Benjamin Franklin asserted: “in this world nothing can be said to be certain, except death and taxes.” What he didn’t tell you was that the moment you became a long-term resident of another country, you started being taxed…twice! Well, sort of.
America Loves You and Your Money
If you are a U.S. citizen, congratulations! You are loved and sought after (some might say “pursued”). Unless you plan to renounce your citizenship (and I’m not recommending it), you are required to report your worldwide income every year to the US government. The IRS lovingly tells you:
If you are a U.S. citizen or resident alien, the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether you are in the United States or abroad. Your worldwide income is subject to U.S. income tax, regardless of where you reside. [IRS.gov]
Take a look at this IRS link with all the various types of taxpayers, treaties, forms, and sublinks. If you didn’t think you needed a professional tax preparer before, you may start thinking differently now. This isn’t your grandfather’s 1040EZ you’re filling out.
Do you feel the love? Just wait. It gets worse before it gets better.
The World Loves You and Your Money
Many countries have established or are scrambling to establish laws which clearly state that if you live in their country, you must pay income tax in their country. The most common laws seem to be that if you live in a country for more than 183 days (yes, that’s just a smidge over half a year) without a clear, somewhat imminent plan to return to the USA (as is the case for perhaps a nonprofit worker sent to West Generica for a 10 month term), they lovingly declare that you are their resident. While the 183-day limit is common, every country is different.
The American Citizens Abroad (ACA) sums it up nicely:
Part of the requirements of being a US citizen is that you must file and pay any relevant US taxes annually no matter where you live and work. Americans who are resident in foreign jurisdictions (countries) should also file and pay local taxes in their country of their residence and then make a declaration to the United States (see taxation section for more information on this).
Does that Mean I Can Be a Taxable Resident of More than One Country?
You certainly can! They all love you and your money, so why not?
The most extreme case I’ve run into personally involved a friend who fell into a triple residency situation back in about 2012. An Asian country had a 60 day residency period, a European country had a 183 residency period, and the US considers all of its citizens to be residents for income tax purposes. What’s the problem? A pilot who was a US citizen lived in Europe and had 60 days of hotel layovers in that Asian country. He already needed to pay tax in Europe, file taxes in the US, and then he received a hefty tax bill from Asia in the mail! This is not a hypothetical situation. It really happened! He became an accidental resident of an Asian country by spending his layovers in a hotel room.
It’s nice to be fought over with such exuberant love, but we’re starting to feel a bit smothered by all of this attention. This love is starting to feel like a vise, and we’re stuck in the middle.
Treaties for the “Avoidance of Double Taxation” and the “Prevention of Fiscal Evasion”
You might still feel the love in that first phrase about “Avoidance of Double Taxation,” but there’s a bit of an edge to that “Prevention of Fiscal Evasion” stuff, right? You’re not wrong. Knowing that many expats are technically residents of the US (as citizens) and of a foreign country (as physically living there), many countries signed treaties to resolve once and for all where you pay your taxes. You can find out if your country has an income tax treaty with the USA through this IRS.gov link where you will also find these words:
If you are a resident of both the United States and another country under each country’s tax laws, you are a dual resident taxpayer…. The income tax treaty between the two countries must contain a provision that provides for resolution of conflicting claims of residence.
Some well-meaning nonprofit workers have read these obscurely worded 20+ page treaties and their 40+ page “Technical Explanations” and decided that they are “tax residents” of the USA for income tax purposes. If you squint your eyes hard enough, you can see that in the text. However, in my opinion, that’s a misreading of the treaties. Most missionaries and limited-income workers that live primarily overseas are tax residents first and foremost of the country in which they live. That is the most natural reading of the tax treaties as explained by Jay F. Guin way back in 2008 (he is now a resident of Heaven where no taxes are due) and of a myriad of expat blogs and websites. Recent changes in the treaties and explanations by the Organisation for Economic Co-operation and Development (OECD) and several lawsuits and penalties against missionaries in India, Sweden, Poland and so forth, seem to confirm that we are tax residents where we live. (Though I have heard whispers of one mission agency winning a case against taxation in Hungary, I don’t know if it was based on residency, if it applied to other nonprofit organizations, or if it will last. In fact, I’ve found no one who can show me that this rumored victory even took place.)
My opinion is that you should consider yourself a tax resident of the country in which you live unless a professional international tax advisor can prove otherwise. I know of confirmed cases in Europe where missionaries have received tax rulings against them in amounts of 50,000 Euros, 120,000 Euros, etc. In some cases, these missionaries thought they were doing the right thing by paying income taxes where they lived, but it still stings. The result is that some people have returned to the US to try to pay off those debts and some have raised the money from precious donors. As the article by Jay F. Guin points out, when those missionaries received 50,000 or more Euros from donors through their agency, that money became taxable income. Knowing European tax rates, they likely forfeited 30, 40 or even 50% of the donated cash to additional taxation.
I have never heard of a case in which an expat nonprofit worker was accused of tax evasion by the US for paying income tax where they live instead of in the USA. On the other hand, I have heard of several foreign countries that taxed, charged back taxes, and inflicted heavy fines on US workers who lived in those countries more than 183 days per year but only paid taxes in the USA. My strong suggestion is to pay income tax where you live unless you can prove in writing that your country of residence says otherwise.
What if There is No Tax Treaty?
If you live in a country which doesn’t have a treaty against double taxation of income tax with the US, well, it is my understanding that…gulp…you have to abide by the laws and regulations of both countries. That actually may not result in any change in your tax rate or final payments, because of the generous US foreign tax benefits which we’ll mention below, but there is some comfort in having a treaty in hand.
Every country’s regulations and every individual’s situation is so very different. Regulations, treaties, and even their interpretations often change. I’ve sometimes found that people who have been on the field for 20 years are doing taxes one way, for 10 years another way, and the new arrivals a third way. Why? Because tax laws change and we continue working off of bad or outdated information. I would urge you to clarify your personal situation with a competent local and/or international tax advisor and to check in with him or her at least every few years to make sure you are still on track with the current regulations.
A Little Bit of Good News
Assuming a tax professional has determined that you are a “tax resident” of the country in which you currently live, your first responsibility is to find out if and how the country will tax your income. This is no easy task in many locales. I’ve heard of some places that don’t tax nonprofit workers or that tax missionaries/pastors very minimally. Other countries have as high as 50% income tax rates (before deductions), include a lot of things that the US would say are not taxable (health insurance, retirement contributions, etc.), and may require estimated annual taxes or even back taxes. We need to do the best we can to obey the confusing regulations with the most qualified local or international tax preparer we can find, and hope for the best. If we are working with a professional and trying to pay our taxes, at least it will be clear that we are not evading taxation but merely unclear on how much to pay.
We also have to file US tax forms which, for Americans living abroad, offer many generous exemptions and credits. I’ve looked at tax forms in various countries, but I’ve never seen anything as confusing as the 100+ page document my America tax preparer sends me each tax season. The average American tax preparer isn’t equipped to fill out these forms. They are complicated but not necessarily expensive. The Foreign Earned Income Exclusion (FEIE), Foreign Tax Credit (FTC), Foreign Housing Exemption and so on can, in some but not all cases, be a real benefit to the US expat who may find that they may have to file income taxes in the USA but not pay much.
Does This Apply to my Interest, Dividends, etc.?
We need to be alert to the fact that these treaties and the FEIE primarily talk about federal income tax. This has nothing to do with your state tax in the US state in which you still may have (and may want) residence. They also do not generally apply to unearned income like long-term capital gains, short-term capital gains, dividends, interest, etc. It is entirely possible these will be taxed by both countries. If both countries want to tax the long-term gain on a mutual fund, for example, it seems often to be the case that you’ll basically be paying the amount required by whichever one of the two countries that costs you the most. If your tax preparers where you live and back in the USA know what they are doing, it will happen pretty naturally as they fill out the forms. A sure-fire strategy is actually the simplest: buy and hold (yes, don’t sell!) low-cost, well-diversified ETF (exchange-traded funds). What you don’t sell, won’t have capital gains and, historically at least, the stock market increases in value if you hold long enough.
Withdrawals from US retirement accounts are a bit more problematic. US Social Security is almost always considered tax free in foreign countries with treaties. However, nongovernmental retirement funds may be seen by the local tax authorities as unearned income and taxed as such. That’s not pleasant! The answers are sometimes hidden in the tax treaties, but you’ll likely need an expert to decipher it for you.
A final word of caution is in order for tax-protected US accounts that don’t seem to really fit retirement and social security-type situations. I’m thinking of special accounts like 529s for college savings and Health Savings Accounts (HSAs). They are generally not discussed in the treaties and may find no equivalent in the local economy. How will they be taxed overseas? No one seems to be quite sure, but my guess is that they are both unearned income and taxable abroad. Vagabond Finances has a suggested fix for the 529-problem, but the HSA issue remains too new to have found much discussion at this point.
So we need to remember, as US expats, trying to figure out our very peculiar Vagabond Finances, we have some special warnings here:
- We cannot add funds to an IRA in any year in which we don’t have earned income that is not excluded by the FEIE. See here.
- We need to find out locally how our retirement withdrawals like 401ks, 403b, and IRAs will be taxed.
- We need to utilize a technique which is available for avoiding the taxation of 529 withdrawals. See here.
- We need to find out locally how HSAs will be taxed. And let us know!
- We should know the local Gift Tax regulations for when a donor wants to give us some cash. See here.
What Happens if You Are Wrong?
We’ve done our best to give you a bit of an overview of the income tax issues we face, but each situation is so complicated. We really want to urge you to use a tax preparer in the US that has dealt with expats (ideally nonprofit expats) and also a tax preparer in your country of service who understands expats. There will still be gray areas in which the tax preparer will say uncomfortable words like, “Umm, I think we should probably.…” It seems to us that even if our tax preparer gets it wrong that it was still worth every penny or ruble or yen that we paid. It proves to the government – foreign or American – that we consulted a professional in order to try to correctly pay our taxes. There is no question in that situation that we were not trying to evade taxes. Maybe we and our tax preparers will make some errors in trying to follow complex, multi-national regulations, but we want it to be clear that they were errors and not intentional. We must not ever be, or even appear to be, tax evaders. Why?
- It could be damaging to the reputation of our organization and, in the case of missionaries like myself, to the reputation of the Lord Jesus
- We and others could be kicked out of the foreign country
- We and others could be stuck with a bill that can amount to as much as 6 years of back taxes and 300% penalties (that’s the worst we’ve heard of)
- We and others could theoretically be jailed in some countries
- Our generous donors might end up footing the tax bills and penalties
Multi-billionaires and powerful political figures play games with citizenship, residency, off-shore banking and the like, but we limited-income workers can neither afford to pay such bills or afford to dirty the reputation of our work and ministries.
Friends, some of the stories we’ve mentioned above are very serious. We know people who have changed countries or returned to the USA because they discovered (or they were discovered by others) to have not been paying taxes due abroad. We heard recently of someone who returned to the US with a tax bill for about $150,000 in his pocket. Those are life-rocking stories. We don’t wish them on any of us.
That’s one of the primary reasons why Mark launched Vagabond Finances. We need to take a hard look at the financial decisions that are colored by our foreign, nonprofit lifestyle. Taxation is the toughest, most confusing and most dangerous of the issues we will treat on this website. Please take it seriously in order to protect yourself and to preserve your ministry abroad.