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Scenario # 1: You are moving from the U.S. to some strange, exotic land

Let us suppose….You are reading this book for the first time, while you are still in the U.S. You are soon to embark on your trip overseas, to work for the first time outside of the U.S. Perhaps you are an experienced veteran of the work force, taking your specialty overseas for an international employer who has just signed you to a multi-year contract. Or perhaps you are a young professional going into the field of law or going to work for an investment banking house or perhaps you are a teacher, going to teach at an international school. Let’s use the latter occupation, teacher, as an example for this scenario because those young bankers or lawyers will not have much time off to put their initial, qualifying year for foreign earned income exclusion in jeopardy. You, the teacher, on the other hand, are more apt to screw yourself up because of a misunderstanding of the time you must be overseas during your first year overseas – a year that begins from the date of your arrival in your new place of residence through the next 365 days. For tax year 2014 – and that means ‘calendar year’ because the IRS operates on a calendar year reporting basis - you are entitled to a maximum of $US99,200 as foreign earned income exclusion. If you are married and your spouse is working overseas, too, then each of you would be entitled to exclude a maximum of $US99,200 from taxable income. You cannot transfer any excess, ‘unused’ exclusion from one spouse to another – if two of you each earn less than $US99,200 and it is all eligible for the exclusion, then you will still have to file a tax return but you will not owe any taxes. If either or both of you have more income than the exclusion + standard or itemized deductions + tax exemptions, you are going, in essence, to be taxed at the maximum rate – and that includes all income not eligible for foreign earned income exclusion.

Tax benefits for the U.S. expat are necessary. First, the costs of living a comparable life in Hong Kong or Dubai or Singapore are at stratospheric levels compared to, say, the cost of living in Iowa. Mind you, I have absolutely nothing against Iowa - I like the place – I spent time, two summers ago, living in Iowa City while taking writing classes at the University of Iowa (and no, I am not foolhardy to think that there ever can be a ‘tax literature’ genre!)! Yet costs of life are very, very different. The average salary in mid-levels, Hong Kong, where a concentration of international expats reside is over $US 200,000 and even with that salary, life is a struggle because of the highest real estate costs and rentals in the world. Secondly, without those benefits and with the singular distinctive obligation of the U.S. expat – we seem to be the ONLY expats with an annual filing obligation - my British, German, French and Australian friends don’t have to file tax returns - they do not even think about their income, their travels, their tax consequences. Their countries do not tax upon world-wide income, just the income taxed within their territory. Heck, there are no tax consequences for them as there are for us, the U.S. expat or green card holder. If tax laws became too draconian, there would be no Americans overseas to represent U.S. products, services and industry – I like my Australian and New Zealand friends but let’s face it – they simply cannot do as good a job as Americans when it comes to representing America overseas! For the U.S. to compete on an international level, it needs its own citizenry representing the U.S.!

Tax home

Your tax home is usually in the vicinity of where you work. It does not necessarily have to be your family home. Your family home might be in California. You maintain that residence and have intentions of returning there, years from now. Yet that family residence is halfway around the world and as you are not living there, it is not necessarily your tax home, anymore. O.K., you arrived from San Francisco to your new home in Hong Kong on 1 August 2014. Through 31 July 2014, your tax and family home was San Francisco. To meet the requirements for excluding either a portion or the total of 5/12 (1 August – 31 December 2014) of your non-U.S. earned income, you must qualify by meeting the physical presence test for 2014.

Let us get back to that U.S. teacher, as an example. He or she came to his/her new land on or about 1 August 2014 to begin work shortly thereafter. To qualify your August – December 2014 income tax excludable for your 2014 tax return you must meet the requirements of the physical presence test for your first year. (1 August 2014 – 31 July 2015). To put it simply, you CANNOT be in the U.S. for 35 days or more during that period of time. Less is best! If you go back home over the Xmas vacation, then you’d better start counting days if your school year ends in mid-June: if you exceed your 35 days maximum before 31 July 2015, then you will be taxed in full on your overseas income – now you do not want that to happen, do you? If you meet these rather strict requirements for the physical presence test during your first year of residency overseas, then you have a choice of either filing your tax return on time (15 April or, with automatic extension, 15 June), without being eligible for the exclusion and then filing an amended return, requesting a refund of what you earlier might have paid on your initial return when you file upon reaching eligibility. You want my advice? Unless you’ve got a very large withholding refund coming, then go on extension and file one return, as soon as possible, after you’ve reached ‘eligibility’. File for an additional extension before 15 June and then file only one return, as soon as you are formally eligible – it is a heck of a lot easier – trust me!!! Anyhow, Hong Kong teacher, file your return after 1 August 2015, with that return on extension....and it’ll be a veritable ‘piece of cake’ for you, now and into the future! Once you’ve met the physical presence test requirements for 2014, if you are overseas and working for 2015, then you are then more than likely to be eligible for bona fide residency classification – and this is both a heck of a lot easier to maintain and keep within limits of – and amazingly flexible for you – especially if you are a teacher not working but entitled to spend future entire summers back home in the U.S. without jeopardizing your ability to take advantage of the foreign earned income exclusion!

The Bona Fide Residence Test

This is the other, generally easier way to qualify for the foreign earned income exclusion. It is quite applicable to situations similar to Scenario # 2, below, and is, by and large, applicable to all long-term expats and green card holders. If you are a legitimate/bona fide resident of a foreign country (or countries) for an uninterrupted period that includes an entire year, then you are eligible to use the bona fide residence test to qualify. Let’s use our Hong Kong teacher as an example. Let’s assume that she or he followed the initial year guidelines to qualify for 2014 under the physical presence test, and that our friendly teacher is still at the job at the end of 2015. Well for tax year 2015, because of that ‘uninterrupted first year’, that teacher could go back to the states for the balance of the summer, come home again for Thanksgiving and then take the Christmas holidays back home in the States with his or her family and not worry one bit about exceeding the 35 days because the ONLY thing that matters under the bona fide residence test for tax year 2015 is that you are indeed a bona fide resident! If you can afford it, take those vacations – see the world! You are not violating the conditions of bona fide residency – once you attain it, you definitely do not want to lose it!

Scenario # 2: The expat who’s been overseas for years…….

At least once a year, every year, for the quarter of a century I’ve been working overseas, I get a telephone call from someone who was referred by a mutual acquaintance. The person calling me would sheepishly tell me that he or she has a problem. What’s the problem, I ask. I haven’t filed my income taxes, he or she states. How long, I ask……. Well the longest time I’ve ever heard, in response, has been 37 years. If you have consistently had an annual tax bill due to the IRS, you are going to have some problems and you’d best consult someone to assist you. If, on the other hand, you have been consistently earning a salary overseas that is under the yearly maximum foreign earned income exclusion – if that’s your case, then no sweat – file for a few years of past due returns as well as the current year. This was the ‘unofficial’ way of doing things, for years. Then, on 18 June 2014, the IRS announced both a new, revised Offshore Voluntary Disclosure Program and, more importantly Streamlined Procedures for legitimate expatriates (with residency requirements just a bit more stringent than those one follows for the foreign earned income exclusion), with three years of tax returns and six years of FinCEN114 reporting as part of the requirements and certifying, through a new form, Form 14653, that the filer is non-willfully neglect in prior non-filings or incorrect filings. There’s a whole lot more detail about this program in a separate section of this book……read it – it could be quite beneficial to you.

If you have been around the world, living outside of the states for a while and you have a tax preparer doing your tax return for you, then it’s the bona fide resident that you are, my friend, and this is the way you’ve been filing – even if you didn’t realize that this is what your tax preparer has been listing for you, year after year after year. What’s that? You don’t look at the tax return that’s been prepared for you? Yeah, I’d like to say: ‘Shame on you!’ but let’s face it – very few people actually look at their tax return. This is the sad state of affairs we’ve come to, vis-a-vis the U.S. tax system: it is a system that has become so convolutedly impossible to understand that most filers simply sign and never look. You are signing this to be a true, complete and full return - you have a liability, if nothing else, to actually look at that bleeping return - even if you do not understand it....and if you do not understand it, then ask questions - this is part of what you have been paying for!!! You have no excuse for not looking at what you’ve been signing, attesting to be the truth, the whole truth and nothing but the truth…..because the penalty for not telling the whole truth could be costly….. For all intents and purposes, if you are legitimately a ‘lower end’ (income-wise) expat, you are fulfilling your legal responsibilities by filing an annual individual income tax return. Yet, in all likelihood, since you are overseas, you file the return by hard copy, not eFiling your return. True, in the future, this will be changing, as all firms preparing 11 returns or over MUST eFile……unless each and every one of my clients signs a letter of understanding about the differences between eFiling and that old fashioned hard copy way. Me? I simply choose NOT to eFile either for myself or my clients. Call me a luddite, call me ‘computer challenged’, call me what you will but I would rather submit a hard copy of a return, knowing that I am aiding the process of screwing up a system that already is overloaded with far too much paper and has little capability of handling much more. Yet it is not only your patriotic duty but your legal responsibility to file, so don’t sweat not eFiling (which you are compelled to do, regardless, for FinCEN114), sign and send in that hard copy of your return - and keep a copy of that return along with your with proof of mailing, because the U.S. government loses things, too – they lose things far more than they’ll ever willingly admit!!

The Foreign Housing Exclusion

Not too many years ago, one had an unlimited amount that could be excluded under the foreign housing exclusion. Then Senator Chuck Grassley came along and under the Tax Increase Prevention and Reconciliation Act, limits were imposed, city by city by city, around the world. That maximum amount is allowed for verifiable rents, repairs, utilities, insurance, furniture rental and parking costs. What? You paid more than you are allowed? Tough luck! You have a limit, now, for the foreign housing exclusion. That exclusion would be the excess of all of these costs over a base amount of approximately $US15,000 – this is based upon an annual cost of living in the U.S. and to be specific, it is $US15,872 for tax year 2014 - that was deemed to be the average annual housing cost for tax payers residing in the U.S. Some people in some jurisdictions needed this exclusion for tax ‘fairness’ as these costs were truly part of their unreimbursed business way of life (mine to aspire to, yet never likely to attain..), part of the requirements going with that highest of levels of the biggest of the big. The tax act of May 2006 killed that…..such is life…..

It is interesting to note that neither bill that either the House of Representatives or the U.S. Senate passed, respectively, included the two items that Senator Charles Grassley, Republican of Iowa included within the conference bill which was then automatically passed by both houses of Congress and signed into law by the President. This is a truly sad commentary – we elect legislators who do not read what they vote upon, who rely upon legislative aides who do not have the time to read what is ‘hidden’ into many joint conference committee bills. The rider added to that bill now set limits on the maximum amount that could be excluded, based upon cost of housing, per location; and the graduated income tax, with progressive rates is, for all intents and purposes, inapplicable to those taking advantage of foreign earned income and housing exclusions: that the very first dollar over and above all valid expenses, deductions and exclusions would now be taxed as if the taxpayer were at the 33 percent tax bracket rather than starting out at the lowest 10 percent rate and working up to the higher rates – progressive taxation is now a thing of the past for expats. And, if you lived in a high cost of living/low tax jurisdiction (ie Singapore, Hong Kong, Dubai), you, the U.S. expat, could expect to encounter some previously unseen tax problems. It is now 2015 – sadly, nothing has changed in Washington. Do you think any of the 535 Congresspersons or Senators read Hire-FATCA of 2010? Not one! That, my friends, is a very, very sad commentary about American democracy…..