Do You Pay Tax On Foreign Income as a US resident? The short answer is yes, the U.S. taxes its citizens and residents on worldwide income, regardless of where it’s earned; income-partners.net helps navigate these complexities. Understanding these obligations, including reporting requirements like FBAR and Form 8938, ensures compliance and unlocks opportunities for strategic partnerships to maximize your financial growth.
1. Understanding US Tax Obligations for Foreign Income
1.1. What Constitutes Foreign Income for US Tax Purposes?
Foreign income encompasses any income you receive from sources outside the United States. This includes, but isn’t limited to, income from:
- Foreign Employment: Salaries, wages, tips, and other compensation earned while working abroad.
- Foreign Investments: Dividends, interest, capital gains, and other profits from investments held in foreign accounts or entities.
- Foreign Business Activities: Income from a business you operate in a foreign country.
- Foreign Real Estate: Rental income or profits from the sale of property located outside the US.
- Royalties: Payments received for the use of your intellectual property in a foreign country.
1.2. Who is Required to Report Foreign Income?
US citizens and resident aliens are generally required to report their worldwide income, including foreign income, on their US tax returns. This applies regardless of whether you live in the US or abroad. According to the IRS, resident aliens include individuals who have a green card or meet the substantial presence test.
1.3. What are the Key Forms for Reporting Foreign Income?
- Form 1040, U.S. Individual Income Tax Return: This is the standard form used to report your worldwide income, including foreign income.
- Schedule B (Form 1040), Interest and Ordinary Dividends: Use this schedule to report interest and dividends received from foreign accounts.
- Schedule D (Form 1040), Capital Gains and Losses: Use this schedule to report capital gains or losses from the sale of foreign assets.
- Form 2555, Foreign Earned Income: Use this form to claim the foreign earned income exclusion or the foreign housing exclusion/deduction.
- Form 8938, Statement of Specified Foreign Financial Assets: Use this form to report specified foreign financial assets if the aggregate value exceeds certain thresholds.
- FinCEN Report 114 (FBAR), Report of Foreign Bank and Financial Accounts: Use this report to disclose any financial interest in or signature authority over foreign financial accounts exceeding $10,000 at any time during the calendar year.
2. Navigating Key Tax Considerations
2.1. The Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion (FEIE) is a significant benefit that allows qualifying US citizens and resident aliens to exclude a certain amount of their foreign-earned income from US taxation. For 2024, the maximum exclusion amount is $126,500.
2.1.1. Who is Eligible for the FEIE?
To qualify for the FEIE, you must meet both of the following tests:
- Tax Home Test: Your tax home must be in a foreign country throughout your period of bona fide residence or physical presence.
- Bona Fide Residence Test or Physical Presence Test: You must meet either the bona fide residence test or the physical presence test.
2.1.2. Bona Fide Residence Test
This test requires that you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year (January 1 to December 31).
2.1.3. Physical Presence Test
To meet this test, you must be physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
2.2. The Foreign Tax Credit (FTC)
The Foreign Tax Credit (FTC) allows you to claim a credit for income taxes you have paid to a foreign country on foreign-source income. This credit can reduce your US tax liability.
2.2.1. How Does the FTC Work?
The FTC is designed to prevent double taxation of your income. You can choose to either deduct the foreign taxes you paid as an itemized deduction or claim a foreign tax credit. In most cases, claiming the credit is more beneficial.
2.2.2. Limitations on the FTC
The amount of the FTC you can claim is limited to the amount of US tax attributable to your foreign-source income. This limitation is calculated separately for different categories of income.
2.3. Foreign Housing Exclusion and Deduction
In addition to the FEIE, you may also be able to exclude or deduct certain foreign housing expenses.
2.3.1. Foreign Housing Exclusion
If you qualify for the FEIE and have housing expenses, you can exclude a certain amount of your housing costs from your gross income.
2.3.2. Foreign Housing Deduction
If your housing expenses exceed the excludable amount, you may be able to deduct the excess.
2.4. Understanding Tax Treaties
The United States has tax treaties with many foreign countries. These treaties can affect the taxation of your foreign income.
2.4.1. How Tax Treaties Can Help
Tax treaties can provide reduced tax rates on certain types of income, such as dividends and interest. They can also help clarify which country has the right to tax certain types of income.
2.4.2. Where to Find Tax Treaty Information
The IRS publishes a list of tax treaties on its website. You can also find treaty information on the website of the foreign country in question.
3. Reporting Foreign Assets: FBAR and Form 8938
3.1. What is the FBAR (FinCEN Report 114)?
The Report of Foreign Bank and Financial Accounts (FBAR), now known as FinCEN Report 114, is a required filing for US persons with a financial interest in or signature authority over foreign financial accounts.
3.1.1. Who Must File an FBAR?
You must file an FBAR if you are a US person and have a financial interest in or signature authority over one or more foreign financial accounts, and the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year.
3.1.2. What is a Foreign Financial Account?
A foreign financial account includes bank accounts, securities accounts, and other types of financial accounts located outside the United States.
3.1.3. When is the FBAR Due?
The FBAR is due annually on April 15, with an automatic extension to October 15.
