Returning To The US - Tax Considerations?

Question

US citizens living abroad need to file income tax (American citizens living abroad still have to pay tax to US - legal ways to avoid?) but there is a Foreign Earned Income Exclusion (http://taxes.about.com/od/taxhelp/a/ForeignIncome.htm) that covers ~99k USD. But it requires that you meet certain residency requirements.

In my situation, I'm an ex-pat that is considering returning to the US.

US Taxes are based on calendar years, so if I work from Jan-Oct (for example) I will pay local taxes on those 10 months and I will not qualify for the FEIE mentioned above. Does this mean I will need to pay US income taxes on top of the local taxes?

Would I pay less taxes by returning to the US on Jan 1st verse May 1st, assuming equal incomes in both countries?

Answer 1

According to the 2555ez instructions, the residency requirements do not necessarily have to match the tax year. So, as long as you've been in the other country for a year, you can take the exclusion. Note that you may not be able to take the full exclusion, but only a percentage, based on the number of days in the tax year that you were in the specified country.

Here's some relevant text from this year's i2555ez publication. (Bold, as published; italics, as highlighted by me)

Physical Presence Test

To meet this test, you must be a U.S. citizen or resident alien who is physically present in a foreign country, or countries, for at least 330 full days during any period of 12 months in a row. A full day means the 24-hour period that starts at midnight.

Line 2a. To figure 330 full days of presence, add all separate periods you were present in a foreign country during the 12-month period in which those days occurred. The 330 full days can be interrupted by periods when you are traveling over international waters or are otherwise not in a foreign country. See Pub. 54 for more information and examples.

Line 2b. The 12-month period on which the physical presence test is based must include 365 or 366 days, part of which must be in 2013. The dates may begin or end in a calendar year other than 2013.

Answer 2

US Taxes are based on calendar years, so if I work from Jan-Oct (for example) I will pay local taxes on those 10 months and I will not qualify for the FEIE mentioned above. Does this mean I will need to pay US income taxes on top of the local taxes?

Not necessarily. First, as @Kent mentioned - physical presence test is for running 330 days in the period of 12 months, so from October to October (unless you've been to the US for visits) you're golden. That allows you to prorate the exclusion (i.e.: since you're covered till October, you get 5/6 of the full exclusion). If you can also claim bona-fide foreign residency, then you may not have to count the days. You'll have to be a citizen of the country you're residing at for that.

Second, you don't have to use the exclusion to reduce your US tax liability. You can (also) use foreign tax credit (FTC). If you live in a country with income tax that you paid, you can use form 1116 to calculate how much credit you can be allowed (if all of your income is the foreign income for that year - all the tax paid will be allowed). This may reduce or even eliminate your US tax obligation even without the FEIE.

You can combine the FEIE and the FTC - however only the tax on the amounts not excluded will be counted towards the credit.

You should also check with a tax adviser (US-licensed EA or CPA) whether there's something in the tax treaty the US may have with your country of residence. Especially if you're a dual citizen.

Would I pay less taxes by returning to the US on Jan 1st verse May 1st, assuming equal incomes in both countries?

It is impossible to tell by just the dates. Take a tax return preparation program and start filling the numbers for your scenarios. Tax rates and exclusion levels haven't changed significantly, so a 2013 or even 2012 software can give you a pretty good idea of where things are headed.