Tax planning for US citizens in Europe
Tax planning can be complex and daunting for US citizens living in Europe. The US taxes its citizens no matter where they live. If you’re a US citizen living in Europe, you might have to pay taxes in both the US and Europe.
Many American expatriates are unaware of the unique tax laws and regulations that apply to them, which can result in costly mistakes and penalties. However, with proper planning and guidance, US citizens in Europe can optimize their tax situation and minimize their tax burden.
Foreign Earned Income Exclusion (FEIE)
One of the most significant tax benefits available to US citizens living in Europe is the Foreign Earned Income Exclusion (FEIE).
This exclusion allows US expats to exclude up to $120,000 (for the tax year 2023) of their foreign-earned income from US federal income tax. To qualify for the FEIE, US citizens must meet either the physical presence test or the bona fide residence test.
The physical presence test requires that the taxpayer be physically present in a foreign country for at least 330 full days during any 12-month period. The bona fide residence test requires that the taxpayer be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. Properly utilizing the FEIE can result in significant tax savings for US citizens in Europe.
The US has tax treaties with many countries to avoid double taxation for its citizens. These agreements explain how much income each country can tax and which countries can tax certain types of income.
Foreign Tax Credits
In addition to the FEIE, US citizens living in Europe may also be eligible for the Foreign Tax Credit (FTC).
The FTC allows taxpayers to offset their US federal income tax liability with foreign income taxes paid on the same income. This credit is especially helpful for US citizens living in high-tax countries like many European nations.
To claim the FTC, taxpayers must file Form 1116 with their US tax return and provide documentation of the foreign taxes paid. It is essential to properly track and document foreign taxes paid to ensure maximum credit is received.
Foreign Account Tax Compliance Act (FACTA)
The Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions and some non-financial foreign entities to report the foreign assets held by their US account holders.
If they don’t, they may have to pay a fee for certain payments. The HIRE Act also requires US citizens to report their foreign financial accounts and assets, depending on their value.
Reporting Requirements (FBAR – FinCEN-114)
US citizens living in Europe are subject to additional reporting requirements beyond the standard US tax return.
These requirements include filing a Foreign Bank Account Report (FBAR) if they have foreign financial accounts with an aggregate value exceeding $10,000 at any point during the year.
Additionally, US citizens living in Europe may need to fill out Form 8938 if they have foreign financial assets with a total value higher than certain amounts. Not following these rules can lead to hefty fines and should be taken seriously.
To submit the FBAR, go to the BSA e-filing site and use FinCEN 114 to send it online. The process is easy. You need to gather your account information and enter it into the online system. You can hire someone else to do it, but you still need to file FinCEN 114a to give them permission.
Capital Gains Tax
If you’re an American living abroad who has to pay capital gains tax in another country, you can use the IRS Foreign Tax Credit benefit when filing your US tax return. This means you can claim a $1 US tax credit for every dollar of tax you’ve paid in the foreign country. This prevents American expats from paying taxes twice on their capital gains.
If you live outside the United States and are a US citizen or resident alien, you usually have to file income tax, estate tax, and gift tax returns, and pay estimated tax, just like those who live in the United States.
Generally, whether you have to file a return depends on your income, age, and filing status. You usually need to file a return if your total income from all sources worldwide is at least the amount listed for your filing status in Chapter 1’s Filing Requirements table of the Tax Guide for U.S. Citizens and Resident Aliens Abroad (Publication 54).
If someone else claims you as a dependent on their taxes, check out Chart B – For Children and Other Dependents in the Form 1040 and Form 1040-SR instructions to see if you need to file a tax return.
You need to use US dollars in your tax return. If you receive money or pay expenses in foreign currency, you need to convert it to US dollars. Look at Foreign Currency and Currency Exchange Rates to help you with currency conversion.
Child Tax Credit (CTC)
You may qualify for the child and dependent care credit if you paid expenses to a care provider to care for someone who qualifies while you were working or looking for work.
If you are married and filing separately, you probably can’t take this credit, but there are exceptions if you meet certain requirements.
The credit amount is a percentage of your work-related expenses paid to the care provider. The percentage depends on how much you make in a year.
To qualify for the child and dependent care credit, meet the following criteria:
- Your child who was under age 13 when you paid for their care,
- Your spouse who could not take care of themselves and lived with you for more than half of the year, or
- Someone else who lived with you for more than half of the year could not take care of themselves, and either: (a) you could claim them as a dependent; or (b) they earned $4,400 or more or filed a joint tax return, or you (or your spouse, if filing jointly) could be claimed as a dependent on someone else’s 2022 tax return.
What Happens If US Citizens Don’t File Their Taxes While Living Abroad?
If you’re a US citizen living abroad, you could get in trouble if you don’t file your US taxes. The IRS can make you pay extra money if you file your taxes late or if you pay your taxes late. You could get in trouble if you knew you were supposed to file your taxes on purpose.
- Failure to File Penalty: 5% of the unpaid taxes for each month the tax return is late, up to 25%.
- Failure to Pay Penalty: 0.5% of the unpaid taxes for each month the tax payment is late, up to 25%.
- Over 60 Days Late: The penalty can go up to 25% of your unpaid taxes.
The IRS has a way for Americans living abroad to file US taxes without being penalized, even if they didn’t know they needed to. You only have to submit federal tax returns from the last three years and FBARs from the last six years under the Streamlined Filing Compliance Procedures, regardless of how many years you have missed. This is a simpler and less expensive way to become compliant.
How Can I Avoid Paying US Taxes Abroad?
You can avoid filing US tax returns and paying taxes by giving up your US citizenship. This is a big decision, so ensure you understand all the requirements and implications before you decide.
If you’re a US citizen or green card holder, you must file a tax return and pay taxes annually, even if you live outside the US. But, you can avoid paying taxes twice and lower your US tax bill by using special tax credits, deductions, and exclusions available to Americans who live abroad.
It’s essential for Americans living in Europe to plan their taxes well. You can use FEIE and FTC, track foreign taxes paid, and follow reporting rules to make the most of your taxes and pay less. To do this right, you need to work with a tax expert who knows international tax rules and can help you save money while following the law.
Why partner with a specialist Expat accountant?
Living outside of the US can make your tax filing requirements complicated. To ensure you pay the minimum amount of taxes, it’s critical to work with an accountant who understands every aspect and avenue for reducing your tax liability. We have a dedicated team of tax accountants who work exclusively with US expats earning and investing in Europe. Partnering with a specialist expat accountant can help you navigate complex tax regulations and optimize your tax situation.