Most American expats always have a concern about paying their taxes on the same income to two countries (the United States and their current country of location). That's why some of them go ahead and renounce their citizenship to avoid facing such challenges, developing issues, or attracting penalties from such defaults. Well, this is part of the reason why the United States decided to come up with a foreign tax credit (FTC) to make sure that expats don't have to make double payments on the same income anymore.
However, expats need to understand that depending on their capability to use the foreign tax credits, their U.S. income liability may continually increase or reduce. Although foreign tax credits exist, not everyone can claim them and that's because it (FTC) has some similarities to foreign earned income exclusion (FEIE). American expats can claim foreign tax credits by filing Form 1116 to reduce their taxable income to the U.S.
The Foreign Tax Credit
In case you come across American expats abroad that can reduce their taxable income paid to the U. S., it's essential to know that they can do that with the help of foreign tax credit. American expats abroad use foreign tax credits to pay their foreign liabilities in their current location at the same rate (dollar-to-dollar). When American expats pay their income payment to a foreign country, the foreign tax credit gives them a chance to use credits on taxes they owe to the U.S. and this in turn reduces their tax liability.
U.S. Expats need to know that there are some limitations to foreign tax credits. That's because it can't be claimed anyhow on incomes earned outside the United States which makes it a bit tricky.
Some regulations however exist for anyone that wants to claim foreign tax credits and they include the following:
Must be imposed on expat
Should have been paid by expat
Must be the legitimate and substantial liability for foreign tax
Must be based completely on income
Taking Advantage of Foreign Tax Credits
Notably, most countries receive payments from their citizens on income made worldwide irrespective of where they are living. However, some nations have financial systems suited to ensuring that their citizens aren't choked up with such big responsibilities. There are ways through which expats can take advantage of foreign tax credits.
Some of them include the following:
1. Keeping Track of Income
One of the best ways through which expats can take advantage of foreign tax credits is by monitoring all the incomes earned in both where they live and their nation of origin.
Some incomes that they should monitor include the following:
Rental properties
Investments
Employment
American expats that can accurately keep track of their incomes can ensure that they claim the maximum amounts accruing to their foreign tax credits.
2. Understanding Tax Treaties Between Different Countries
Do you know that countries in the world have treaties put in place to decide how income earned in a country is taxed in a country? For expats that are looking for ways to take advantage of foreign tax credits, they need to have a great knowledge of treaties between their home country and the one in which they reside. This helps them to properly reassess their foreign tax credit options: knowing about exemptions and related reductions.
3. Using Strategies for Tax Planning
For smart Americans that want to enjoy their foreign tax credits to the maximum, they end up having different financial strategies to use. A good instance is a case in which American expats create an efficient structure when doing their business or making investments in other ventures. Also, American expats can take advantage of deductions and make investments in retirement accounts that are deferred.
4. Considering File Taxes Separately
Sometimes, expats who are couples abroad can take advantage of the foreign tax credit by filing separately rather than doing it together as a couple. This is because American expat couples who file separately can get to enjoy their foreign tax credits individually other than those who do it jointly. Also filing separately can help expats who are couples to decrease the rate of their total liability.
5. Knowing About Foreign Tax Credits Basics
Interestingly, it's impossible to gain any benefit from foreign tax credits without first understanding what it is all about. American expats should know that through the help of foreign tax credits, they can reduce their liability in their home country. However, all expats need to know that if the amount owed is less than the paid foreign tax, the available excess can be spread throughout concurrent years for an even lower liability.
Summing Up
While this can be a big financial issue for expats to deal with, having an idea about some safeguards (e.g., Foreign Tax Credits) put in place by the government is essential. This helps them to avoid paying at double rates and penalties involved with non-compliance with such laws. Expats can take advantage of foreign tax credits by keeping track of their income, understanding tax treaties between countries, and using strategies for tax planning.
Being prepared is the most important thing you can be as an expat. Be sure that you are well informed and keep up with laws, as they can change every year. Keeping in touch with an inline expat community can also be a good way to be sure you’re constantly “in the know.”
