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How to Avoid Tax Surprises When You Retire Abroad

October 17, 2022

How to Avoid Tax Surprises When You Retire Abroad

You’re getting close to retirement age and want to know where you can live to make your money last longer. Maybe the answer is to retire somewhere else. But first, it’s important to think about the tax consequences in order to avoid tax surprises when you retire abroad, because not all places to retire are the same.

Taxes on Income Worldwide

Even if a U.S. citizen moves out of the country, they still have to pay taxes there. Even if they don’t owe any U.S. income tax while living abroad, some retirees still have to file an annual return with the IRS. Even if all of their assets were moved to another country, this would still be true. In the end, you may still have to pay taxes on your income no matter where it comes from.

In contrast to most other countries, the United States taxes people based on their citizenship, not where they live. As a result, every U.S. citizen and resident alien must file a tax return each year that shows their worldwide income. This includes income from foreign trusts and foreign bank and securities accounts.

Even if a taxpayer is eligible for tax benefits like the foreign earned income exclusion or the foreign tax credit, which reduce or eliminate U.S. tax liability, they still have to file.

The only way to get these tax breaks is to file a U.S. income tax return, even if you are eligible.

On a U.S. tax return, any income earned or tax-deductible costs paid in a foreign currency must be reported in U.S. dollars. In the same way, any taxes must be paid in U.S. dollars.

Also, people who are retired and live in a foreign country may have to fill out tax forms there. You may, however, be able to get a tax credit or deduction for income taxes you paid to a foreign country. If both countries tax the same income, these benefits can help you pay less tax.

Nonresident aliens who get money from the U.S. must figure out if they have to pay taxes in the U.S. Usually, nonresident aliens have until April 15 to file.

Reporting on FBAR

U.S. citizens who own a foreign bank account, brokerage account, mutual fund, unit trust, or other financial accounts must file a Report of Foreign Bank and Financial Accounts (FBAR) by April 15 if they:

Have a financial interest in, signature authority, or other authority over one or more accounts in a foreign country; and
The total value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.

A foreign country does not include places like Puerto Rico, Guam, the United States Virgin Islands, American Samoa, or the Northern Mariana Islands, which are all owned by the United States.

Income from Social Security or Pensions

If Social Security is your only source of income, your benefits may not be taxed, and you may not need to file a federal tax return. If you get Social Security, you should get a Form SSA-1099, which is a “Social Security Benefit Statement.” This form shows how much you get from Social Security. Also, if you get money from a pension or an annuity, you should get a Form 1099-R for each plan that pays you.

In most other countries, income from retirement is not taxed. For example, if you are a U.S. citizen who retires abroad and gets Social Security, you may owe U.S. taxes on that income, but you may not have to pay taxes in the country where you are spending your retirement years.

But suppose you also get money from other sources (either in the U.S. or your country of retirement), like a part-time job or self-employment. In that case, you may have to pay taxes on some of your benefits in the U.S. Each country is different, and you may also have to report and pay taxes on any income you made in the country where you retired.

Exclusion for Income Earned Abroad

Using the Foreign Earned Income Exclusion, the IRS lets people who meet certain requirements not pay U.S. income tax on all or part of their income from full-time, part-time, or self-employment jobs or business income (FEIE). This amount will be $112,000 per person in 2022. If two people are married and both work abroad and meet either the bona fide residence test or the physical presence test, each person can choose the foreign-earned income exclusion. Together, they can keep up to $224,000 off their taxes in 2022.

Only if certain rules are met, like living outside of the country for at least 330 days in a 12-month period, or an entire calendar year, is income earned abroad not taxed.

Tax Agreements

The United States has income tax treaties with a number of other countries, but these treaties don’t usually get people out of having to file their taxes.

Under these treaties, people who live in other countries but are not citizens are taxed at a lower rate or don’t have to pay U.S. income taxes on certain sources of income they get from the U.S. These lower rates and exemptions are different for each country and each type of income.

Most treaty rules are reciprocal, which means they apply to both countries. So, a U.S. citizen or resident who gets income from a treaty country and is taxed by a foreign country may be able to get certain credits, deductions, exemptions, and lower tax rates from the foreign country.

State Texas

Many states also tax the income of residents, so even if you retire abroad, you may still have to pay state taxes unless you lived in a state with no taxes before you moved abroad. Some states follow the rules of U.S. tax treaties, but others don’t. Because of this, it is smart to get advice from a tax expert.

Relinquishing U.S citizenship

During any tax year, taxpayers who give up their U.S. citizenship or stop being lawful permanent residents of the U.S. must file a dual-status alien return and attach Form 8854, Initial and Annual Expatriation Statement. When the tax return is due, a copy of Form 8854 must also be sent to the Internal Revenue Service (including extensions).

If you give up your U.S. citizenship, you won’t lose your right to get Social Security, pensions, annuities, or other income in retirement. But the U.S. Internal Revenue Code (IRC) says that the Social Security Administration (SSA) must take out tax from certain monthly benefits given to nonresident aliens. If you are a nonresident alien and get Social Security retirement income, the SSA will take a 30 percent flat tax out of 85 percent of your benefits unless you qualify for a tax treaty benefit. This means that 25.5% of your monthly benefit amount is taken out.