American expats are often under the impression that if they’re already filing an income-tax return in a foreign country, they aren’t required to file a tax return and report that same income in the U.S.
American citizens/residents are required to report their worldwide income regardless of whether they are living outside the United States, working on a foreign-flagged vessel, or employed by a foreign corporation. Even if you’re filing income tax in another jurisdiction, that same income is still required to be reported on your U.S. income-tax filing.
If you find yourself in a situation where you’re incurring the tax obligation of another jurisdiction, you can take satisfaction in knowing that you probably won’t be double taxed on your income. If you paid or accrued foreign taxes to a foreign country and are subject to U.S. tax on the same income, you may be able to take either a credit or an itemized deduction. You can claim a credit only for foreign-income taxes that are imposed on you by a foreign country — social security taxes don’t count towards the credit. While the IRS gives you the option to take an itemized deduction or a foreign-tax credit, you may not claim both. In most cases, taking the foreign-tax credit in place of the itemized deduction results in a more favorable outcome.
The credit is only designed to provide relief from U.S. income taxes that would’ve otherwise been due and aren’t meant to equalize the tax between the foreign jurisdiction and the U.S. For example, a long-term capital-gain rate in a foreign jurisdiction might be 25 percent and in the U.S. it would only be 15 percent. Assuming a capital-gains tax on $100K of income would be $25K in that foreign jurisdiction (100K x 25%) you’d only be entitled to a U.S. foreign-tax credit of $15K as that’s the max amount of tax you would’ve paid in the U.S. assuming that income was taxed at a 15 percent rate.
While the foreign-tax credit can be a bit complicated, it shouldn’t deter Americans from investing overseas due to fear of adverse tax consequences. Many mutual funds invest in foreign companies that result in having to pay a foreign tax — if you’ve ever received an investment 1099, chances are there was a small amount allocated to a foreign-tax credit on that form. Since much of our economy is now globalized, many accountants are familiar with the tax credit and can help.
The career of a professional mariner sometimes affords opportunities and circumstances that crew might not have planned on. The travel requirements of a mariner often results in a nomadic lifestyle in which they live overseas, purchase a home or property, and in some cases get married and start a family. Since U.S. citizens file an income tax every year regardless of whether they live overseas, a common concern is that an American expat will be double taxed on their income. But most taxing regimes have exemptions and credits to prevent this.
This article originally ran in the December 2021 issue of Dockwalk.