The Dual Citizenship Taxes Rules (Expat Reference Guide)

The Dual Citizenship Taxes Rules (Expat Reference Guide)

The Dual Citizenship Tax Rules

When a person is considered to be a dual citizen — and one of the countries they have dual citizenship with is the United States — the tax rules are relatively straightforward. In general, if a person is considered to be a US citizen, then they are taxed on their worldwide income. This is true, even if they reside in a foreign country and earn all of their income from foreign sources. It is not uncommon for some dual citizens living overseas to not realize they are US citizens until they are into adulthood –– this is referred to as being an Accidental American. Likewise, a person is able to renounce their US citizenship if they want by formally expatriatingbut this could have ancillary tax implications by way of the exit tax. For US citizens living outside of the United States, let’s look at some important issues they should be aware of.

15 International Tax Tips for Dual Citizens

Here are 10 of the more common issues involving expats and U.S. tax:

1. Worldwide Income

The United States taxes US persons on their worldwide income, no matter where they live and where the income is sourced from. This is different than most countries in which they tax their citizens differently depending on whether they reside in the country or in a foreign country. It is also important to note that a US person is different than a US citizen. A US person includes a US citizen, legal permanent resident, or foreign national who meets the substantial presence test. Therefore, it is very important for legal permanent residents who are leaving the United States for good to properly relinquish their green card and consider whether or not they have to file formal expatriation papers such as Form 8854.

2. Worldwide Account and Asset Reporting

In addition to reporting worldwide income on a tax return, US persons also have to include their global assets on a myriad of different international information reporting forms. This is true, even if the assets are acquired after they move outside of the United States. There are various different forms and requirements depending on the type of asset and category of income — which we will summarize below.

3. Foreign Tax Credit (FTC)

Even though a person may have to pay US tax on their worldwide income, they may qualify to apply foreign tax credits to their US tax liability in order to reduce or eliminate there US tax on that income.

There is an equation that is used to calculate the credit and while it does not always result in a dollar-for-dollar credit —  it is a great way to reduce tax liability.

Not all taxes qualify for the foreign tax credit.

4. Foreign Earned Income Exclusion (FEIE)

When a US person resides outside of the United States and has a different country tax home, they may qualify for the foreign earned income exclusion and foreign housing exclusion.

The taxpayer must meet either the physical presence test or the bona fide residence test. By doing so, the taxpayer can eliminate more than $100,000 of income from their tax return — as well as a portion of their housing.  Another great benefit to the foreign earned income exclusion is that spouses can each use their own exclusion amount for the income they earn.

A few important tips: while you can use FEIE along with the foreign tax credit together for the same source of income, you cannot double-dip on the same dollar income. In addition, FEIE is used for earned income and not passive income and generally contributions to pension are not included in the foreign earned income exclusion either.

5. Totalization Agreement

The foreign earned income exclusion does not apply to self-employment tax. But, the United States has entered into totalization agreements with about 25 different countries in which the expat would only have to pay into the Social Security system in the country they are residing and not the US — in order to avoid double payment.

It is important to note that there are only 25 countries that have Totalization Agreements.

For example, there is a Totalization agreement with Australia but New Zealand does not.

6. Foreign Tax-Free Income

It is important to note that even though foreign income may be tax-free in the country of source (especially with foreign pension contributions), that does not mean it is tax-free in the United States. For example, if a person is earning interest income in a country that does not tax interest income, the expat would still have to include the interest income on their US tax return.

Taxpayers should always check the treaty if one is applicable to see if there is an exception, exclusion, or limitation to the tax rules.

7. Dividends

In general, many countries — especially Asian countries — do not tax dividends. Unfortunately, those rules usually do not crossover into the US tax laws. Therefore, an expat that earns dividend income in a foreign country would still have to include that dividend income on their US tax return — along with any applicable tax credits.

8. Interest

While a nonresident alien may escape tax on U.S. borne interest income, a US expat who has not formally expatriated but simply resides outside of the United States does not enjoy those same tax benefits — the foreign interest income is also taxable in the US.

9. Capital Gains

Nonresident aliens are exempt from US capital gains with certain exceptions and limitations. Since a US expat who resides overseas is not a nonresident alien but rather a foreign resident (with US person status), these rules do not apply. Capital gain earned outside of the United States by a US person expat is still taxable to the expat on their US tax return.

10. Cryptocurrency

Cryptocurrency gains from overseas virtual currency is taxable in the US. In other words, while some foreign countries have exceptions to the taxation of cryptocurrency, the US still requires income associated with cryptocurrency, including: exchanges, gains, dividends, or interest (if it is in an investment account type of crypto-fund) to be included on the US tax return — crypto investment funds may also lead to complications with reporting on Form 8621.

11. Foreign Account Reporting & FBAR (FinCEN Form 114)

When a US person has foreign bank accounts and other financial accounts with an annual aggregate total that exceeds $10,000 on any given day in any year, they have to report the accounts on the FBAR (aka FinCEN Form 114). The form is filed electronically directly on the FinCEN website.

12. Foreign Asset Reporting on Form 8938

Expats with specified foreign financial assets may have to report the assets each year on a Form 8938 if they meet the threshold requirements for filing.* The Form 8938 is submitted with the tax return. There may be some overlap between the Form 8938 and FBAR — as well as other forms such as Forms 5471, 8621, and 8865.

*The threshold for filing form 8938 is much higher for foreign residents than it is for US residents.

13. Foreign Real Estate Rental and Reporting

When a person owns foreign real estate that generates income, the income must be included on the US tax return, Schedule E — this is true, even if the income nets a loss after expenses are accounted for. If the real estate is owned by an individual, then it is not an asset that is reported for FATCA Form 8938. Conversely, if the asset is owned in an entity such as a sociedade anonima, then the S.A. includes the value of the real estate on the Form 5471 or other form.

14. Foreign Investments

Expats have to report their worldwide investments to the US on their tax return. There are many different flavors of foreign investments — and many different international information reporting forms that may be required to be filed. It is important for the expat to ascertain the specific type of investment in order to evaluate what form is includable on the US tax return. It is also very important to consider that just because the asset grows tax-free overseas such as a UK ISA or a French Assurance Vie does not mean it will grow tax-free in the United States as well — because usually it is not treated as tax-deferred in the US.

15. Foreign Mutual Funds

Expats who own foreign mutual funds are typically reported both on the FBAR and Form 8621 — the latter which is used to report PFIC or “passive foreign investment companies.” There are many complicated rules involving the reporting of PFIC and excess distributions. Keep in mind that the rules changed a few years back and unless an exception applies, the Form 8621 is still required even if there is no excess distributions. 

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