If you reside outside of the United States, your income tax obligations do not stay in the United States; they follow you. Your obligations may, in fact, be increased rather than left behind.
Some expats may tell you that the U.S. Internal Revenue Service (IRS) can do nothing to you while you are living abroad. Some may tell you they have been abroad for many years without any problems. You are not exactly a big blip on the IRS screen, so why would they send an auditor here just for you?
Precedents
The IRS likes to set precedents. If it can pick and win a type of case, then it will go after all others that fall into the same category. This applies to not only the type of income, but also the amount of taxes deemed to be due.
If you and your family live outside the United States, it is difficult (and probably not cost-effective) for the IRS to do anything except a mail-in audit. The problems arise when you return to the United States.
How can you explain what you have been doing and earning after you suddenly appear as a taxpayer again after a long absence? Many people do return after long absences –usually for family or medical reasons.
Living abroad can be a great experience, but to make a return to the United States a painless transition, know the rules and use them to your advantage, both now and for whatever the future holds for you.
Earned Income
This is one of the most misunderstood terms in the tax lexicon. As the phrase states, it is income you earn. You are not deemed to have earned the interest from a CD. You are not deemed to have earned income unless you work for it.
The Foreign Earned Income Exclusion gives you the potential to deduct up to $82,000 of earned income from your tax return every year you qualify. If your spouse qualifies, you have up to an additional $82,000 to use, for a total of $164,000. A good start!
However, the deduction is not automatic. First, you have to file. If you do not file, you can lose the deduction. If you are given an advantage, why not use it?
Business Owners
There are certainly advantages to owning a business, either by starting your own incorporated company or by investing in one.
Usually you are not taxed on the profits unless you take them out by way of dividends or as wages (see previous section). In addition, there is an item called the Foreign Tax Credit.
Many expats own their car, property and other items via a corporation (sociedad anónima, or S.A., in Costa Rica), because they have been advised it will protect them from personal liability should problems arise, such as a vehicle accident. This comes with an obligation to file an additional set of forms with your U.S. tax return, because the U.S. government does not care why you use the corporation, or if it is basically inactive. Specifics regarding your position and ownership percentage determine what information you are required to provide.
The Central American Free-Trade Agreement with the United States (CAFTA) will have implications in the area of taxation. Costa Rica already has an exchange-of- information treaty with the United States. Increased commercial ties and ever-increasing computer technology will make this area even easier for governments to explore.
Banking
Unless you have been in a very remote area for a long time, you will be aware that the figure $10,000 is an important number. It appears on many bank forms. It is on the Customs declaration you make on international flights. It is also used as a qualification to report to the U.S. Department of the Treasury, if you have bank accounts in a foreign country whose total value exceeds $10,000. This applies if the balance exceeds $10,000 even for only a part of one day.
This may not be an issue now, but if you return to the United States some years in the future, how do you explain the appearance of more than the magical $10,000 in the bank account you just opened? Sale of property? Where have you been living and how were you able to pay your living expenses? If it comes from your bank account in another country, why was this information not filed with your tax returns? So, you didn’t file tax returns?
How would you prove the money was earned legally, and if it was legal, why did you not file and use the “gift” of the Foreign Earned Income Exclusion and/or other tax credits?
Marriage
You fell in love and married a non-U.S. citizen who has children. The children are not U.S. citizens. You support the children 100%. Do they qualify as dependents? Sorry, no.
If you have a child together, you should inform the U.S. Embassy so you can apply for a Social Security number and citizenship on behalf of your child.
After you marry a non-U.S. citizen, you file as “married filing jointly” or “married filing separately,” and your new spouse has to apply for a taxpayer identification number.
If you file jointly, the worldwide income of your spouse must be included. If your spouse has income, filing separately could be more advantageous.
Home Ownership
The IRS allows a $250,000 home exclusion. If you qualify, it would be wise to show the gain on your tax return and that you are taking the exclusion. If the gain is not shown, questions upon your return to the United States could include: Where did the money come from? Why did you not use the exclusion? Why did you not report a bank account holding more than $10,000? and so on. Hard to answer, and to avoid penalties and taxation. But you can do the right thing, and keep most or all of your gains.
Social Security and Other Benefits
If your only source of income is Social Security, you are not taxed on it and you do not have to file a return. If you have other income, it could be taxable, and Social Security is added to the amount to determine your liability.
If the department that pays your benefit reduces your income, it may have assumed you are not a citizen, since you do not reside in the United States, and may withhold 30%. To get your money back, you should file a return and request a refund.
U.S. tax laws are complex, but you can make them work for you by not putting your head in the sand; they will not go away. Discuss your situation and concerns with a qualified adviser.
For more information about U.S. tax issues, call U.S. Tax & Accounting at 288-2201.
