Pass either the “foreign-residence test” (whereby you must have established legal residency in another country for an uninterrupted period of at least one year) or the “physical-presence test” (you qualify if you are physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months).
3. Actually have earned income for work.
4. File a U.S. income tax return for each year you live abroad.
This is not a tax deduction, credit, or deferral. It is an outright exclusion of the earnings from taxable gross income. There are no income taxes due on this amount earned offshore.
How valuable this tax break is for you depends on your “tax home.” Your tax home is the location of your regular, principal place of business. If you work overseas but maintain a U.S. residence, your tax home is not outside the U.S.
Say you move to a tax haven like Panama. You buy a new house and set up your own private consulting business. In doing so, you establish Panama as your “tax home” in the eyes of the IRS.
Let’s assume you do well your first year. After expenses, you make $79,400 selling your consulting services to the local Panamanians. You’re earning money inside the country, so the local Panamanian government would tax you at a maximum rate of 27%. (You also may have to pay a top corporate tax rate of 30%.)
You can apply for this from the IRS. If you qualify, you can exclude that entire $79,400 from U.S. income taxes. That’s a significant savings—even if you still have to pay Panamanian income tax.
However, there are even ways to get around these local taxes. Let’s say you move your business and your “tax home” to a place like Monaco or St. Kitts and Nevis. Both countries do not charge foreigners income taxes. Let’s say you make $79,400 a year again, and you qualify for the foreign earned income exclusion from the IRS. In that case, you don’t have to pay income taxes on the entire $79,400.
The first thing you have to do is choose a new country that has low or no local taxes. Make sure you check out the local tax situation of any prospective country.
If you choose Costa Rica, for example, the local government will charge you the same income tax as the locals: 25% for income and 30% for corporate taxes.
On the other hand, if you choose a place like Andorra with no local taxes, you could use the foreign earned income exclusion to avoid all local and U.S. income taxes.
Everyone’s tax situation is different, so it’s important to speak to a qualified tax professional or attorney once you’ve chosen your country. Make sure he is familiar with international tax reporting rules. Don’t be afraid to ask questions. Could you use the foreign earned income exclusion in your situation? Are there are other tax hurdles you need to know about (such as social security, capital gains, estate taxes)? Don’t move forward unless you’re satisfied with the answers.
In the July issue of International Living magazine, I tell readers about how to apply for this money-saving scheme. Subscribers, you can access the full article here. If you are not a subscriber and would also like to save a fortune on your taxes, sign up here.
For International Living
Editor’s note: Do you jump when you hear the doorbell or grow suspicious of new friends that ask too many questions? After all, they could be the dreaded tax collector. If so, you are like many other Americans, who don’t know where to start in the process of filing taxes abroad. We could solve this problem for you with one easy-to-read report. Find out more here.
Read related IL Postcards:
- The Tax Man Cometh…or Maybe Not
- The Party Line on Taxes
- How to Profit From Panama’s Duty-free Zone