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Exemption From State Taxes For U.S. Citizens Overseas

“Kathleen and Lief, thanks to your e-letters and conferences, we took our early retirement in 2013 and love it. Your e-letters continue to guide and inspire us. Great job!

“Living the entire 2014 abroad, raised the ‘state of residency’ question for this upcoming tax season. Maybe Lief or his team can clarify this for us:

“We lived the entire 2014 year abroad in different countries. We do not have permanent residency in any foreign country, and we do not own any property in the United States or abroad. We did not visit the United States in 2014.

“What should be our state of residence in 2014 on tax returns? The state in the United States where we lived and filed our 2013 year taxes or foreign?”

“Thank you both and best regards.”

–Irina Y., perpetually retired overseas

Yes, your state of residence for U.S. tax purposes is the state where you last were resident.

Remember that, if you were out of the United States for the entire year of 2014, you should be eligible for the Foreign Earned Income Exclusion… if you worked and had earned income while you were moving around last year.

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“Kathleen, Irena Y. asked about taxes for the year 2014 when she traveled extensively and spent no time in the United States. The IRS grants a federal Foreign Earned Income Exclusion if certain criteria are met. However, states usually do not grant this exclusion, but this varies by state.

“Thanks, Kathleen and Lief. It’s nice to be able to send people to a website and seminars that are really helpful to those who may be considering a move out of the United States. Please keep up the good work and the integrity.”

–George F., United States

State income taxes are a tricky thing for an American moving overseas. When deciding whether or not you must continue paying state tax as an American abroad, most states look at your “intent” to return. If you move overseas with the intent to return in a year or two, then you are obligated to file state tax returns for those interim years. If you have no intent to move back, then you have no filing obligation.

But who’s to say what your intent is? Your intent could be to stay overseas forever, but you end up moving back to your original state after a couple of years to take care of your aged mother.

Further, some states, including California, don’t allow for the Foreign Earned Income Exclusion. California also will argue that you are required to pay taxes to their state forever after you’ve moved overseas even if you have no plans to move back.

To avoid confusion and tax liability, many people move to an income tax-free state before moving overseas. However, note that establishing residency in a tax-free state such as, say, Florida, getting a driver’s license from that state, and then moving overseas isn’t necessarily a fool-proof strategy. You should seek personalized tax advice before deciding how to proceed.

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