Are you or your client a U.S. American living in Australia? There are over 100,000 U.S. Americans living down under. Not a huge number compared to other nationalities migrating to Australia, but still a big group and rapidly increasing.
U.S. Tax Living in Australia
As a US citizen or resident alien, the US will tax your worldwide income even while you live in Australia. So you got the Australian tax system to deal with plus the US. Both countries will want to tax your income. How does that work? How do you avoid paying tax twice? What is a Foreign Earned Income Exclusion? How to qualify for a foreign tax credit? And what is a nonresident alien?
Jane Bruno of Bruno American Tax Services will you answers to these questions and a lot more. Here is what we learned but please listen in since Jane explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a podcast app on your mobile phone.
U.S. Tax Living in Australia
As an U.S. citizen or resident alien, the U.S. taxes your worldwide income irrespective of where you actually live. And the first step in achieving this is to make you file a US tax return.
You might have left the States decades ago. You might have never set foot on American soil. Or you might only earn Australian sourced income – all taxed in Australia. You still need to file a tax return in the States if your income exceeds a certain threshold.
Filing Income Thresholds
The threshold is different for each filing status and also depending on whether you are below 65 or older. So there is not just one threshold but ten to be exact. And these thresholds get adjusted each year for inflation so there will be new thresholds coming out soon.
For 2021 the thresholds are USD 12,550 for a single, USD 25,100 for a married couple filing jointly, USD 5 for a married couple filing separately, USD 18,800 for a head of household and USD 25,100 for a qualifying widow(er).
The USD 5 for a married couple filing separately is highly relevant to you if you are a US citizen or Greencard holder and married to an Australian. Then you are married but filing separately and hence you need to file even if you have just USD 5 of income.
Alien
An alien is somebody who is not a US citizen. Full stop. So by definition, at least in the eyes of the U.S., over 7 billion aliens inhabit the globe.
A resident alien is an alien who either has a lawful permanent visa to live in the US – a so called Green Card – or who passes the substantial presence test. You pass this test if you are in the States for at least 31 days in a calendar year and at least 183 days over a period of three years including a calendar year and the preceding two years. You can elect to be treated as a resident alien if you are the spouse of a US citizen or resident alien.
Even as a non-resident alien – alien if you are not a US citizen and non-resident if you don’t live in the States and don’t have a Greencard – you might need to file a US tax return. And this is the case when you engaged in a US trade or business or if you have US sourced passive income from which not enough tax was withheld.
When To File
Your tax return – Form 1040 – is due on April 15th, but living abroad you receive an automatic extension to June 15th. You can request an additional extension to October 15 (Form 4868) before June 15th. But interest is still calculated from April 15th on any taxes due.
What To File
As a U.S. citizen or resident alien (aka Greencard holder), your worldwide income is subject to U.S. income tax, regardless of where you live. You include your worldwide gross income you would include if you were living in the States. You can claim the same deductions you could claim if you were living in the States. And you get the same tax-free threshold, tax rates and foreign tax credits as if you were living in the States. Generally speaking – of course the devil is in the detail.
But your actual U.S. tax liability might still be lower than if you lived in the States. And this is thanks to specific exclusions and deductions you can only claim when you have lived outside the US long enough to qualify – usually at least a full tax year.
They are the
1 – Foreign Earned Income Exclusion,
2 – Foreign Housing Exclusion and
3 – Foreign Housing Deduction.
Neither of these exempt you from filing if your gross income is above the filing threshold, but they can reduce your US tax by a substantial amount.
Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion allows you to exclude a certain amount of your earned income from U.S. tax. The emphasis is on earned as in income from employment, trade or business income. The FEIE does not apply to passive incomes like pensions, interest, dividends or capital gains.
For 2021 – the tax year ending 31 December 2021 – the FEIE is USD 112,000. So if you earned USD 212,000 in 2021, you could subtract USD 112,000 leaving USD 100,000 as taxable in the U.S.
The FEIE applies to each individual. So even if you are married and filing jointly, you can each claim the FEIE and hence exclude USD 424,000 from your joint income.
The FEIE adjusted income – reported on Form 2555 – is taxable at tax rates applying to the original gross amount – the so-called stacking rule. So in the example above you would use the tax rates applicable to an income of USD212,000 to tax the lower amount of USD 100,000.
The FEIE comes with one big disadvantage: Foreign Tax Credits. If you apply the FEIE to your taxable income, then you receive no foreign tax credits for tax you paid for that part of your income. But you can still claim foreign tax credits for any income that wasn’t excluded under the FEIE.
Foreign Housing Exclusion or Deduction
In addition to the FEIE, you can claim a foreign housing exclusion or deduction – using Form 2555 – for your housing expenses minus the base housing amount. The exclusion applies to housing paid for with employer provided amounts like a salary, while the deduction applies to housing paid for through self-employment.
Your housing expenses are your reasonable expenses incurred, limited to 30% of your maximum FEIE. High-cost localities like Melbourne, Perth or Sydney have a higher limit listed in the Instructions for Form 2555. Housing expenses do not include the cost of buying a property, making improvements or incurring other expenses to increase its value. And your housing expenses can also not exceed your total foreign earned income.
The base housing amount is usually 16% of your FEIE. So in rough terms your exclusion or deduction might be 14% of your maximum FEIE.
Foreign Tax Credit
You can claim a foreign tax credit – using IRS Form 1116 – for the tax you already paid in Australia. But only for income the U.S. is actually taxing, so not FEIE income.
In the example above only US$100,000 or roughly 50% of your earned income is taxable in the States. So if you paid US$ 40,000 in Australia on the income of US$201,100, you could only claim a tax credit for half of the tax paid in Australia, so US$20,000.
While Australia’s top marginal rate is 45%, the U.S. charges 37%. And the Australian top marginal tax rate kicks in much earlier. So you will often be better off disregarding the FEIE, but claiming a full foreign tax credit. But exercise caution when making this decision. You can only claim a new FEIE if six years have passed since you last rejected an FEIE. The only exception is when you got permission from the Internal Revenue Service to change back earlier.
Any qualifying unclaimed foreign tax credits you may carry back for one year and then carry forward for 10 years, but you can only claim these against other foreign income. So if you return to the States and still have excess foreign tax credits, you can’t use these against US sourced income.
Foreign Bank Accounts
The U.S. does not tax wealth as such. But the IRS is still keen to know about your foreign bank accounts. Especially how your money got there and if it produced any income. There are two different forms – Form 114: Foreign Bank Account Report (FBAR) and Form 8938: Foreign Account Tax Compliance Act (FATCA).
If your aggregate foreign holdings exceed $10,000, you file the FBAR Form 114 electronically with the Department of the Treasury. It is due – like your Form 1040 tax return – by April 15th with an automatic extension to October 15th if you live outside the States.
If your foreign assets exceed US$200,000 on 31 December or US$300,000 at any time during the tax year, you also file FATCA Form 8938. If married and filing jointly, these thresholds increase to US$400,000 and US$600,000 respectively.
Please remember that thanks to FATCA foreign banks most likely already report your bank data to the IRS, so please make sure you get your numbers right on Form 8938.
Contribution to Superannuation Funds
Concessional contributions to Australian superannuation funds are taxed as wages for US purposes at ordinary income tax rates.
So this is a rough overview of things to consider and do around your US tax living in Australia. Of course as most things around tax, the devil is in the detail and US tax law is complicated. So make sure you seek professional US tax advice before you do anything drastic.
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Disclaimer: Tax Talks does not provide financial or tax advice. This applies to these show notes as well as the actual podcast interview. All information on Tax Talks is provided for entertainment purposes only and might no longer be up to date. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s personal circumstances.
Last Updated on 03 September 2022
Tax Talks spoke to Jane Bruno - Tax Accountant at Bruno American Tax Services - for more details.
The US is one of a few selected countries who tax their citizens on worldwide income regardless of residency. How is Australian sourced income taxed in the US? How do your US clients qualify for a Foreign Earned Income Exclusion (FEIE) or a foreign tax credit? How does an Australian spouse become a resident or nonresident alien? How to "file" an US tax return (Form 1040), FBARS (Form 114) or FACTCA (Form 8939)? This episode aims to give you the tools to better assist your US clients with their US tax obligations and find the right help when needed.
