FAQs: Overseas Employees and Contractors
When are my returns due and when am I required to pay my taxes?
Individual returns are due on April 15th (assuming the 15th isn’t on a holiday or weekend) after the close of each calendar year but can be filed up to two months later for individuals who are out of the US on the initial due date. Individual returns can also be extended and filed no later than October 15th (assuming the 15th isn’t on a holiday or weekend).
S Corporation and partnership returns are due on March 15th (assuming the 15th isn’t on a holiday or weekend) after the close of the calendar year but can be extended and filed no later than September 15th (assuming the 15th isn’t on a holiday or weekend).
An extension of time to file is not an extension of time to pay. All taxes must be paid in full by their original due dates to avoid penalties and interest. Individuals who qualify for the combat zone extension can file and pay at a later date if they meet certain requirements. See the tab addressing this in FAQs.
Can Hughes Szuberla CPAs file my old tax returns?
Yes. Contact us to proceed.
Why do I have to pay federal and state income tax on income I earn outside of the US?
People often mistakenly believe that income earned outside of the US is not subject to US income tax. In fact, all US citizens and US resident aliens are required to pay US income tax on their income regardless of where it is earned.
Further, most states which levy and collect income tax require that their residents pay income tax on all income earned during the year without regard to where it is earned. Generally, states ensure that their residents don’t pay state tax on the same dollar of income twice by either offering a credit against income taxes paid to other states or by excluding the other state income from their own income tax calculation. In most states, once you become a resident you remain a resident even if you work outside of the state for extended and indefinite periods of time. A few states have exceptions to state income tax in the event the resident is outside of the state for lengthy and indefinite periods.
Primary Tax Benefits of Earning Income Outside of the US
There are three primary tax benefits of earning income outside of the US: 1) the foreign earned income exclusion, 2) foreign housing exclusion, and 3) foreign tax credit
Foreign Earned Income Exclusion
There are only two ways to take the foreign earned income exclusion (the “Exclusion”): meet the time requirement of the physical presence test or qualify as a bona fide resident. In addition, you must be a US citizen or resident alien to claim the foreign earned income exclusion. Other important requirements are listed at the end of this section. Qualifying under either test allows you to exclude up to the first $120,000 for 2023 and $126,500 for 2024 of foreign earned income from your taxable income. This amount is prorated when the time overseas during the year does not include the full calendar year (January 1st through December 31st).
Physical Presence Test
The time requirement of the physical presence test is met by physically being outside of the US for a minimum of 330 non-consecutive full 24-hour days out of any consecutive 365 day period which includes at least part of the tax year in question. If you have only 35 US days during 2023, you may qualify for the Exclusion in full. If you have more than 35 US days, there is a chance to qualify for a prorated Exclusion. For example, if you were in the US through March 31, 2023, then you began a contract and are overseas from April 1, 2023 through March 31, 2024, you would use the period from April 1, 2023 through March 31, 2024 as your 365-day measurement period. As long as you’re outside of the US for at least 330 days during this period, you would meet the time requirements of the physical presence test. The Exclusion would be prorated for 2023 (April 1st through December 31st) and prorated for 2024 (January 1st through March 31st). It is not possible to take a prorated Exclusion based on a number of days outside of the US that is less than 330 full 24-hour days out of a 365 day period. In other words, 330 is the minimum. If you can’t qualify on this basis, you can see if you qualify as a bona fide resident.
Bona Fide Residency
First, bona fide residence can only be established on a calendar year basis, unlike the physical presence test. This means that you must be in the country where you claim to be a bona fide resident from January 1st through December 31st of the year in question, excluding short periods for vacation, leave, etc.
Second, the issue of whether or not a U.S. citizen can be considered a foreign resident for purposes of claiming the Exclusion is weighed on the basis of facts and circumstances. In other words, there is no single rule that offers a “safe harbor” and that includes obtaining a residency visa or even paying tax to a foreign country. Instead, the IRS views each taxpayer’s activities individually to determine whether or not the individual acted in the manner a resident would act and whether or not the evidence demonstrates the actual intention of being a bona fide resident of a foreign country.
Evidence that would suggest you would meet the IRS’s threshold would be as follows:
- You can prove your intention to be a resident of the foreign country and consider yourself one
- You are living and working in the foreign country on a permanent and indefinite basis
- You have a permanent local address which is also your “abode”
- You do not maintain a home/apartment in the US
- You speak the local language or take classes to learn it
- You have a resident visa and you have no trouble entering and exiting the country at will
- You are not required to stay in a single location but are able to travel within the country of residence without restriction.
This list is not intended to be exhaustive. Items 1, 2, 3, and 7 are critical and item 4 is extremely helpful in supporting this claim. An individual who maintains a residence in the US (owned or rented) to which he or she regularly returns during periods away from work is unlikely to qualify as a bona fide resident of a foreign country.
Beyond meeting the time requirements of the physical presence test or qualifying as a bona fide resident, having an “abode” in the US in either case precludes a taxpayer from claiming the exclusion according to the language of Internal Revenue Code Section 911. However, abode is not defined in the Internal Revenue Code or Treasury Regulations. Various tax court rulings indicate that a rough definition of abode focuses on the place where the majority of the taxpayer’s domestic and familial relationships reside. For many people with a spouse and/or children located in the US, homes or apartments in the states, and other substantial domestic ties to the US, their abode may be determined to be in the US which would clearly preclude them from successfully defending a claim to the Exclusion under the bona fide residence test. In a more recent development, where some taxpayers have been able to prove they met the physical presence requirement, the IRS has taken the position that their domestic ties to the US were more substantial than those overseas and, therefore, they had a US abode. In such cases the IRS has disallowed the Exclusion. Therefore, it is important to be able to show stronger relationships and economic ties overseas than in the US when claiming the Exclusion under the physical presence test. We expect this claim to include some risk unless or until a taxpayer successfully challenges the IRS’ claim to the contrary in US tax court. Lastly, a taxpayer must also be a US citizen or resident alien to claim the Exclusion.
For those of you in a combat zone the abode issue is no longer a concern. The IRS issued a new law in August 2018 that removed the ambiguity regarding having an “abode” in the US while meeting the 330 days overseas or bonafide residency test for those working in a combat zone.
Foreign Housing Exclusion
In addition to the foreign earned income exclusion a Taxpayer can claim a foreign housing allowance. If the employer is covering the cost of foreign housing for an employee, this housing exclusion amount will be claimed on Form 2555. In addition, if the employee is responsible for his/her own housing out of regular payroll, he/she can deduct the amount using the foreign housing allowance. The deductible amount is different in each host country, and specific allowable deductions and amounts can be found on Form 2555 Instructions.
Generally deductible items include furnishings, insurance on property, rent, repairs, residential parking fees, and utilities excluding phone. Things deemed lavish or unnecessary, such as pay television, will not qualify as deductions. Other things that do not qualify are taxes, domestic labor (maids, cooks, etc.), mortgage payments for the foreign residence and property depreciation.
Of course, there are limits as to the amount of your expenses you can deduct, and these limits are determined by the FEIE limits (as a side note: you can claim the income exclusion, the housing exclusion, or both, but you can’t exclude the same income for both). The 2023 FEIE is set at $120,000 (meaning that is the amount of foreign income that can be excluded from income reported to the IRS, if the FEIE is claimed). In regards to your housing deduction, you can normally expect to deduct no more than 30% of the FEIE limit. So, in 2023, one could deduct up to $36,000 (30% of $120,000). However, it is important to understand that only qualified foreign housing deductions beyond the first 16% of the FEIE are deductible regardless. This severely limits the benefit of the housing exclusion for many taxpayers. To reiterate, if you are earning more than $120,000 in 2023 and are paying foreign housing costs, you may be able to exclude additional income on your tax return using the foreign housing allowance.
Foreign Tax Credit
Since all US citizens and US resident aliens pay income tax on their worldwide income, the US allows a credit against the US income tax that would otherwise have to be paid on foreign income, up to the amount of the foreign taxes paid on the same income. This prevents a US taxpayer from paying tax twice on the same dollar of income. In no case are any foreign taxes paid or withheld refundable by the US government. In most cases, the amount of the credit which is unable to be used in the year it is incurred can be carried forward to be used in a future tax year.
You are not permitted to take both the Exclusion and the foreign tax credit on the same dollar of income. In other words, you can only claim a foreign tax credit on the amount of foreign income which exceeds the Exclusion claimed on the return in question.
If you do not also claim the Exclusion, you will generally get close to a dollar for dollar credit on your US federal return for the amount of foreign income tax paid.
Should I file a form 673? What happens if I do so?
Form 673 is only a withholding form. It notifies your employer that you believe you will meet the qualifications to claim the foreign earned income exclusion during the tax year for which you file it. As a result, your employer will stop withholding income taxes until your earnings exceed the exclusion limit for that year ($120,000 for 2023 and $126,500 for 2024). Filing this form does not qualify you to claim the exclusion. Likewise, not filing it does not preclude you from doing so. Whether or not a taxpayer can claim the exclusion is based on the facts set forth under the tab titled “Primary Tax Benefits of Earning Income Outside of the US”
Unless you are 100% certain that you will qualify to claim the exclusion we do not recommend that you file form 673. Your income tax withholdings stop when you file it. If you are ultimately unable to claim the exclusion you will face a large tax underpayment, even if you were unable to meet the requirement through no fault of your own. (There is only one exception to this rule and it does not apply if working in a combat zone).
What happens if I can't meet the minimum 330 days overseas in order to claim the exclusion based on physical presence?
If you can’t meet the minimum time requirement of the physical presence test you can’t claim the exclusion on this basis at all. The only exception to this rule, the waiver of time requirement, is if you are required to leave the country before the time requirement is met due to a sudden and violent uprising. In that case you would have to prove that you would otherwise have been able to meet the minimum time requirement (330 days). This exception does not apply to any countries which are designated combat zones. The IRS publishes the countries which qualify for this waiver each year. Guidance for 2023 has not yet been released.
My overseas work contract starts in the middle of the year. What is my tax year?
Your tax year is always a calendar year (January 1st through December 31st). The income you receive during each calendar year is reported on that year’s tax return. Bonuses paid at any time during a contract are taxed in the year in which they are paid. If you receive a bonus on December 25, 2023, but do not actually get paid until January 3, 2024, it is taxable in 2024.
While income is taxed in the year it is received, the exclusion is prorated for each year to equal the ratio of the number of days spent outside of the US each year compared to 365. For clarification, see the tab above titled “Primary Tax Benefits of Earning Income Outside of the US” under the physical presence test.
Am I required to report foreign bank accounts and assets?
Possibly. The Treasury Department requires that if the combined value of your foreign financial accounts (or those for which you have signatory authority) at any time during the previous year exceeds $10,000, you must file a FinCEN Report 114 online by April 15th of the subsequent year. The filing of Form FinCEN Report 114 is automatically extended to October 15th. Foreign accounts include foreign bank accounts, foreign trusts, overseas investment accounts, and foreign retirement accounts if there is a guaranteed payment from the account and if the investor exercises any level of control over the investment, or any financial account for which the taxpayer has signatory authority. Certain taxpayers may also be required to file form 8938 with their tax return. Penalties for not filing these forms can range from $10,000 up to half of the balance of the account. Willfully withholding this information can be cause for criminal charges. Clients who are not sure if they have a filing requirement in this regard should contact us to verify.
You are required to file if you are 1) a citizen or resident of the U.S., 2) a domestic partnership, 3) a domestic corporation, or 4) a domestic estate or trust.
I moved from one state to another during the calendar year. In which state do I pay tax?
You will generally file a part year resident return in each state. The income reported to each state will be the income you earned while a resident of each state.
How many exemptions should I claim on my W4?
Generally speaking you should claim 1 for yourself, 1 for your spouse and 1 for each of your dependents. If you are paying foreign taxes or going to claim the foreign earned income exclusion this will change. Please contact us if you would like assistance determining how many exemptions to claim on your W-4.
I earn income as an independent contractor (1099). How does my tax situation differ from that of an employee?
As an independent contractor (IC), your earnings are from self-employment and are generally subject to Social Security and Medicare taxes at 15.3% in the US regardless of where the income is earned. This is in addition to income tax. The combination of these two taxes can be shocking. However, self-employment income earned in countries with which the US has a “totalization agreement” is often not subject to the self-employment tax. Instead, the taxpayer is considered to be covered by the foreign country for this purpose. A list of countries with which the US has totalization agreements can be found here: http://www.ssa.gov/international/agreements_overview.html
What is the 'combat zone' extension?
Individuals who qualify for the combat zone extension can file their returns and pay their taxes after the original due date if they meet certain requirements. An individual (or spouse) who is physically located and working in direct support of US armed forces in a combat zone on the original due date of their return can file and pay his or her taxes within 180 days of last exiting a combat zone. This 180 days is extended further by one day for each day between January 1st and April 15th after the close of the tax year in question during which the individual is located in a combat zone. In order to obtain the benefit of the combat zone extension, you must keep your Letters of Authorization which document your deployment period and combat zone location. Without this the IRS will only accept a letter from your employer stating the same.
I'm under audit. What do I do?
Before contacting the IRS, contact us as soon as possible.
When preparing my tax information, what should I do to substantiate my deductions in the event my return is audited?
Audits are fairly rare. However, planning to successfully defend against an audit should always take place when the return is prepared. To this end, good practices include the following:
Original copies of all tax documents going back 3 years (this may be longer for certain states).
Always save receipts to prove any deductions claimed.
Keep a full and current copy of your passport if you are claiming the exclusion. This is the primary source of evidence to prove your physical presence throughout the exclusion period. If you are ever required to surrender it, always make a copy before doing so.
I don't have my passport. How can the IRS prove I was in the US?
Most taxpayers aren’t aware that the burden of proof to substantiate claims made on a tax return remains with the taxpayer. This means that when the IRS audits your return, they can disallow claims made until you can prove those claims were legitimate. Many of our clients mistakenly believe otherwise to their detriment. Unfortunately, the IRS offers no relief in the case of a taxpayer who is claiming the exclusion but who can’t prove their dates overseas due to a lost or stolen passport.
What information does Hughes Szuberla require in order to prepare my return?
Generally we request the following info:
- W-2s / 1099s / 1098s / 1095s / prior year federal and state tax returns (new clients only). Always keep your original documents.
- Dates overseas if you qualify for the foreign earned income exclusion because you were, or will be, overseas for at least 330 days during any 365 day period which includes at least part of the tax year in question
- The foreign address and city you worked in
- U. S. state of residence during tax year and current U.S. address
- Phone number
- Date of birth (for every person on the return including dependents)
- Indicate whether you’ve ever filed form 2555 before to take the exclusion and if so, what the last year was that you filed it
Any other tax related info you have: marital status, dependent(s) (SS#’s, full names, dates of birth), house expenses (property taxes, interest, indicate if you recently purchased), interest/dividend/rental income, capital gains from investments, charitable contributions (list the amounts, the organization they were contributed to, and state whether cash or property) car registration fees, etc.
How can I obtain my tax documents to send to Hughes Szuberla?
If you are unable to find the tax documents needed to prepare your returns, you have two options: call each of the institutions/employers/brokers/etc. and ask them to resend the documents or obtain a record from the IRS. In order to obtain a record from the IRS, either order them online at www.irs.gov or call (800) 829-1040 and request an unmasked “wage and income transcript” for the tax year in question. They will either fax it or mail it to the address you have on file with the IRS. If you have the fax number of the CPA at Hughes Szuberla you are working with, you can have the IRS fax the transcript directly to that individual.
After I send my tax information to Hughes Szuberla, what happens next?
You should receive an email confirmation from us by the close of the next business day stating that we received your tax information. This email will usually include a link you will use to pay our fee. We will begin preparing your return after we receive confirmation that the fee is paid. Once we prepare the return we will email you with any outstanding questions. Once those questions are resolved, we will send you a draft for review and the e-file authorization form (Form 8879). Once we receive the e-file authorization signed form we will e-file your return(s). The e-file authorization must be signed by the taxpayer and spouse (if applicable).
I'm considering setting up an LLC, S corporation or other entity. Can you help?
Yes. Contact us to determine what entity makes the most sense for your situation.
How should I send my tax information to Hughes Szuberla?
We send all our previous clients a link to a secure portal where they can upload their documents safely. If you are a new client or do not have the email with the link please email info@HSTaxCPAs.com.