Are you approaching retirement age and wondering where you can move to make your nest egg last longer? Retiring abroad may be the answer. But before packing your bags, it’s important to look at the tax implications to avoid unpleasant surprises.
Leaving the country does not exempt U.S. citizens from their domestic tax obligations. While some retirees may not owe any U.S. income tax while living abroad, they must still file a return annually with the IRS””even if all of their assets were moved to a foreign country. The bottom line is that you may still be taxed on income regardless of where it is earned.
Unlike most countries, the U.S. taxes individuals based on citizenship, not residency. As a result, every U.S. citizen (and resident alien) must file a U.S. tax return reporting worldwide income (including income from foreign trusts and foreign bank and securities accounts) in any given taxable year that exceeds threshold limits for filing.
The filing requirement generally applies even if a taxpayer qualifies for tax benefits, such as the foreign earned income exclusion or the foreign tax credit, substantially reducing or eliminating U.S. tax liability.
These tax benefits are not automatic and are only available if an eligible taxpayer files a U.S. income tax return.
Any income received or deductible expenses paid in foreign currency must be reported on a U.S. return in U.S. dollars. Likewise, any tax payments must be made in U.S. dollars.
Also, retired taxpayers may have to file tax forms in the foreign country where they reside. They may, however, be able to take a tax credit or a deduction for income taxes you paid to a foreign country. These benefits can reduce taxes if both countries tax the same income.
Nonresident aliens who receive income from U.S. sources must determine whether they have a U.S. tax obligation. The filing deadline for nonresident aliens is generally April 15.
FBAR Reporting
U.S. persons who own a foreign bank account, brokerage account, mutual fund, unit trust, or another financial account are required to file a Report of Foreign Bank and Financial Accounts (FBAR) by April 15 if they have financial interest in, signature authority or other authority over one or more accounts in a foreign country, and if rhe aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.
The definition of a foreign country does not include U.S. territories and possessions, such as Puerto Rico, Guam, the U. S. Virgin Islands, American Samoa, or the Northern Mariana Islands.
Income from Social Security or Pensions
If Social Security is your only income, your benefits may not be taxable, and you may not need to file a federal income tax return. If you receive Social Security, you should receive a Form SSA-1099, Social Security Benefit Statement, showing the amount of your benefits. Likewise, you should receive a Form 1099-R for each distribution plan if you have pension or annuity income.
Retirement income is generally not taxed by other countries. As a U.S. citizen retiring abroad who receives Social Security, for instance, you may owe U.S. taxes on that income but may not be liable for tax in the country where you’re spending your retirement years.
However, if you receive income from other sources (either U.S. or country of retirement), from a part-time job or self-employment, for example, you may have to pay U.S. taxes on some of your benefits. Each country is different, and you may also be required to report and pay taxes on any income earned in the country where you retired.
Foreign Earned Income Exclusion
If you’ve retired overseas but take on a full or part-time job or earn income from self-employment, the IRS allows qualifying individuals to exclude all, or part, of their incomes from U.S. income tax by using the Foreign Earned Income Exclusion (FEIE). In 2023, this amount is $120,000 per person.
If two individuals are married and work abroad and meet either the bona fide residence test or the physical presence test, each one can choose the foreign-earned income exclusion. Together, they can exclude as much as $240,000 for the 2023 tax year.
Income earned overseas is exempt from taxation only if certain criteria are met, such as residing outside of the country for at least 330 days over 12 months or an entire calendar year.
Tax Treaties
The U.S. has income tax treaties with many foreign countries, but these treaties generally don’t exempt residents from their obligation to file a U.S. tax return. Under these treaties, residents (not necessarily citizens) of foreign countries are taxed at a reduced rate or are exempt from U.S. income taxes on certain items of income they receive from sources within the United States. These reduced rates and exemptions vary among countries and specific items of income.
Treaty provisions are generally reciprocal and apply to both treaty countries. Therefore, a U.S. citizen or resident who receives income from a treaty country and is subject to taxes imposed by foreign countries may be entitled to certain credits, deductions, exemptions, and reductions in the rate of taxes of those foreign countries.
Also Worth Noting
Many states also tax resident income, so even if you retire abroad, you may still owe state taxes unless you established residency in a no-tax state before you moved overseas. Some states honor the provisions of U.S. tax treaties; however, some states do not.
Taxpayers who relinquish their U.S. citizenship or cease to be lawful permanent residents of the U.S. during any tax year must file a dual-status alien return and attach Form 8854, Initial and Annual Expatriation Statement. A copy of Form 8854 must also be filed with the Internal Revenue Service by the tax return’s due date (including extensions).
Giving up your U.S. citizenship doesn’t mean giving up your right to receive Social Security, pensions, annuities, or other retirement income. However, the U.S. Internal Revenue Code (IRC) requires the Social Security Administration (SSA) to withhold nonresident alien tax from certain Social Security monthly benefits. Unless you qualify for a tax treaty benefit, as a nonresident alien receiving Social Security retirement income, SSA will withhold a 30% flat tax from 85% of those benefits. This results in a withholding of 25.5% of your monthly benefit amount.
Taxes for Americans living overseas are complicated and can be an important factor in your retirement decision. Consider working with a tax professional well before you plan to retire ”“ this column is for general information only and should not be considered specific advice.
Norman G. Grill is managing partner of Grill & Partners LLC, certified public accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien.
