Did you know that foreign income is still taxed by the United States? Millions of Americans who earn money abroad or plan to earn money abroad should be aware of their tax obligations. The United States is currently one of the only countries in the world that taxes based on citizenship, and not residency. However, there are some exclusions and foreign tax credits that can reduce your tax liability. Overall, reporting foreign income can be tricky. Here’s an overview of how to report foreign income at tax time.
What is Foreign Income?
First, let’s clearly define foreign income. Foreign income is any income you receive overseas. This can include the following:
Foreign wages: Foreign wages are wages paid to you for services rendered or goods sold. This can mean being employed by a foreign company or being self-employed but working abroad.
Foreign interest and dividends: Foreign interest is money earned through foreign bank accounts. Foreign dividends are payouts from foreign-earned stocks.
Foreign real estate: Foreign rental income is income earned on a property you rent out located in a foreign country. Alternatively, if you sell a property that is located outside the United States, you’ll need to report the gains or losses on the sale during tax season.
How Do I Report Foreign Income on My U.S. Tax Return?
If you earned foreign income, you would need to report it on Form 1040 when filing your tax return. You may also need to file other tax forms depending on what type of income you earned. For example, if you earned foreign interest and dividends, you’d report these on Schedule B of Form 1040. Foreign business income is reported on Schedule C. Most capital gains are reported on Schedule D. Rental property income is reported on page 1 of Schedule E. However, in more complicated tax situations, there could be additional forms to file, like Form 8938, Statement of Specified Foreign Financial Assets or Form 114, Report of Bank and Financial Accounts. In any case, you should speak to a qualified tax preparer about which forms your specific tax situation requires.
What is the Foreign Tax Credit?
Some taxpayers might worry about paying taxes twice on the same income. The Foreign Tax Credit (FTC) is one of two safeguards that help American taxpayers avoid this issue. This credit allows American expats, or U.S. citizens who live abroad, to offset foreign taxes paid abroad dollar-for-dollar. For example, if you’re an American expat who paid income taxes to the foreign country where you reside, the FTC gives you a tax credit to use on your U.S. income tax return.
Requirements
To claim this credit, you must be the following requirements:
The tax must be imposed on you. This basically means that if your resident country does not require income taxes to be paid, you do not qualify for the FTC.
You must be the one who paid or accrued the tax. This means if you have not paid the tax or accrued it, you do not qualify for the FTC.
The tax must be the legal and actual foreign tax liability. This means that if the tax is not legal, and you are not required to pay it, you do not qualify for the FTC.
The tax must be an income tax. This means that if the tax is another type of tax besides income tax, you do not qualify for the FTC. The IRS has specific rules on what they deem to be a foreign income tax. Be sure to check with your tax preparer for clarification.
How to Calculate the Foreign Tax Credit
Calculating your maximum FTC can be tricky, but essentially you can divide your foreign taxable income by your total taxable income (including U.S. income). Then take this quotient and multiply it by your U.S. tax liability. For example, if you earned $50,000 in Spain and another $10,000 in U.S. income, you’d have a total taxable income of $60,000. Let’s also assume you had a U.S. tax liability of $12,000. You would take your foreign income of $50,000 and divide it by your total taxable income of $60,000 to get 0.83. You would then multiply 0.83 by your U.S. tax liability of $12,000 to get your maximum FTC of $10,000.
Additionally, the FTC can carry over to the next tax year or carry back to a previous tax year. Unused FTC amounts can be carried over for up to 10 years. Taxpayers can claim the FTC by filing Form 1116.
What is the Foreign Earned Income Exclusion?
The other safeguard that helps American taxpayers avoid paying taxes twice on the same income is the Foreign Earned Income Exclusion (FEIE). The FEIE allows you to exclude all or some of your foreign earned income on your U.S. tax return, including salaries, wages, bonuses, commissions, and self-employment income. It does not include passive or investment income. The FEIE is available to U.S. expats who meet one of the following requirements:
Work outside the United States as an employee
Work outside the United States in a self-employed or partnership structure
Pass the Bona Fide Residency Test. This requires being overseas for work for longer than one year and having a permanent place of work in the foreign country.
Pass the Physical Presence Test. This requires living outside the United States for 330 full days out of the year.
U.S. taxpayers must use Form 2555 to claim the FEIE and can exclude up to $120,000 of foreign income for the 2023 tax year. The amount is due to increase to $126,500 for tax year 2024. Married couples filing jointly can exclude up to $240,000 as long as both spouses meet either the bona fide residency test or the physical presence test.
Help Reporting Foreign Income
Reporting foreign income can get complicated very fast. While this article covers several topics related to foreign income, it really is just the tip of the iceberg and applies to most simple tax situations. American taxpayers who live in the country, as well as expats, who earn foreign income should seek best practices regarding foreign income from reliable and knowledgeable tax professionals. If you need tax help, Optima can assist.
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Sometimes after the death of a loved one, we are left to deal with grief, funeral planning, and an estate. In some cases, we inherit assets from a deceased loved one. Unfortunately, not much in this life comes for free, and even the things we inherit can cost us. In this article, we will take a closer look at estate and inheritance taxes, including who is affected by them and how they work.
These days it is very common for individuals to have regular income, as well as supplemental income. While regular income earned through an employer typically has taxes withheld, some supplemental income does not. If you earn supplemental income, it’s important to learn how it is taxed and when. Here is a brief overview of supplemental income tax.
If you have an unpaid tax bill, you know the stress that comes with owing the IRS. The IRS is a powerful agency with the ability to collect what is owed to them using severe methods. These can include garnishing your wages or levying your bank accounts. With a 10-year statute of limitations, the agency has plenty of time to forcefully collect tax debts. While some taxpayers might want to ignore their tax bills, doing so comes with many risks. Here are some of the top risks of owing the IRS.
The IRS will collect.
The IRS will always warn you of intent to collect or enforce through IRS notices. After these notices have been ignored, the IRS will place you in their Automated Collection System (ACS). This basically means they can issue liens, levy your bank accounts, and garnish your wages. Alternatively, the IRS may turn your tax debt over to a debt-collection agency.
The IRS may file a federal tax lien.
If a tax balance goes unpaid and notices are ignored, the IRS can file a Notice of Federal Tax Lien. This basically lets creditors know that you have tax debt. A lien is a legal claim against a property, usually placed because the property owner owes someone money. Liens can severely hinder your ability to access credit. In addition, they can also damage your reputation since they are public information.
The IRS can seize your assets.
If a tax balance goes unpaid, the IRS will send you a Notice of Intent to Levy. If they do not hear from you after 30 days, they may proceed with the levy. The IRS is known to levy bank accounts, wages, and more. Wage levies, also called wage garnishments, are when the IRS takes some of your paycheck to put toward your unpaid tax bill. The amount they levy will depend on your filing status and number of dependents.
The IRS may also levy your bank account. If your tax balance is greater than your bank account balance, they are authorized to levy the entire account. The same goes for joint bank accounts that you have access to. If you own a small business, or do contract work, the IRS can levy these earnings. If you file your taxes and are due a tax refund, the IRS will keep the refund and apply it to your unpaid tax bill. The IRS will stop levying if you arrange a payment agreement or if you pay your tax bill in full.
The IRS will charge you penalties and interest.
Your tax bill doesn’t end with your unpaid taxes. The IRS will charge you interest until the balance is paid in full. The current rate for underpayment is 7% annually, at least through June 2023. On top of that interest, the IRS will charge a failure-to-pay penalty on your unpaid taxes. The current rate is about 0.5% per month or partial month the balance remains unpaid, for a maximum of 25% of your unpaid tax. The amount is increased to 1% per month or partial month if you do not pay within 10 days of receiving an IRS Notice of Intent to Levy. However, if you set up a payment plan with the IRS, the rate drops to 0.25% per month or partial month.
You may lose traveling privileges.
Under the Fixing America’s Surface Transportation (FAST) Act, the IRS requires your Department of State to deny passport applications and renewals submitted by taxpayers with tax bills of $52,000 or more. The State may also revoke your valid passport or limit your ability to travel outside the U.S.
How Can I Get Relief from My Tax Debt?
Clearly, the risks of owing the IRS are extreme and affect all facets of life. If you’ve been ignoring IRS notices coming through your mail, it may not be long before these risks apply to you. Ignoring your tax issues will certainly not make them disappear. Your best bet is to find a way to work with the IRS to see what your options for repayment are. We know how stressful this process can be, but Optima is here to help you with all of your tax issues.
Many taxpayers are reporting smaller refunds this year. While many cases can be credited to tax credits returning to pre-pandemic levels, several others could be because of an outdated Form W-4. Unbeknownst to some, a W-4 needs to be updated whenever certain life changes occur. If it‘s outdated, you may not have enough tax withheld during the year. This basically results in a smaller refund at tax time. However, the recent 2020 changes to the W-4 form have confused some taxpayers. Here’s a breakdown of how to fill out a W-4.
What is a W-4?
Formally known as the Employee’s Withholding Certificate, a W-4 is an IRS tax form that helps employers calculate how much tax to withhold from an employee’s paycheck. This form is most commonly filled out by an employee upon starting a new job. However, it can be submitted at any time of the year. An accurate W-4 will help you avoid overpaying or underpaying your taxes during the year.
When Should I Fill Out a W-4?
You should fill out a W-4 each time you start a new job. This is true even when the new job is a second job or gig work. This basically means you will have multiple W-4s if you have multiple jobs. You should also fill out a new W-4 when you experience a life change that can trigger a tax liability. For example, getting married or divorced should result in a new W-4 being submitted to your employer. Having a child, claiming a new dependent or removing a dependent are other scenarios in which you might want to adjust your withholding.
How To Fill Out a W-4
Step 1: Fill in your personal information.
First, you’ll enter your personal information, such as your full name, address, Social Security number (SSN), and tax-filing status. Your tax-filing status is very important here as it will determine which tax credits and deductions you might qualify for during tax time. Technically, you can stop at this step and sign the W-4. Your employer will withhold at a default rate. However, this may not result in the right balance of a decent-sized paycheck and tax refund.
Step 2: Determine your withholding.
For most, this is the trickiest section of the W-4. If you need clarification, you should seek help from your Human Resources department at work. Here you’ll need to choose your tax withholding according to the number of jobs and combined income you have, including self-employment. This also includes your spouse if you file jointly.
If you have multiple jobs, the W-4 for the highest paying job should have Steps 2 through 4(b) filled out. The W-4s for all other jobs can have Steps 2 through 4(b) blank. This will ensure accurate tax withholding.
If you have multiple jobs, and the earnings for both are roughly equal, you can choose to check box 2(c). You will need to make sure the W-4s for both jobs have this box checked.
If you want to omit the fact that you have a second job, you can choose to withhold a certain amount of tax from your paycheck on line 4(c). If you do not want to have additional tax withheld, you can opt to make estimated payments to the IRS instead.
Step 3: Add your dependents.
If you earn under $200,000, or $400,000 for married couples filing jointly, you can claim your dependents by following Step 3 on the W-4. If you are filing jointly, make sure only one of you claims these child-related tax credits through withholding. Claiming credits on both forms can result in too little tax will be withheld, and you could have a tax bill at tax time. In general, it is recommended that the highest-earning job claims the child-related tax credits on Form W-4. Taxpayers should note that they are not required to claim dependents here if they would rather have more taxes withheld from their paychecks to reduce their tax bill.
Step 4: Make other adjustments.
Here you will make other adjustments, including other income you receive outside of work, deductions other than the standard deduction, and extra withholding. You might want extra tax withholding if you are self-employed and want taxes withheld from these earnings.
Step 5: Sign the W-4 and submit to HR.
Sign and date the complete W-4. This step is required for the form to be accepted.
Additional Help With a W-4
These steps should help you successfully fill out a W-4, resulting in the appropriate amount of tax withheld from your earnings. Some taxpayers might be interested in altering their W-4 in order to have more taxes taken out of their paycheck to receive a larger tax refund at tax time. To do this, you can reduce the number of dependents on your W-4 or add extra withholding on line 4(c). Alternatively, if you want fewer taxes withheld, you can increase the number of dependents, reduce the number on line 4(a) or 4(c), or increase the number on line 4(b). Beware though, as this can result in a tax bill at tax time.
Taxpayers should always ensure that they are adjusting their W-4 when necessary to avoid unwelcome surprises at tax time. If you need tax help, Optima Tax Relief and our team of knowledgeable tax professionals are here to assist you.
