US Expat Taxes for Americans Living in Israel
Israel has been a target for the IRS in the past few years, which means that expats living in Israel need to be extra careful about reporting their US taxes. With over 200,000 Americans residents, Israel is a country on the IRS’s radar. The Israeli tax authorities and the IRS share tax information. This means that it is important for Americans living in Israel stay current with their taxes.
Americans living in Israel are required to file taxes each year. All Americans who earn over a certain threshold are required to report all their worldwide income each year, whether that income was earned in the US, or is it was earned in Israel, or anywhere else in the world. However, there are several ways to reduce or eliminate your US tax liability.
Foreign Earned Income Exclusion and Foreign Tax Credits
The main two ways to reduce or eliminate the amount of taxes owed while living abroad is through the foreign earned income exclusion and foreign tax credits. The foreign earned income exclusion allows an expat who meet certain criteria to exclude the first $105,900 in 2021, for their 2020 taxes. A husband and wife can each use this exclusion, which makes the total of $211,800 between a couple. In addition to the $105,900, an American living abroad can use the Foreign Housing Exclusion which allows a deduction for housing and living expenses. The amount available changes based on the city where the expat lives. In order to use the foreign earned income exclusion and the foreign housing exclusion, certain requirements need to be met, including either the Bona Fide test or the Physical Presence test.
The second way to reduce US tax liability is through Foreign Tax Credits. Foreign Tax Credits are credits for taxes paid in Israel that can be applied to US tax liability. Due to Israel’s high tax rate, many American expats living in Israel are able to use Foreign Tax Credits to reduce the amount of taxes they owe. Foreign Tax Credits are also the only way that expats can get the child tax credit refund.
FBAR and Israeli Retirement Accounts
Expats who have over $10,000 in foreign financial accounts are required to file a FBAR form each year as part of their US tax return. This form lists all foreign financial assets, including bank accounts, pension accounts, life insurance policies, securities accounts, kupot gemel, and keren hishtalmut accounts. Employers often contribute into these retirement plans which means that expats living in Israel are more likely to have over $10,000 in foreign financial accounts which would cause them to need a FBAR.
In addition, expats who are filing single, head of household or married filing separately and have over $200,000 in foreign financial accounts, and expats filing married filing jointly and have over $400,000 in foreign financial accounts will need to file a form 8938 as part of the FATCA regulations. The difference Israeli retirement vehicles make it common for Americans living in Israel to need to file these forms.
While the US has a Tax Treaty with Israel, they do not have a totalization agreement. A totalization agreement generally exempts Americans expats who pay social security to foreign countries from paying US social security. This means that self-employed Americans living in Israel are still required to pay social security taxes in the US, even though they also pay the social security equivalent in Israel. Expats are still able to use the foreign earned income exclusion and foreign tax credits to reduce or eliminate their total income tax obligations, but the self-employment taxes are separate.
Careful tax planning can help eliminate these tax obligations. One way to avoid paying self-employment taxes in the US is by forming a foreign corporation. While a corporation allow you to pay yourself a salary and avoid the self-employment taxes, owning a foreign corporation will cause other tax obligations. As an owner of a foreign corporation, you will be responsible to file a form 5471 each year as part of your US tax return. This form can be tedious, but there are no additional taxes assessed in the US if you are the owner of a foreign corporation. However, your tax filing obligations will also increase in Israel if you own a foreign corporation, including accounting fees for Israeli taxes.
For Americans living in Israel who were unaware of their requirements to file US taxes while living abroad, the IRS’s Streamlined Filing Procedures is the best way to get caught up to date with their taxes without owing additional penalties. The Streamlined Filing Procedures requires an individual to file the past three tax returns, past six FBARs and a certification of non-willfulness. The Streamlined Filing Procedures is only for expats who were unaware of their responsibility to file while living abroad or their responsibility to report foreign income.
We have filed taxes for hundreds of Americans living in Israel and we work with several Israeli accounting firms who are able to advise on Israeli tax issues as well as prepare Israeli tax returns. In addition, we help Israeli Green Card holders and Israeli’s Investing US businesses and nonresident investing is US property. We have accountants of staff who are fluent in Hebrew are knowledgeable with Israeli tax law. Send us an email or give us a call and we can answer any questions you have.