Striving for a better world

Navigating financial obligations as a U.S. citizen or green card holder living abroad can be challenging due to global taxation rules and complex regulations. Here’s a comprehensive guide to understand some of the most important obligations and requirements:

U.S. Citizens
  • Tax Obligations: U.S. citizens face worldwide taxation and must file an annual tax return with the IRS. The Foreign Earned Income Exclusion (FEIE) allows you to exclude up to $120,000 of foreign-earned income in 2024​ (My Expat Taxes)​.
    • Example: A U.S. citizen earning $140,000 in Germany exceeds the $120,000 FEIE limit and will need to pay taxes on the remaining $20,000.
    • Penalties: Failure to report global income accurately can result in penalties up to 75% of the unpaid tax due to fraud​ (IRS.gov)​.

When the FEIE is applied, the first $120,000 of the income is excluded from U.S. taxable income. The remaining $20,000, however, is subject to U.S. federal income tax. The U.S. taxes its citizens on their global income, so this $20,000 would be included in your taxable income.

 

  1. Federal Income Tax: For the tax year 2024, suppose this income falls into a marginal tax bracket of 24% (this rate is hypothetical and used for illustration; actual rates can vary based on the tax brackets set for the year). Therefore, you would owe approximately $4,800 in U.S. federal income tax on the $20,000, assuming no other deductions or credits apply specifically to this amount.
  2. Foreign Tax Credit: To avoid double taxation, you can claim a credit for taxes paid to Germany on the $20,000. This means that if you paid $5,000 in German taxes on this portion of your income, you could potentially offset your U.S. tax liability with a foreign tax credit up to the amount of U.S. taxes due on that income.
German Tax Implications

In Germany, worldwide income is also taxed for residents. However, as a U.S. expatriate, you would typically be taxed only on the income earned within Germany unless you qualify as a tax resident (usually by staying more than 183 days in a year in Germany).

  1. Income Tax: Germany’s income tax rates are progressive. For example, an income of $140,000 would likely place you in a higher tax bracket. As of recent years, this could be around 42% for higher incomes. Thus, the $20,000 could be subject to this rate. However, the exact tax will also depend on various factors, including whether you qualify for any deductions or allowances under German tax law.
  2. Avoiding Double Taxation: Germany and the U.S. have a tax treaty to prevent double taxation. This agreement ensures that you won’t pay tax twice on the same income. You would typically declare your worldwide income in Germany and use the tax paid in the U.S. as a credit against your German tax liabilities, or vice versa, depending on various factors such as residency status and where the income is sourced.
  3. Reporting Requirements: Citizens must file an FBAR for foreign accounts exceeding $10,000 and Form 8938 for assets exceeding FATCA thresholds. The FATCA thresholds are $400,000 in foreign assets on the last day of the tax year or $600,000 at any time during the year for married couples filing jointly​ (Wise).
    • Example: If a U.S. expat couple has foreign accounts totalling $500,000, they must file an FBAR and Form 8938.
    • Penalties: Failure to file an FBAR can result in penalties of up to $10,000 for non-wilful violations and up to $100,000 or 50% of the balance of the account, whichever is greater, for wilful violations​ (IRS.gov).
Practical Steps:
  • File U.S. Tax Return: Declare your worldwide income and claim the FEIE for the first $120,000. Report the remaining $20,000 as taxable income and calculate your tax and potential foreign tax credits.
  • File German Tax Return: Declare your income in Germany if required (depending on your residency status) and calculate your tax due. Claim credits for any U.S. taxes paid.
U.S. Green Card Holders
  • Tax Obligations: Green card holders are taxed on worldwide income like U.S. citizens. They may face an exit tax if they renounce their status, assessed on their net worth and U.S. residency status​ (IRS.gov).
      • Example: A green card holder with a net worth exceeding $2 million may face the exit tax if they give up their green card.
      • Penalties: Misreporting or underreporting taxes when renouncing green card status can lead to significant financial penalties.

Let’s delve deeper into the scenario where a green card holder with a net worth exceeding $2 million decides to give up their green card, potentially facing an exit tax, also known as the expatriation tax.

Understanding the Exit Tax

The U.S. imposes an exit tax under certain conditions when someone relinquishes their green card. This tax is part of the expatriation tax rules aimed at individuals who terminate their U.S. resident status. It’s triggered if any of the following conditions are met:

    1. Average Annual Net Income Tax: If the individual’s average annual net income tax for the five years ending before the date of expatriation or termination of residency is more than a specified amount adjusted annually for inflation ($178,000 for 2023).
    2. Net Worth: If the individual’s net worth is $2 million or more on the date of expatriation.
    3. Certification of Tax Compliance: If the individual fails to certify on Form 8854 that they have complied with all U.S. federal tax obligations for the five years preceding the date of expatriation.
Example Expanded:

Suppose a green card holder named Alex has a net worth of $2.5 million and decides to relinquish their green card. Since Alex’s net worth exceeds the $2 million threshold, they would be subject to the exit tax.

Calculation of Exit Tax:

The exit tax is calculated as if Alex sold all their assets on the day before expatriating. For instance, if Alex owns:

  • A home valued at $1 million.
  • Stock investments worth $1 million.
  • Other assets and cash totalling $500,000.

 The gains from these deemed sales would be subject to capital gains tax. The first $767,000 of gain (as of 2023) is exempt from this tax under the expatriation rules.

Financial Impact:

  • If the total unrealized gains on the home, stocks, and other assets amount to $600,000, then Alex would only be taxed on $600,000 – $767,000 = $0, as the gains do not exceed the exemption threshold.
  • However, if the unrealized gains amount to $900,000, Alex would be taxed on $900,000 – $767,000 = $133,000.

Compliance Requirements:

Alex must file IRS Form 8854 to certify compliance with U.S. tax laws for the past five years and to calculate the exit tax due. Failure to file this form could result in significant penalties and continuing U.S. tax obligations.

Considerations:
  • Tax Planning: It is crucial for individuals like Alex to engage in tax planning with a financial advisor or tax professional specializing in expatriation tax issues to explore lawful strategies to minimize the exit tax.
  • Future Tax Liability: Understanding the implications of giving up residency is essential, as it might affect Alex’s future U.S. source income and estate tax liabilities.
People Who Worked Temporarily in the U.S.
  • Departure Tax: An individual who lived and worked temporarily in the U.S. and leaves may face an exit tax if their worldwide assets exceed $2 million or if they meet other criteria​ (IRS.gov)​.
    • Example: An Indian national leaving the U.S. after five years of work may have to pay an exit tax depending on their assets.
    • Penalties: Failure to comply with departure tax requirements can result in interest charges and significant penalties.
  • Tax Treaties: Tax treaties between the U.S. and other countries can prevent double taxation​ (Online Taxman)​.
    • Example: A U.S. citizen living in France can claim reduced tax on U.S. pension distributions under the tax treaty.
Specific Financial Aspects

U.S. Pensions (401ks, IRAs)

  • Tax Treatment: Distributions from U.S. retirement accounts are taxable in the U.S. and may also be taxed in your resident country​ (My Expat Taxes)​.
    • Example: A U.S. retiree withdrawing $50,000 from their 401(k) while living in Germany could potentially be taxed in both countries without treaty relief.
    • Penalties: Incorrect reporting can lead to substantial penalties, including interest on underpaid taxes and fines.

Health Savings Accounts (HSAs)

  • Tax Treatment: HSAs often don’t receive favourable tax treatment abroad, and distributions can be taxed locally.
    • Example: If you withdraw money from an HSA while living abroad, you may be taxed by the country where you reside.
    • Penalties: Misreporting HSA withdrawals can lead to fines and back taxes.

 U.S. Bank Accounts

  • Reporting Obligations: U.S. bank accounts must be reported under FBAR and FATCA if thresholds are met​ (Wise)​.
    • Example: A U.S. expat with $15,000 in a U.S. savings account must report it on an FBAR.
    • Penalties: Failure to file FBARs can lead to penalties up to $100,000 or 50% of the account balance, whichever is greater​ (IRS.gov)​.

 U.S. Investment Accounts

  • PFIC Rules: Non-U.S. mutual funds and ETFs are classified as PFICs, resulting in higher taxes and complex reporting​ (Wise)​.
    • Example: A U.S. expat investing in a Canadian mutual fund may face PFIC rules, which involve higher taxes and complex reporting.
    • Penalties: Misreporting PFIC income can lead to significant financial penalties.

Written by: Alex Gover – Independent Financial Adviser

This communication is for informational purposes only based on our understanding of current legislation and practices which are subject to change and are not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.

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By scheduling an appointment with an adviser they will reach out to you at your requested time. 
Personal advice, whenever it suits you.