U.S. Taxes When Living Abroad Explained

What do the world’s only superpower, the United States, and a tiny African backwater, Eritrea, have in common?

America and Eritrea are the only two countries in the world to tax citizens on their worldwide income, no matter where they live. Other countries tax their citizens only if they live or earn money in the country.

Americans living abroad have no congressmen or senators representing their interests. Back in 1764, I think we referred to this as taxation without representation…

There are plenty of advantages to living (and investing) overseas when it comes to your U.S. taxes.

But not having to file every year is not one of them…

Today, I’m going to bust five myths that are out there about expat taxes—and that’s the first of them.

Myth #1: Overseas, You Don’t Need To Worry About U.S. Taxes

As I’ve been saying, this idea—which many people still believe—is just plain wrong.

Americans abroad have to file a tax return to the IRS every year, even if it’s just to tell them we don’t owe them any money.

The cost of this—both in time plus, in many cases, paying a tax preparer—is an unnecessary burden that, Eritrea aside, no other nation puts its citizens through when they move to another country.

The IRS stands alone in this regard, when it comes to the reach and power of tax collectors in the developed world…

With this in mind, no matter where you move around the globe, you’ll still owe something to Uncle Sam every year, even if it’s just paperwork.

This leads me to the second myth I want to bust today…

Myth #2: Avoiding Taxes Is A Good Reason To Move Abroad

Sure, you can save some money by structuring your affairs in the appropriate offshore ways… That’s what I’m all about, after all.

But here’s what I always say: Don’t make major life decisions (like whether to move abroad) based on taxes alone.

If you do, it can easily translate into miserable living.

Several U.S. states, including Florida, Texas, and Nevada, impose no personal income tax. But personally, I wouldn’t move to any of those places because, frankly, I don’t find them appealing places to live.

No amount of tax savings is going to change that.

Your personal preferences when it comes to the best places to live may be different than mine… but you get my point.

The same holds when going offshore.

Don’t restructure or reinvent your life just to be able to take advantage of low tax bands… and don’t choose a country to move to based solely on its approach to taxation.

Go offshore for diversification and a better lifestyle.

When you do, arrange your affairs to take advantage of every (legal) tax benefit available to you in the place where you’ve decided you want to be.

Which brings me to Myth #3… Sort of the opposite idea to Myth #2—but many folks out there believe both…

Myth #3: You’ll Pay Higher Taxes Overseas Than In The U.S.

There are plenty of places with good residency visa options that also have potential tax benefits… If it happens that the place that makes sense for your residency also comes with a favorable tax situation, all the better.

What should you look for? Countries that tax residents jurisdictionally.

This is when a country taxes you on income earned in that country only, even though you’re a resident.

It’s this approach to taxation that creates the biggest opportunity.

Residing in a country where taxation is based on the jurisdiction, it’s possible to organize your affairs in a way that can reduce or even eliminate your tax burden.

Countries that take this approach to taxation are sometimes referred to as tax havens.

Panama—where I live and work—is a good example of this approach.

As a resident in Panama, you are taxed in Panama only on income earned in Panama.

Therefore, it’s easy to live in Panama as a retiree and owe no taxes locally.

Belize, Malaysia, and the Dominican Republic also tax jurisdictionally (but a foreigner could be subject to tax on certain foreign investment income in the DR).

Another approach a country can take to taxation is referred to as a remittance-based system.

This is when a country taxes you only on income you bring into the country.

Income earned outside the country and not brought into the country (not remitted) is not taxable.

Myth #4: You’ll Automatically Owe Taxes In A Foreign Country Even If You Live There Part-Time

At the heart of this myth is an important issue to get to grips with in the offshore space: legal residency versus tax residency.

When sizing up the potential tax consequences, you have to consider two different aspects of spending time in a country…

The first is how much time you can spend in the country without obtaining legal residency.

The second is how much time you can spend in the country before triggering tax residency.

It’s possible to be a legal resident in a country without becoming a tax resident—if you don’t spend more than half a year there.

Meantime, you don’t have to be a legal resident to find yourself a tax resident if you spend more than half a year in a country, legally or not.

I’ll take Portugal as an example, as I get this question a lot.

In the case of Portugal, you can’t spend more than 180 days per year in the country unless you obtain legal residency or you’re an EU citizen.

So, if you are an EU citizen, you could come and go from Portugal indefinitely without having to worry about registering for residency. However, if you spend more than 183 days in Portugal in a calendar year, you’re technically considered a tax resident.

Get legal residency in Portugal under the country’s self-sufficiency visa option (the D7 Visa) and you’re meant to be in the country for a minimum 183 days per year. Spending that much time in Portugal makes you a tax resident. Portugal’s Golden Visa residency program (which is being abolished) only required you to be in the country effectively a week a year… meaning you could avoid becoming a tax resident.

In short, the bottom line is legal residency doesn’t necessarily mean you are automatically a tax resident; and you can end up being technically a tax resident even if you don’t have legal residency.
It all depends on the country.

So, make sure you understand the rules for the country where you’re considering spending time before you get too far into your process.

Myth #5: As A U.S. Person, Living Overseas Means You’ll Owe Tax In Two Countries

I mentioned at the top of this article (Myth #1) that living in a foreign country doesn’t mean you can escape the need to file a U.S. tax return.

However, for many if not most Americans abroad, filing a return is all we will have to do… we won’t actually owe any taxes in the States.

This is thanks to double taxation treaties.

So, if the United States or Canada and your country of interest have a tax treaty, it will in almost all cases eliminate the possibility for double taxation—i.e., that both your new country of residency and your home country will demand a tax from you on the same income.

In short, if you are tax-resident in Portugal, and you pay tax in Portugal—even if you are a U.S. citizen—you won’t owe tax on that same income in the U.S. Same holds true for most countries.

However, if your new residence demands a lower tax than your home country would, the IRS (or CRA in Canada) may demand the difference.

Sincerely,

Lief Simon
Editor, Simon Letter