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Innocents Abroad, Beware of the Tax Man

Tracy Byrnes

Nowadays, if you want to properly climb the corporate ladder, it's almost a prerequisite that you go overseas for a few years to learn your company's global business.

And since the decision to uproot your family for the sake of your career takes much pondering, it's no wonder that the tax implications are the furthest thing from your mind.

That's OK. Most companies will make sure that while you are, for instance, on assignment in Britain, your tax bill costs you no more than if you stayed at home in New Jersey.

In some cases, your salary will be padded. You'll get extra money for housing and other goods and services, if you're sent to a place that's more expensive than where you live now, as well as for the extra out-of-pocket costs you incur by moving your family overseas.

And while the tax rules for Americans abroad are thorny, help is available. Many companies will pay an outside accounting firm to prepare your tax return for you. If not, go to your local embassy and ask for help. The IRS has representatives all over the world.

But whether your return is prepared by a professional or you do it yourself, there are certain issues that you should know about.

To start, you get an automatic two-month extension on your tax-filing deadline until June 15. So you don't have to file a form to qualify for this extension. But when you eventually file your return, attach a statement to the back of it explaining that you're filing two months later because you live and work abroad. Be sure to include your foreign address and the reason you are living there.

But just because your tax return isn't due, doesn't mean you don't have to pay your tax bill. If you owe U.S. tax, you'll owe interest on that amount from April 15 until you file your return.

Now here's the biggest thing you need to know about going abroad: As long as you're a U.S. citizen, no matter where you live, most money you earn anywhere in the world is taxable on your U.S. tax return, says Mark Luscombe, a principal federal tax analyst with CCH Inc., a provider of tax and business law information. Even if you don't set foot in our country for the next two years, your earnings are subject to U.S. tax.

Even worse, any wages you earn overseas -- the tax guys call that your foreign-earned income -- most likely will be taxed by your host country as well.

So that means your earnings could be taxed twice!

Thankfully there are a few U.S. provisions that will help offset this double whammy.

Foreign-Earned Income Exclusion

If you lived overseas for long enough in the tax year, you may be able to exclude up to $80,000 of your foreign income from your U.S. tax bill. This foreign-earned income exclusion helps prevent your income from being taxed by both the U.S and your host government.

Your foreign-earned income includes things such as salary, commissions and bonuses.

To qualify for this exclusion, you must pass one of two tests to show that you were in the foreign locale for a sufficient amount of time. The two tests are the bona fide resident test and the physical-presence test.

To qualify as a "bona fide resident," you must take up residence in the foreign locale and remain there for an entire tax year -- Jan. 1 through Dec. 31. Whether you have "taken up residence" is judged on a case-by-case basis, but it generally means you're maintaining a home in the country in which you are working.

So if you lived overseas from Jan. 1 through Dec. 31, and you earned at least $80,000, you exclude the full $80,000 from your U.S. taxable income.

Let's say you went overseas in October 2004. To pass this test, you would then have to stay through December 2005 because the rules say you must be there a full year. At that point, you could take one-quarter of the $80,000 as an exclusion for the 2004 tax year and then get the full exclusion for the 2005 tax year.

But what if you don't stay overseas for a full tax year?

In that case, the physical-presence test might be the way to go. To get the full $80,000 exclusion, you must be in the foreign locale for any 330 days during a 12-month period.

But the calendar tax-year requirement still applies. So if you were in England for 330 days during 2004, you'd get the full exclusion. But if you were sent there on Oct. 1 and spent 330 days there over the following 12 months, you'd only qualify for one-quarter of the exclusion on your 2004 tax return. Note that you don't have to remain overseas for a full tax year under the physical-presence test. So if you went home on Sept. 30, 2005, you'd still be able to claim three-quarters of the exclusion.

Housing Exclusion

If housing costs at home in New Jersey are less than those in London, your company may help with the difference. But if you get housing reimbursement, it is considered income and becomes taxable.

The good news is that any amount you spend above that reimbursement may be excluded from your tax bill.

The amount of the housing reimbursement is based on a quirky government equation. Basically, it's 16% of a midlevel bureaucrat's salary. So for 2004, the floor was $11,581, notes Bob Fuerst, a senior tax editor at RIA, a Thomson business providing tax information and software to tax professionals. While that amount is taxable, any additional housing expenses above $11,581 may be wiped out thanks to the housing exclusion.

So let's say your salary is $150,000, and you spent $50,000 above the floor on housing. Since you more money than the amount you spent on housing, you can exclude the full $50,000 from income. Now you have $100,000 left. Assuming you met one of the residence tests above, you can take the full $80,000 foreign-earned income exclusion. That means you excluded $130,000 from income.

Foreign Miscellany

Here are a few more things to note:

And finally, be sure to check out Publication 54 -- Tax Guide for U.S. Citizens and Resident Aliens Abroad for more details. But rest assured, if after the above exclusions your tax bill is still higher than it would've been had you stayed in Jersey, most companies will pay the difference.

Bon voyage!