As an American living abroad, your tax obligations remain subject to US tax laws, including the requirement to report global income on your US tax return. The IRS requires US citizens and residents to report not only income earned within the United States but also income generated from foreign sources. Understanding which types of foreign income must be reported is important for ensuring compliance and avoiding penalties.
Here is an overview of the types of foreign income that US citizens must report on their tax returns.
1. Foreign Earned Income
Foreign earned income refers to wages, salaries, bonuses, or other forms of compensation that you earn from a foreign employer while living abroad. This includes income from full-time employment, part-time work, freelance jobs, and self-employment.
As an expat, you may be eligible for the Foreign Earned Income Exclusion (FEIE), which allows you to exclude up to $126,500 (for tax year 2024) of foreign-earned income from US taxation. To qualify for the FEIE, you must meet either the Bona Fide Residence Test or the Physical Presence Test.
While the FEIE can reduce your taxable income, it is important to note that income earned through self-employment may still be subject to self-employment taxes (Social Security and Medicare taxes), which cannot be excluded under the FEIE.
2. Foreign Investment Income
Income from foreign investments must also be reported on your US tax return. This includes:
- Interest income: Earnings from savings accounts, bonds, or loans in foreign financial institutions.
- Dividend income: Earnings from stocks or shares in foreign companies.
- Capital gains: Profits from the sale of foreign assets, such as real estate or stocks.
Foreign investment income is generally taxable in the US, although you may be able to claim a Foreign Tax Credit (FTC) to offset the taxes paid to a foreign country on this income. The FTC helps prevent double taxation, ensuring that you are not taxed twice on the same income.
When reporting foreign investment income, it’s essential to provide the appropriate documentation, such as statements from foreign banks or financial institutions. You may also need to disclose these accounts if they meet the reporting thresholds for FBAR (Foreign Bank Account Report) or FATCA (Foreign Account Tax Compliance Act).
3. Foreign Rental Income
If you own property abroad and rent it out, the income you receive from renting that property is considered foreign rental income. This income is subject to US taxation and must be reported on your tax return, even if you are paying taxes on the income in the foreign country where the property is located.
Foreign rental income is generally reported on Schedule E of your tax return, along with any allowable deductions for expenses related to maintaining and managing the rental property. These expenses might include mortgage interest, property management fees, maintenance costs, and property taxes.
4. Pensions and Retirement Income from Foreign Sources
Americans living abroad must report foreign pensions and retirement income on their US tax return. Whether it’s from a government pension, private pension, or retirement account, the income is generally taxable in the US.
If you receive retirement income from a foreign country, you may be subject to taxation in both the foreign country and the US. However, if the US has a tax treaty with the foreign country, the treaty may allow you to avoid double taxation by exempting certain types of income from tax or offering a reduced tax rate.
You should also be aware of any reporting requirements for foreign retirement accounts, such as Foreign Pension Plans or Non-US 401(k) accounts.
5. Social Security and Disability Benefits from Foreign Countries
If you are receiving social security or disability benefits from a foreign government, you are required to report that income on your US tax return. These benefits are generally taxable in the US unless a tax treaty between the US and the foreign country provides an exemption.
In many cases, the US will tax social security benefits paid by foreign governments, but you may be able to exclude these benefits if the country from which the benefits are paid has a tax treaty with the US that offers a reduction or exemption. It’s important to check the specifics of any applicable tax treaty to understand how your benefits may be taxed.
6. Income from Foreign Partnerships, Corporations, and Trusts
If you have an ownership interest in a foreign partnership, corporation, or trust, you are required to report your share of the income generated by these entities on your US tax return. This may include income earned through foreign corporations, such as Controlled Foreign Corporations (CFCs), or income received from foreign trusts.
In some cases, you may need to file additional forms, such as:
- Form 5471 (Information Return of US Persons with Respect to Certain Foreign Corporations)
- Form 8865 (Return of US Persons With Respect to Certain Foreign Partnerships)
- Form 3520 (Annual Return to Report Transactions with Foreign Trusts)
These forms are essential for ensuring compliance with US tax laws concerning foreign business interests and can help you avoid penalties for failure to report foreign income.
7. Income from Foreign Gifts or Inheritances
If you receive a gift or inheritance from a foreign person or entity, you may be required to report it to the IRS, depending on the value of the gift or inheritance. While gifts or inheritances themselves are typically not subject to income tax, there are reporting requirements if the value exceeds certain thresholds.
- Gifts: If you receive a gift from a foreign person that exceeds $100,000 in a given year, you must report it on Form 3520 (Annual Return to Report Transactions with Foreign Trusts).
- Inheritances: Inheritances from foreign sources are generally not taxable, but if you inherit property with significant value or income-generating potential, you must report it.
The IRS requires reporting to ensure that large gifts or inheritances are appropriately tracked and accounted for, especially when foreign estates are involved.
8. Foreign Scholarships or Fellowships
If you receive a scholarship, fellowship, or grant from a foreign source, the funds are typically taxable unless the scholarship is used for qualified education expenses (such as tuition, fees, or books) and meets the criteria for exclusion under the Foreign Earned Income Exclusion (FEIE).
Scholarships that cover non-educational expenses, such as room and board, must be reported as income. You should consult IRS guidelines and your scholarship’s terms to determine how it must be reported.
9. Foreign Unemployment Benefits
Unemployment benefits from foreign governments are also considered foreign income and must be reported on your US tax return. These benefits are taxable in the US, although some countries may have tax treaties that reduce the amount of tax you owe.
As an American living abroad, it’s important to keep track of all types of foreign income and ensure it is properly reported on your US tax return. Failing to report foreign income can lead to serious consequences, including penalties and interest. Additionally, it’s critical to be aware of available exclusions and credits, such as the Foreign Earned Income Exclusion and the Foreign Tax Credit, which can help reduce your tax liability.
