Are you or your client a US American living in Australia? There are over 100,000 US Americans living down under. Not a huge number compared to other nationalities migrating to Australia, but still a big group and rapidly increasing.
As a US citizen or resident alien, the US will tax your worldwide income even while you live in Australia. So you got the Australian tax system to deal with plus the US. Both countries will want to tax your income. How does that work? How do you avoid paying tax twice? What is a Foreign Earned Income Exclusion? How to qualify for a foreign tax credit? And what is a nonresident alien?
US Tax Living in Australia
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As an US citizen or resident alien, the US taxes your worldwide income irrespective of where you actually live. And the first step in achieving this is to oblige you to file a US tax return.
You might have left the States decades ago. You might have never set foot on American soil. Or you might only earn Australian source income all taxed in Australia. You still need to file a tax return in the States if your income exceeds a certain threshold.
This threshold was – assuming that you are under 65 – US$10,350 for a single, US$20,700 for a married couple filing jointly, US$4,050 for a married couple filing separately, US$13,350 for a head of household or US$16,650 for a qualifying widow(er) in 2016. These numbers are adjusted each year.
Even as a nonresident alien you might need to file a return if engaged in trade or business activities in the States, usually when not enough tax was withheld.
What is an alien? An alien is somebody who is not a US citizen. Full stop. So by definition, at least in the eyes of the US, over 6 billion aliens inhabit the globe. A resident alien is an alien who either has a lawful permanent visa to live in the US – a so called Green Card – or who passes the substantial presence test. You pass this test if you are in the States for at least 31 days in a calendar year and at least 183 days over a period of three years including a calendar year and the preceding two years. You can elect to be treated as a resident alien if you are the spouse of a US citizen or resident alien.
When To File
Your tax return – Form 1040 – is due on April 15th, but living abroad you receive an automatic extension to June 15th. You can request an additional extension to October 15 (Form 4868) before June 15th. But interest is still calculated from April 15th on any taxes due.
What To File
As a U.S. citizen or resident alien, your worldwide income is subject to U.S. income tax, regardless of where you live. You include all gross income, you would include if you were living in the States. You can claim all deductions you could claim if you were living in the States. And you get the same tax-free threshold, tax rates and foreign tax credits as if you were living in the States. Generally speaking – of course the devil is in the detail.
But your actual US tax liability might still be lower than if you lived in the States. And this is thanks to specific exclusions and deductions you can only claim when you have lived outside the US long enough to qualify – usually at least a full tax year.
They are the Foreign Earned Income Exclusion and Foreign Housing Exclusion or Foreign Housing Deduction. Neither of these exempt you from filing if your gross income is above the filing threshold, but they can reduce your US tax by a substantial amount.
Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion allows you to exclude a certain amount of your earned income from US tax. The emphasis is on earned as in income from employment, trade or business income. The FEIE does not apply to passive incomes like pensions, interest, dividends or capital gains.
For 2017 – the tax year ending 31 December 2017 – the FEIE is $102,100. So if you earned $202,100 in 2017, you could subtract $102,100 leaving $100,000 as taxable by the US.
The FEIE adjusted income – reported on Form 2555 – is taxable at tax rates applying to the original gross amount – the so-called stacking rule. So in the example above you would use the tax rates applicable to an income of $202,100 to tax the lower amount of $100,000.
Foreign Housing Exclusion or Deduction
In addition to the FEIE, you can claim a foreign housing exclusion or deduction – using Form 2555 – for your housing expenses minus the base housing amount. The exclusion applies to housing paid for with employer provided amounts like a salary, while the deduction applies to housing paid for through self-employment.
Your housing expenses are your reasonable expenses incurred, limited to 30% of your maximum FEIE. High-cost localities like Melbourne, Perth or Sydney have a higher limit listed in the Instructions for Form 2555. Housing expenses do not include the cost of buying a property, making improvements or incurring other expenses to increase its value. And your housing expenses can also not exceed your total foreign earned income.
The base housing amount is usually 16% of your FEIE. So in rough terms your exclusion or deduction might be 14% of your maximum FEIE.
Foreign Tax Credit
You can claim a foreign tax credit – using IRS Form 1116 – for the tax you already paid in Australia. But only for income the US is actually taxing, so not FEIE income.
In the example above only US$100,000 or roughly 50% of your earned income is taxable in the States. So if you paid US$ 40,000 in Australia on the income of US$201,100, you could only claim a tax credit for half of the tax paid in Australia, so US$20,000.
While Australia’s top marginal rate is 45%, the U.S. charges 39.6%. So you will often be better off disregarding the FEIE, but claiming a full foreign tax credit. But exercise caution when making this decision. You can only claim a new FEIE if six years have passed since you last rejected an FEIE. The only exception is when you got permission from the Internal Revenue Service to change back earlier.
Any qualifying unclaimed foreign tax credits you may carry back for one year and then carry forward for 10 years, but you can only claim these against other foreign income. So if you return to the States and still have excess foreign tax credits, you can’t use these against US sourced income.
Affordable Care Act
The Affordable Care Act applies to the 2016 tax year. So make sure to declare yourself as not subject to the Affordable Care Act “shared responsability” provision. And indicate that you benefit from “deemed covered” status from a foreign health plan without the need to participate in a US plan.
Foreign Bank Accounts
The US does not tax wealth as such. But the IRS is still keen to know about your foreign bank accounts. Especially how your money got there and if it produced any income. There are two different forms – Form 114: Foreign Bank Account Report (FBAR) and Form 8938: Foreign Account Tax Compliance Act (FATCA).
If your aggregate foreign holdings exceed $10,000, you file the FBAR Form 114 electronically with the Department of the Treasury. It is due – like your Form 1040 tax return – by April 15th with an automatic extension to October 15th if you live outside the States.
If your foreign assets exceed US$200,000 on 31 December or US$300,000 at any time during the tax year, you also file FATCA Form 8938. If married and filing jointly, these thresholds increase to US$400,000 and US$600,000 respectively.
Please remember that thanks to FATCA foreign banks most likely already report your bank data to the IRS, so please make sure you get your numbers right on Form 8938.
Contribution to Superannuation Funds
Concessional contributions to Australian superannuation funds are taxed as wages for US purposes at ordinary income tax rates.
So this is a rough overview of things to consider and do around your US tax living in Australia. Of course as most things around tax, the devil is in the detail and US tax law is complicated. So make sure you seek professional US tax advice before you do anything drastic.
See you in the next episode.
Disclaimer: Tax Talks does not provide financial or tax advice. This applies to these show notes as well as the actual podcast interview. All information on Tax Talks is provided for entertainment purposes only and might no longer be up to date. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s personal circumstances.
Last Updated on 25 November 2019
The US is one of a few selected countries who tax their citizens on worldwide income regardless of residency. How is Australian sourced income taxed in the US? How do your US clients qualify for a Foreign Earned Income Exclusion (FEIE) or a foreign tax credit? How does an Australian spouse become a resident or nonresident alien? How to "file" an US tax return (Form 1040), FBARS (Form 114) or FACTCA (Form 8939)? This episode aims to give you the tools to better assist your US clients with their US tax obligations and find the right help when needed.