Nowadays, going on an overseas rotation is as common as the 10-hour workday.
If you are contemplating a foreign assignment, you'll no doubt have to weigh many career, family and financial considerations. But taxes probably won't be one of them. As part of your financial package, most companies will agree to make you "whole" where taxes are concerned. That is, your tax bill while on assignment in Japan will cost you no more than if you stayed at home in Albuquerque.
Still, you should be familiar with some important tax concepts. The most important one is this: If you are a U.S. citizen, Uncle Sam will tax you on your
income, even if you don't set foot in your home country for the next 18 months.
In addition, any wages you earn overseas, a.k.a. foreign earned income, most likely will be taxed by your host country. "Double taxation!" you scream.
But fear not. The following three tax provisions were created to stop the screaming:
Foreign Earned Income Exclusion
You can qualify to have up to $74,000 of your foreign earned income excluded from your U.S. tax bill. The size of your foreign earned income exclusions depends on either:
- The number of days during the year in which you were a "bona fide resident" of the foreign country, or ...
The number of days you were physically present in the foreign country during a 12-month period.
To qualify as a bona fide resident, you must take up residence in the foreign locale and remain there for an entire tax year (January through December). 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, you could take the entire $74,000 exclusion (assuming you had more than that in income).
But if you were sent overseas in October 1999, you would have to stay through December 2000 before you could take a prorated one-quarter of the $74,000 as an exclusion for the 1999 tax year (and the full exclusion for the 2000 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 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 Japan for 330 days during 1999, you'd get the full exclusion. But if you were sent to Japan 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 1999 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, 2000, you'd still be able to claim three-quarters of the exclusion.
Foreign Tax Credit
Many professionals who are sent overseas earn far more than $74,000. So what happens to the rest of their salaries? And what happens if they travel widely while on overseas assignment, making it impossible to meet the physical presence test or the bona fide residence test? Fortunately, the tax code has the answer: Say hello to the foreign tax credit.
You can elect to take the foreign tax credit for a percentage of taxes paid to a foreign country.
Here's how it works: Let's say you earned $150,000 on assignment in Japan. And let's just assume you owe Japan $40,000 in taxes. With $74,000 excluded from U.S. taxes, you're only dealing with $76,000 in U.S. taxable income now, or 51% of your total foreign earned income. So only 51% ($20,400) of the foreign tax you paid to Japan will be allowed as a credit on your U.S. return.
In place of the foreign tax credit, you could also simply take the taxes you paid to another country as an itemized deduction on
-- Itemized Deductions
. Remember, your itemized deductions are limited to a percentage of your adjusted gross income, so in most instances, the credit works out better.
Now what if housing costs at home in Albuquerque are cheaper than those in Tokyo? Your company probably will foot the difference. That housing reimbursement is part of your wages, but you can exclude most of it from taxes. The amount
excludable is known as a floor, and it's based on a government standard that is the equivalent of 16% of a midlevel bureaucrat's salary. For 1998, the floor was $9,643.
Here's how it works in practice: Say your salary is $150,000, and you spent $50,000 above the floor on housing. You can take the $74,000 foreign earned income exclusion (if you qualify) and exclude the entire $50,000 housing reimbursement from your U.S. taxable income.
But don't go out and rent the penthouse suite. Say your income is only $100,000. After taking the $74,000 foreign earned income exclusion, you only have $26,000 left for your housing exclusion.
Foreign Tax Bill
So we've alleviated the impact of your foreign assignment on your U.S. tax bill. But what happens if your tax bill to Japan is still more than your U.S. tax bill would have been had you never accepted the assignment?
Most companies will pay the difference. They call it a hypothetical vs. actual tax calculation. "The excess of hypo over actual is generally included in wages," says Nick Morrow, foreign tax specialist at
, a New York accounting firm.
For more information, check out these
Internal Revenue Service
Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad
Publication 514, Foreign Tax Credit for Individuals; How To Figure the Credit
Publication 593, Tax Highlights for U.S. Citizens and Residents Going Abroad; Income Earned Abroad
And be sure to read the income tax
treaty between the U.S. and the country you're transferring to.
If you have any questions, send them to
email@example.com. Please remember to include your full name and resident country. The Global Tax Forum appears every other Wednesday.
TSC Global Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.