For U.S. citizens living abroad or earning income from foreign sources, questions often arise on how the U.S. tax system applies to them and how they can ensure compliance while minimizing tax liability.
From understanding what foreign income is to navigating various tax forms and deductions, it is important for accountants to understand the ins and outs of U.S. tax on foreign income in order to help their clients ensure compliance and avoid penalties.
To support this effort, forward-thinking accounting firms are increasingly using tax preparation software and scan-and-populate solutions to tackle the challenges of foreign income reporting. With federal, state, and local tax programs that cut tax workflow time and increase productivity, accountants can automate the tax prep process and create a seamless client experience.
Let’s take a look at the basics of foreign income reporting and discuss how technology can ensure compliance and minimize tax liability.
Foreign income is defined as any income earned from sources outside of the United States. It encompasses a wide range of financial activities, including but not limited to:
Foreign earned income is defined as income earned through labor or services while living and working in a foreign country. This category typically includes salaries, wages, bonuses, and self-employment income received from foreign employment or business activities.
It’s crucial to distinguish foreign earned income from other types of foreign income, as the Foreign Earned Income Exclusion (FEIE) , a valuable U.S. tax benefit, specifically applies to this category. Investment income, rental income, and passive income from foreign sources do not qualify for the FEIE. These types of income may be subject to different tax treatment.
The Foreign Earned Income Exclusion (FEIE) is a significant tax benefit provided by the IRS to U.S. citizens and residents who meet certain criteria. The FEIE allows eligible taxpayers to exclude a portion of their foreign earned income from U.S. taxation, potentially resulting in a reduced or zero U.S. tax liability on that income.
U.S. citizens and residents are generally required to report their worldwide income to the IRS. However, the U.S. tax system recognizes that U.S. individuals living abroad may face unique challenges and expenses. The FEIE is in place to alleviate some of the tax burden on expatriates.
To claim the FEIE, you must have foreign earned income , your tax home must be in a foreign country , and you must be one of the following:
So, if you earned less than the most recent IRS threshold in foreign income during a tax year, you could potentially exclude your entire foreign earned income from U.S. taxation. The IRS Interactive Tax Assistant can help you determine whether income earned in a foreign country is eligible to be excluded from income reported on your U.S. federal income tax return ( Form 1040 ).
Form 2555 is the key form for claiming the Foreign Earned Income Exclusion (FEIE). To qualify, you must meet the following criteria:
Meeting these criteria allows you to exclude a specified amount of foreign earned income from your U.S. tax return.
The Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) are two distinct methods for mitigating the double taxation of foreign income.
As mentioned above, the FEIE allows you to exclude a specific amount of foreign earned income from your U.S. taxable income. This exclusion applies only to income earned through your labor or services while living and working in a foreign country.
The FTC, on the other hand, allows you to claim a credit on your U.S. tax return for foreign income taxes paid to a foreign government. This credit can offset your U.S. tax liability on foreign income that is not eligible for the FEIE, such as investment income or passive income.
To claim these, you’ll first have to qualify. If you do, you’ll then file additional tax forms (Form 2555 for the FEIE and Form 1116 for the FTC) and attach them to Form 1040. You report the FEIE on your Schedule 1, Line 8, and the
FTC on Schedule 3, Line 1.
The Foreign Earned Income Exclusion (FEIE) allows eligible individuals to exclude a portion of their foreign earned income from U.S. taxation. This exclusion can significantly reduce or eliminate the U.S. tax liability on foreign income. However, the specific amount of foreign income that is tax-free in the U.S. under the FEIE can change annually due to inflation adjustments.
For the tax year 2022 (the tax return filed in 2023), you may be eligible to exclude up to $112,000 of your foreign-earned income from your U.S. income taxes. For the tax year 2023 (the tax return filed in 2024), this amount increases to $120,000. For the tax year 2024 (the tax return filed in 2025), the foreign earned income exclusion amount is $126,500.
The FEIE applies specifically to foreign earned income, which generally includes income from employment or self-employment earned while living and working abroad. It does not apply to other types of foreign income, such as rental income, dividends, interest, or capital gains, which may be subject to different tax rules and may not be eligible for the FEIE.
Additionally, to qualify for the FEIE, you must meet certain criteria, including passing either the bona fide residence test or the physical presence test, having a tax home in a foreign country, and being a U.S. citizen or resident.
Tax laws can change, so be sure to check the latest FEIE limits and eligibility requirements for the tax year in question.
Reporting foreign income to the IRS is a critical aspect of tax compliance for U.S. citizens and residents. Depending on the type of income and your specific circumstances, you may use different forms and reporting methods.
One essential reporting requirement is the Foreign Bank Account Report (FBAR) , also known as FinCEN Form 114. If the aggregate value of your foreign financial accounts, including bank accounts, exceeds $10,000 at any point during the tax year, you must file an FBAR to disclose these accounts. Failure to do so can result in severe penalties.
Additionally, taxpayers with significant foreign financial assets may need to file Form 8938 , the Statement of Specified Foreign Financial Assets, as part of their federal income tax return. The reporting thresholds for Form 8938 vary based on factors such as filing status and residence.
If you are working for a foreign employer and do not receive a W-2 form, reporting your foreign earned income can be a bit more complicated. In such cases, you should keep detailed records of your earnings, including pay stubs, contracts, and any other relevant documentation.
When it comes time to file your U.S. tax return, you will typically use Form 1040, the standard individual tax return form. You will report your foreign earned income on this form, specifying the source and amount of income. If you are eligible for the FEIE, you will also complete Form 2555.
The trusted guide to complex international tax questions from Thomson Reuters® Checkpoint.
Form 1099-DIV is used to report dividend income received from various sources, including foreign corporations. If you receive dividends from foreign companies, you should receive a Form 1099-DIV from the paying entity. This form will outline the amount of dividends paid to you and any foreign taxes withheld at the source.
To report foreign dividend income on your U.S. tax return, you will typically use Schedule B , which is an attachment to Form 1040. Schedule B requires you to list all your sources of interest and dividend income, including any foreign dividends. You will also need to report any foreign taxes paid on this income.
Foreign qualified dividends are a specific type of dividend income received from foreign corporations that may qualify for lower tax rates in the United States. To be considered foreign qualified dividends, the following criteria must be met:
Foreign qualified dividends are generally subject to lower tax rates than ordinary income.
Here are some key considerations regarding U.S. tax implications for owning property abroad:
It’s worth noting that tax laws and regulations can change over time, so it’s essential to stay updated on current rules and requirements to ensure that you fulfill all reporting obligations while minimizing your tax liability. Proper tax planning and compliance are key to managing the tax implications associated with foreign property ownership.
Owning property abroad, whether it’s real estate, bank accounts, or other assets, can have tax implications that U.S. citizens must be aware of and comply with. Various factors may come into play including the type of property, its use, and the income generated from it.
It’s important to note that U.S. citizens are generally required to report their worldwide income and assets to the Internal Revenue Service (IRS), even if they reside abroad. Failure to comply with these reporting requirements can result in penalties.
Given the complexities of international tax laws, tax professionals should consider an integrated tax research solution to keep pace with the latest information on foreign income and property in order to ensure full compliance and maximize potential deductions and credits for clients.
The Foreign Account Tax Compliance Act (FATCA) is a U.S. law that aims to combat tax evasion by requiring foreign financial institutions to report information about U.S. account holders to the IRS. FATCA also imposes reporting requirements on U.S. taxpayers with specified foreign financial assets.
If you have financial accounts or assets held in foreign institutions, you may need to report them to the IRS under FATCA. This reporting is in addition to the FBAR and Form 8938 requirements mentioned earlier.
Failure to comply with FATCA reporting obligations can result in penalties and may trigger additional scrutiny from the IRS. It’s crucial to stay informed about FATCA requirements and ensure reporting obligations are fulfilled.
Navigating the complexities of U.S. tax on foreign income can be challenging for individual taxpayers and tax professionals alike.
Understanding and managing U.S. tax on foreign income is essential for supporting clients who are living abroad or earning income from foreign sources. While tax laws and regulations can be complex, the latest advances in tax software can boost accuracy and streamline reporting.
Here are some key considerations for accountants assisting clients with foreign income tax forms:
Tax software is a valuable tool for accountants serving clients with foreign income reporting requirements. It simplifies the often complex process of reporting foreign income, reduces the risk of errors, ensures compliance with tax laws, and ultimately helps accountants provide more efficient and accurate services to their clients.
Many tax software packages offer form-specific guidance, including instructions on which IRS forms to use when reporting foreign income. This helps accountants and clients ensure they are using the correct forms and filling them out accurately.
Tax software can calculate foreign tax credits, which can offset the U.S. tax liability on foreign income. This feature helps accountants ensure that clients maximize their available tax credits, reducing the risk of double taxation. In addition, tax software allows accountants to input financial data from various sources, including foreign income, in a streamlined manner.
Perhaps most importantly, tax software often receives real-time updates and alerts regarding changes in tax laws and regulations, including those related to foreign income reporting. This ensures that accountants and clients are aware of any changes that impact their tax obligations. It’s essential for accountants to select reputable tax software that meets their specific needs and stay updated on the latest tax regulations, especially when dealing with international tax matters.
If you’re an accountant looking to help your clients report on foreign income, SurePrep software can integrate with UltraTax CS, GoSystem Tax RS, CCH Axcess Tax, and Lacerte and can help you reduce manual data entry, ensure compliance, and minimize tax liability.
The AI-powered combination of 1040SCAN , SPbinder , and TaxCaddy integrate with your existing tax software to automate each phase of the tax prep process. Together with Checkpoint Edge ®, you can be sure you are properly interpreting IRS tax legislation in an ever-changing landscape.
