Being an expat has a lot of perks, but handling taxes in multiple countries isn’t one of them. For those of you want to move to London but are concerned about how to deal with taxes, I’m happy to announce that for most of us American worker bees living abroad, keeping the IRS happy is pretty simple.
The first thing to take away from this post is that regardless of where you earn your income, you will always have to let the IRS know about it. Just because you go gallivanting around in a foreign country doesn’t mean that you’ve rid yourself of good ol’ Uncle Sam.
Each year the IRS sets a foreign income exclusion limit for its citizens working abroad. This means that any foreign income earned up to this limit will be excluded from US tax liability. The current limit is $99,200, and it tends to increase slightly each year. As it stands, if you earn less than the equivalent of $99,200 in British pounds, you probably won’t have to worry about paying any extra taxes to the IRS (whew!).
In addition to the exclusion limit, the IRS takes into account the foreign taxes you pay and translates that into what is called a Foreign Tax Credit.
Here’s a little more on the foreign tax credit from the IRS itself:
“The foreign tax credit is intended to relieve you of the double tax burden when your foreign source income is taxed by both the United States and the foreign country. Generally, if the foreign tax rate is higher than the U.S. rate, there will be no U.S. tax on the foreign income. If the foreign tax rate is lower than the U.S. rate, U.S. tax on the foreign income will be limited to the difference between the rates. The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income.” (www.irs.gov)
Because the taxes imposed by the Her Majesty’s Revenue and Customs (HMRC) are generally higher than the taxes imposed by the IRS, US citizens earning income in England typically will not owe any taxes to the US, even if they earn more than $99,200 annually. Where most Americans living in London find themselves in a bit of a pickle is in the case of capital gains, dividends, and the like. Some of these types of income are taxed at a lower rate in the UK.
So, now that all that has been squared away, let’s get on with what paperwork you actually need to fill out and send to the IRS.
US citizens living and working abroad have two choices when filing US income taxes:
1. Foreign Tax Credit (http://www.irs.gov/pub/irs-pdf/f1116.pdf)
2. Itemized Deductions (http://www.irs.gov/pub/irs-pdf/f1040sa.pdf)
If you’ve spent your entire tax year working abroad and earn under the foreign income exclusion limit (i.e. $99.2K), then you’re probably better off going with option (1) because it’s simpler.
If you are a high earner or only spent part of the year working abroad, work out your taxes using both forms (accompanied with a 1040X) to see which one is best for you.
Americans living abroad should still abide by the national tax deadline, though it’s possible to file for an extension if necessary. If this still doesn’t feel like something you’re comfortable handling on your own, there are a number of accountants in London who are accustomed to both UK and US tax laws and can provide a lot of assistance.