u.s. expat tax guide – india
How US citizens in India lower their US taxes with the Foreign Earned Income Exclusion and Indian Foreign Tax Credits
For US expats living in India, one of the biggest concerns is avoiding double taxation—paying tax in both India and the United States. Fortunately, there are strategies available that can help minimize this burden, including using the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC).
How does the Foreign Earned Income Exclusion work for US expats in India?
The Foreign Earned Income Exclusion (FEIE) allows you to exclude a portion of your foreign-earned income from US taxes.
In 2024, you can exclude up to US$126,500 of your earned income from US taxes if you meet specific conditions. This exclusion applies only to earned income, such as wages or self-employment income, and does not cover unearned income like dividends or rental income.
To qualify for the FEIE, you must meet either the Physical Presence Test (being outside the US for at least 330 full days in a 12-month period) or the Bona Fide Residence Test (being a bona fide resident of a foreign country, like India, for an entire tax year).
How does the Foreign Tax Credit help US expats in India?
The Foreign Tax Credit (FTC) helps you reduce your US tax liability by giving you credit for taxes paid to the Indian government. This is especially useful if your income exceeds the FEIE limit or if you have unearned income, such as dividends or investment returns.
The credit applies dollar-for-dollar, reducing your US tax liability by the amount of taxes you paid in India, though it cannot exceed the amount of US taxes owed on that income.
For example, if you paid Indian taxes at a rate of 30%, and your US tax rate is 37%, the foreign tax credit can offset a significant portion of your US tax liability.
Can US expats use both the Foreign Earned Income Exclusion and the Foreign Tax Credit?
Yes, US expats can use both the FEIE and the FTC, but not on the same income. You can exclude up to US$126,500 of your earned income using the FEIE, and then use the FTC to offset any taxes owed on the remaining income, such as investment income or any amount exceeding the FEIE limit.
Using both allows you to maximize your tax benefits and minimize your overall liability.
For instance, if your total earned income is US$150,000, you can use the FEIE to exclude US$126,500. The remaining US$23,500 can then be used for the Foreign Tax Credit, reducing your US taxes further if you paid tax on that income to India.
How can US expats determine the best strategy to minimize taxes?
Choosing between the FEIE and the FTC—or deciding how to use both—depends on your specific situation. Here are some general guidelines to help:
- High Earners: If your income exceeds US$126,500, using both the FEIE and the FTC might be beneficial. The FEIE can exclude the first US$126,500, and the FTC can help reduce US tax on the rest.
- Investment Income: The FEIE only applies to earned income, so if you have significant investment income, you will need to rely on the FTC to offset US taxes.
- Housing Costs: If you have substantial housing expenses, the Foreign Housing Exclusion can further reduce your taxable income.
What are the common misconceptions about using the FEIE and FTC?
A common misconception is that you must choose between the FEIE and the FTC. In reality, you can use both on the same tax return—just not on the same income.
For example, if you exclude a portion of your income with the FEIE, you cannot use the FTC on that same amount. However, you can apply the FTC to any additional income.
Another misconception is that if you claim the FEIE, you cannot claim any other deductions. This is not true. You can still claim the standard deduction or itemized deductions, as well as credits like the Child Tax Credit, provided you meet the qualifications.
How does the US-India tax treaty impact US expats?
The US-India tax treaty helps prevent double taxation by specifying how certain types of income should be taxed by each country.
For example, the treaty outlines rules for income like pensions, dividends, and royalties. Understanding how the treaty applies to your situation can help you avoid paying unnecessary taxes in both countries.
However, US citizens and Green Card holders must still report their worldwide income, regardless of the treaty. The treaty can help determine which country has the primary right to tax certain types of income, but it does not eliminate US filing requirements.
How can US expats stay compliant with tax laws and minimize taxes?
Staying compliant with US tax laws while minimizing your tax burden involves a combination of strategies:
- File Your US Tax Return Annually: Even if you owe no tax, you are still required to file.
- Use the FEIE and FTC Wisely: Understand how to leverage these tools to minimize double taxation.
- Report Foreign Bank Accounts: File FBAR if your foreign account balances exceed US$10,000 at any point during the year.
Consult a Tax Professional: A tax advisor with experience in US and Indian tax laws can help you make informed decisions and avoid costly mistakes.