Updated with figures for 2016 tax returns and forms for the Affordable Care Act. Spoiler Alert: Having foreign income may increase your overall tax amount AND your monthly premiums for health insurance during the year you move to/from the US.
Reminder for Americans with foreign income: Declare all foreign income on US taxes!
For most English teaching assistants in France or Spain, for example, this often simply means including the assistant income on line 21 of Form 1040 as “other income.” This will increase the adjusted gross income, however, and if it is more than $10,350 (if you are single and under 65), you must file tax returns and you might have to pay taxes – unless you have other deductions besides the standard of $6,300 (if you are single) or other exemptions besides the standard of $4,050 (if you have no dependents). Even if your adjusted gross income is less than $10,350, your taxable income is 0 and you are not required to file, it is still a good idea to do so to reduce your risk of audit in the future.
Paid Income Tax in Another Country?
If you paid income taxes in another country, you might be able to use the Foreign Tax Credit (Form 1116). You can either claim a credit for eligible foreign taxes or deduct foreign income taxes as an Itemized Deduction on Schedule A. But if your deductions on Schedule A are less than the standardized deduction, you should choose the standardized deduction instead.
Did Not Pay Taxes on Foreign Income?
If you did not pay taxes on your foreign income, such as English teaching assistants who do not make enough to be taxed in France or Spain or students who received a tax-free scholarship to study in another country, you may be able to use the Foreign Earned Income Exclusion (Form 2555) if you made less than $101,300 in 2016. (Teaching assistants, stop laughing/crying!) However, in order to claim this exclusion, you must be outside of the United States for at least 330 days of a twelve month period that includes part of 2016. This means that most assistants do not qualify, unless they managed to remain outside of the US for more than 35 days over a 365 day period.
Remember that it does not matter what the foreign government calls the money you are receiving – stipend, scholarship, etc. – it is considered foreign income by the IRS and you are legally required to report it on your US income tax.
How to Fill Out Form 2555
If you are able to claim the Foreign Earned Income Exclusion, Form 2555 is quite simple to fill out. This form doesn’t explicitly tell you to put your foreign income on line 7 of Form 1040 though, so just add it to other wages, salaries, etc. if you need to. You will then subtract it out on line 21 where you put the same amount in parentheses and write Form 2555 on the line to the left. When claiming the exclusion, your foreign income does NOT increase your adjusted gross income, but it WILL increase the amount of tax you need to report on line 44 of Form 1040 (if your taxable income is more than 0). Your taxable income is often your adjusted gross income minus $10,300 ($6,300 for the standard deduction on line 40 and $4,000 for the exemption on line 42) if you are single with no dependents.
If you read the instructions for Form 1040, the very last paragraph for line 44 states: “If you claimed the foreign earned income exclusion, housing exclusion, or housing deduction on Form 2555 or 2555-EZ, you must figure your tax using the Foreign Earned Income Tax Worksheet.” The worksheet is on the next page and it basically instructs you to figure out the tax rate of your taxable income (line 43 on Form 1040) PLUS your foreign income (from Form 2555) and then subtract out the tax rate for your foreign income alone. Essentially this pushes your taxable income into a higher tax bracket as it will be higher than if you just look up the tax rate for your taxable income alone. If you also have qualified dividends, then you must use the Qualified Dividends and Capital Gain Tax Worksheet in order to figure out the correct number to put on line 4 of the Foreign Income Tax Worksheet. So simple, right?
If you only have foreign income and you are able to deduct or exclude all of it, then your taxable income will be 0 so you don’t need to worry about using the Foreign Earned Income Tax Worksheet or paying taxes.
However, if you have both US and foreign income (i.e. you worked in the US and then moved to Europe to be an English assistant), you will most likely end up paying more in taxes than if you had only foreign income. Let’s say you have $5,000 for your taxable (NOT adjusted gross) income on line 43 of Form 1040 and $10,000 for your foreign income. You would put 10,000 on line 7 of Form 1040 and (10,000) on line 21. But when you get to line 44, you’ll have to use the Foreign Earned Income Tax Worksheet found in the 1040 instructions. Assuming you are single and do not have qualified dividends, this is how the worksheet would look:
1. Taxable income from Form 1040, line 43 = 5,000
2. Foreign income from Form 2555, line 50= 10,000
3. Add lines 1 and 2 = 15,000
4. Tax on amount of line 3 = 1,793 [look up 15,000 in tax table in 1040 instructions]
5. Tax on amount of line 2 = 1,043 [look up 10,000 in tax table]
6. Subtract line 5 from line 4; include this amount on Form 1040, line 44 = 750
So you would have to put $750 for the amount of your tax. If you did not read the instructions and did not use the Foreign Earned Income Tax Worksheet, you would have simply looked up the tax rate for your taxable income of $5,000, which is $503. But thanks to your foreign income, you must instead pay $750. Even though you can exclude your foreign income from your adjusted gross income, you may still end up paying more taxes. Isn’t being an American expat great?
Freelance Jobs = Self-Employment
Are you a freelance writer, editor, blogger, online teacher, etc.? Chances are, the IRS considers you self-employed as an independent contractor. Although the filing threshold is $10,350 for normal wages at a job, the filing threshold for self-employed income is only $400. The bad news is that the self-employment tax is 15.3% and you won’t be able to file for free with Turbotax since you’ll need Schedule SE. The good news is that you can deduct any expenses that are vital to your business on Schedule C.
Affordable Care Act Filing Requirements
Americans living abroad who do file tax returns, make sure to include Form 8965 Health Coverage Exemptions to show that you are not required to have health care in the US since you do not live in the country. Just use the letter C as the Exemption Type and check the Full Year box in Part III.
If you moved out of or back to the US, you will need both forms 8965 AND 8962 if you received advanced premium tax credits to lower your monthly premium instead of paying the entire premium upfront (or if you didn’t get healthcare coverage at all and will need to pay the penalty – but remember there is also an exemption for a gap in coverage up to 3 months, listed as Exemption Type B). On Form 8962, you will need to answer No to Question 10 in Part II and figure out the monthly premium tax credit since you did not have coverage for the entire year in the US.
For example, I only had coverage in the US from October to December 2015 since I moved back to the US in August. I used Exemption Type C (living outside US) for January to July, and Exemption Type B (short gap in coverage) for August and September on form 8965. Then on form 8962, I only filled out the premium payment information for October to December and left the other months blank.
Yet another way that Americans with foreign income get screwed over is that foreign income is taken into consideration for the calculation of the Premium Tax Credit if you used the Foreign Earned Income Exclusion Form 2555. This essentially means that you have to pay more for health insurance during the year that you moved out of/back to the US. When you register at healthcare.gov, you are requested to give your adjusted gross income so they can calculate the amount of your premium tax credit. However, form 8962 asks for your modified adjusted gross income (which is your adjusted gross income PLUS your foreign income). So unless you want to pay more taxes rather than having a higher monthly premium, give your modified AGI, or your best estimate of it, when signing up through healthcare.gov.
Foreign Bank Account Filing Requirements
For anyone with a foreign bank account – whether you live(d) abroad or not – you will also need to check Yes on line 7A of Schedule B, and you will need to include the amount of interest earned on all domestic and foreign bank accounts on line 1. If at any point during the year, the amount of your foreign bank account was $10,000 USD or more, you must also submit the FBAR form online at the BSA E-Filing System. Like income tax, this form is due by April 15.
(Trying to) File Online
Be wary of the Free File websites as many do not report foreign income correctly (and you can’t use the majority of them anyway if you no longer live in the US). I tried some of them and a few didn’t even include foreign income on the 1040 while others only included the amount in parentheses on line 21 so the adjusted gross income was a negative number. I was also unsuccessful in submitting the forms electronically – even simply using Free Fillable Forms – when I was living abroad and could not put an end date under the Bona Fide Residence part, which created errors and a rejection of the file. The instructions say to write “continues” but that didn’t work for me either. So you may end up needing to mail the paper forms to Texas (if you’re not including payment) or North Carolina (if you are including payment).
Disclaimer: I am not an accountant or tax specialist so if you have questions about your return, contact the IRS.