US taxes when you live abroad

The United States taxes citizens on worldwide income regardless of where they live. It is one of the very few countries that does. Moving abroad adds a second tax system to your life; it does not remove the first.

Most Americans abroad end up owing the IRS little or nothing. That outcome is produced by filing correctly, not by leaving. The two mechanisms that create it, the foreign earned income exclusion and the foreign tax credit, are both claimed on a return. Skip the return and you forfeit the relief that produced the zero, which is how a nil liability turns into a bill with penalties attached.

Filing thresholds abroad are the ones that apply at home, and they are low for anyone self-employed. There is an automatic extension to 15 June for taxpayers living outside the United States, but it extends the filing date, not the payment date.

The FEIE lets you exclude foreign earned income, meaning wages and self-employment profit, up to a cap the IRS re-indexes each year. You qualify through either the bona fide residence test or the physical presence test of 330 full days outside the US in a rolling twelve-month window.

Its limits are structural rather than fiddly, and they are what catch people:

The credit offsets US tax dollar-for-dollar with income tax actually paid to the country you live in. Where the local rate meets or exceeds the US rate on the same income, it usually wipes out the US liability entirely and leaves excess credits to carry forward. It also reaches income the exclusion cannot touch, which matters as soon as you own investments.

The rough rule: high-tax country, use the credit; low-tax country, model the exclusion. Against the US federal top rate of 37%, the countries covered here split as follows.

An income tax treaty allocates taxing rights between two countries and supplies tie-breaker rules when both would treat you as resident. It reduces double taxation and can change how specific income types, such as pensions and government service pay, are treated.

What it almost never does is release a US citizen from US taxation. Most treaties contain a saving clause that preserves the US right to tax its own citizens as if the treaty did not exist. Relief still arrives through the credit or the exclusion, claimed on a return. A treaty is a reason to check the specific article that applies to your income, not a reason to stop filing.

If you work for yourself, the exclusion does not save you. It reduces income tax; it does not reduce self-employment tax, which funds Social Security and Medicare. Without an agreement in place you can find the same earnings charged US self-employment tax and local social contributions.

A totalization agreement fixes this by assigning you to one system and exempting you from the other, evidenced by a certificate of coverage. Arrange it at the start of an engagement rather than at filing time, and price it into any freelance rate you quote before you move.

Two separate reports cover foreign accounts, and neither is a tax. FinCEN Form 114, the FBAR, is triggered by the aggregate high balance across all your non-US accounts at any point in the year, including accounts you merely sign on, such as a business account or an elderly relative's. Form 8938 under FATCA has separate, higher thresholds that vary with filing status and whether you live abroad.

Both carry penalties out of proportion to the tax at stake, and both routinely catch people whose only mistake was assuming that a report follows the money owed. If you have a local current account, a pension pot and a brokerage account, run the thresholds before you assume you are under them. Foreign pensions and certain local investment wrappers can also be treated far less kindly by the US than by the country that issued them, which is worth checking before you buy one.

Leaving the country does not automatically end state tax residency. States run their own domicile and residency tests, and several are notably reluctant to release someone who keeps a home, a driving licence, voter registration, a vehicle, or a pattern of long visits.

Ending state residency is a deliberate sequence of acts, and the evidence is what counts: close or change the address on accounts, surrender the licence, register to vote where you now live if you can, and keep a record of days present. Doing this in the year you leave is far cheaper than arguing it three years later. If you are moving from a state with an aggressive residency test, this is the item to get professional help on first.