Tax Implications of Retiring Overseas

Are you approaching retirement age and wondering where you can retire to make your nest egg last longer? Retiring abroad may be the answer. But first, it’s important to consider the tax implications; that is, the filing and reporting requirements, deadlines, available deductions and exclusions. Further, not all retirement country destinations are created equal. Here’s what you need to know.

Taxes on Worldwide Income

Leaving the United States does not exempt U.S. citizens from their U.S. tax obligation. While some retirees may not owe any U.S. income tax while living abroad, it is likely they must still file a return annually with the IRS. Filing requirements are generally the same wherever one resides. This would be the case even if all assets of a U.S citizen were moved to a foreign country.

Unlike most countries, the United States taxes individuals based on citizenship, even if they live abroad full time. As a U.S. citizen living abroad, when your gross income from all sources, as converted to U.S. dollars and including foreign trusts, securities accounts and foreign bank accounts, is above the threshold for your filing status, you may have a tax liability.

However, if your gross income includes that which you’ve earned while living abroad, you may qualify for additional tax benefits, such as the foreign earned income exclusion or the foreign tax credit for payments made to other countries; both can reduce or even eliminate U.S. tax liability.

Note: These tax benefits are not automatic and are only available if an eligible taxpayer files a U.S. income tax return.

When filing, any income received or deductible expenses paid in foreign currency must be reported on a U.S. return in U.S. dollars. Further, any tax payments must be made in U.S. dollars. If you reside outside the U.S., while you do receive an automatic filing extension until June 15 without filing Form 4868, you are still required to pay any taxes due by April 15.

Taxpayers may also have to file tax forms in the foreign country in which they reside. Foreign filing and tax liability are addressed by the tax treaties that the United States holds with many countries.

Income from Social Security or Pensions

What is consistent wherever one resides, is that if Social Security is your only income, then those benefits are not taxable and you typically will not need to file a federal income tax return. If you do have income from other sources, the benefit is up to 85% taxable. Every year that you receive a Social Security benefit, you should also receive a Form SSA-1099, Social Security Benefit Statement, showing the amount of your benefits received for that year.  Likewise, if you have pension or annuity income from a U.S. source, you should receive a Form 1099-R from each plan that made a distribution to you.

Did you know that even if you have been receiving your Social Security benefit payment as a resident of the U.S., if you make a move, there are countries to which the Social Security Administration will not send payments?

Additionally, retirement income may or may not be taxed by other countries depending on the tax treaty with that country. Each country is different, so consult a local tax professional or one who specializes in expat tax services.

Foreign Earned Income Exclusion

If one has retired overseas, then takes on a full-or part-time job or earn income from self-employment, the IRS allows qualifying individuals to exclude all or part of their income from U.S. income tax by using the foreign earned income exclusion (FEIE). In 2022, the maximum FEIE is $112,000 per person. This means that if you qualify, you won’t pay tax on the first $112,000 of your wages or other foreign earned income.

Note: Income earned overseas is exempt from U.S. taxation only if certain criteria are met such as having resided in a foreign country for at least 330 days over a 12-month period. FEIE does not apply to passive income.

Tax Treaties

The United States has income tax treaties with a number of foreign countries. These treaties generally don’t exempt residents from their obligation to file a tax return. The treaties can, however, offer some protection against double taxation; that is, your liability to the foreign tax authorities may be reduced if both countries tax the same income.

Under these treaties, residents of foreign countries are taxed at a reduced rate or are exempt from U.S. income taxes on certain items of income they receive from sources within the United States.

Treaty provisions are generally reciprocal; that is, they apply to both treaty countries. Therefore, a U.S. citizen or resident who receives income from a treaty country and who is subject to taxes imposed by that country may be entitled to certain credits, deductions, exemptions, and reductions in the rate of taxes of that foreign country. Treaty specifics vary by country. You can find more information as well as a list of all tax treaties at irs.gov.

FBAR Reporting

Regardless of whether one retires in the U.S. or abroad, if you maintain or have signatory authority over any foreign bank accounts, investment accounts or foreign individual pension accounts, you are required to file an FBAR (Foreign Bank Account Report) if the total of the account balances exceed $10,000 at any time during the year. If you take out a loan in a foreign country to purchase property or even transfer money from your U.S. account to a foreign account to pay for a new property, this will trigger FBAR filing requirements.  Note that the penalties for failing to report are steep.

State Taxes

If you receive rental income from a property or properties in the U.S., you should expect to maintain a state tax filing requirement. Barring that distinction, many states tax former residents on their worldwide income up until those former residents establish a new domicile outside the state.  Some states honor the provisions of U.S. tax treaties while many do not.

Relinquishing U.S. Citizenship

Taxpayers who relinquish their U.S. citizenship and cease to be lawful permanent residents of the United States during any tax year must write “Dual-Status Return” across the top of page 1 of their final Form 1040 and attach Form 8854, Initial and Annual Expatriation Statement. Additional rules may apply to deductions, exclusions and credits. Such taxpayers may be subject to exit tax.

Note: Giving up your U.S. citizenship doesn’t mean giving up your right to receive social security, pensions, annuities or other U.S. retirement income. However, the U.S. Internal Revenue Code (IRC) requires the Social Security Administration (SSA) to withhold nonresident alien tax from certain Social Security monthly benefits. At a 30 percent flat tax from 85 percent of the benefit, this could result in withholding of 25.5 percent of your monthly benefit amount if a tax treaty with the country of your new residence doesn’t address.

Consult a Tax Professional Before You Retire

Don’t wait until you’re ready to retire to consult a tax professional. Call our office today, and discuss your options.