For U.S. citizens or resident aliens (green card holders), the rules for filing income, estate and gift tax returns and paying estimated tax are generally the same whether they are in the United States or abroad. They are subject to tax on worldwide income from all sources and must report all taxable income and pay taxes according to the Internal Revenue Code. This post addresses common misconceptions related to the taxation of green card holders living outside the United States, the foreign earned income exclusion, foreign tax credit, totalization agreements, the effect of the saving clause on treaty provisions and filing requirements for individuals with U.S. territory income. We hope that by the end of this post, you will have a better understanding of these topics that are frequently confused and asked about by our clients:

U.S. income tax obligations of U.S. lawful permanent residents living and working outside the United States.

U.S. lawful permanent residents (green card holders) are subject to U.S. income tax on their worldwide income, regardless of where they live or work. This means they must report all income, including income earned outside the United States, on their U.S. tax return (Form 1040). Additionally, these residents may be able to claim the Foreign Tax Credit (FTC) or the Foreign Earned Income Exclusion (FEIE) to mitigate double taxation on their foreign income. They must also meet annual filing deadlines (typically June 15) and may need to file additional forms for foreign assets or accounts, such as the Foreign Bank Account Report (FBAR) if their foreign bank account balances exceed certain thresholds.

Requirements for claiming the foreign earned income exclusion.

To qualify for the Foreign Earned Income Exclusion (FEIE), you must have foreign-earned income, which refers to wages, salaries, professional fees, or other amounts received for personal services performed in a foreign country, your tax home must be in a foreign country where you conduct business or earn income. This means you must maintain a residence there, that according to the US Law to claim FEIE you must be either a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year or be physically present in a foreign country for at least 330 full days during a 12-month period.

To claim the FEIE, you generally need to file Form 2555, “Foreign Earned Income Exclusion,” with your 1040.

Requirements for claiming foreign tax credit

To qualify for the Foreign Tax Credit (FTC), you must be a U.S. citizen or a resident alien for tax purposes, have paid or accrued foreign income taxes to a foreign government. The taxes must be imposed on your income and can be either income taxes or taxes in lieu of income taxes.

The taxes you claim must be of the type that qualifies for the credit. Generally, this includes income, war profits, and excess profits taxes. Certain taxes, such as foreign value-added taxes (VAT), can be excluded from the credit. The foreign taxes must relate to foreign source income. You cannot claim a credit for taxes paid on U.S.-source income. To claim the FTC, you generally need to file Form 1116, “Foreign Tax Credit,” to report the foreign taxes paid and the foreign income earned. If you have certain types of income, different forms may apply: general income, passive income, etc.

The effect of totalization agreements on U.S. employment tax obligations of U.S. citizens and residents living and working outside the United States.

Totalization agreements are bilateral agreements between the U.S. and other countries designed to eliminate dual social security taxation and provide for the coordination of social security benefits. For U.S. citizens and residents living and working abroad, totalization agreements help avoid being required to pay social security taxes in both the U.S. and the foreign country. Under these agreements, workers typically pay into the social security system of the country where they are working, which can simplify compliance and reduce overall tax burdens.

The effect of the saving clause in the income tax treaty.

The saving clause in the income tax treaty allows the U.S. to tax its citizens or residents as if the treaty were not in effect. This means that, while the treaty may provide relief from double taxation, U.S. citizens and lawful permanent residents are still subject to U.S. taxation on their worldwide income. However, non-residents may benefit from treaty provisions that provide exemptions or reduced tax rates on certain types of income sourced from the U.S. Thus, while the saving clause preserves the right of the U.S. to tax its citizens, it does not negate all treaty benefits for non-residents.

Federal income tax filing requirements for individuals with income from a U.S. territory.

Individuals earning income from U.S. territories, such as Puerto Rico, Guam, the U.S. Virgin Islands, and American Samoa, have distinct filing requirements. Generally, if you are a bona fide resident of a U.S. territory for the entire tax year, you typically file your taxes with the territory’s local tax authority instead of the IRS. However, if you have income from both the U.S. and the territory, you may need to file a federal return with the IRS (Form 1040) to report worldwide income and potentially claim a refund for any taxes withheld or overpaid.

Each of these issues requires careful consideration, and individuals should consult with US Tax Consultants for their specific situations to ensure compliance and planning strategies.

Please do not hesitate to ask for a free consultation with us, with no commitment.