Avoiding Double Taxation Using Domestic Laws

US Expats living abroad have to face various challenges when it comes to tax filings and taxes. But the problem that most people face is the double taxation problem.  By double taxation we mean, the taxation of your income in the U.S and the country you are currently residing in i.e. the country of your residence.

In this blog, we will focus on the tools and methods that the US government has made available for expats in order to help them avoid double taxation. These tools come in context with both US domestic laws and US tax treaties. This is why we will explain and focus on the US UK Tax Treaty.

Us Domestic Laws Prevent Double Taxation

There are domestic law provisions that have been designed for taxpayers living abroad. These include foreign earned income exclusion (“FEIE”), the foreign housing exclusion (“FHE”), and foreign tax credit (“FTC”)

Let’s get to the details of what these domestic law provisions are and how they help expats avoid double taxations.

Foreign Earned Income Exclusion

To earn the benefits of this law, an individual must provide proof of their residence in a foreign country that is under the tax net. Which means you have to provide proof that you are paying tax in a foreign country. You can always hire a tax consultant for foreign nationals to help you out with the paperwork if you can’t physically visit the US.

You can either pass the “bona fide residence” test or the “physical presence” test. This will help exclude a portion of your income from income tax.

To claim this exclusion, you must file a US Federal Income Tax Return (Form 1040). To claim the FEIE, an individual must file Form 2555 with their US federal income tax return.

Foreign Housing Exclusion/Deduction

Apart from the FEIE, if US expats qualify under the bona fide residence or physical presence tests, they can deduct from their gross income or their housing cost amount in a foreign country. The exclusion can be availed whenever you have wages. The deduction is applicable whenever you are self-employed. If you want to claim the foreign house exclusion/deduction, You must file Form 2555.

But, there is a condition, the housing cost amount is subject to certain limitations that are adjusted based on geographical location.

Foreign Tax Credits

Now if you fall under the category of higher-income earners who may be subject to higher taxations, a US expat can claim a foreign tax credit (“FTC”) for foreign income taxes paid. The amount of money taken in as foreign tax credits are limited to the amount of foreign source taxable income and this cannot be used to offset US source income.

The taxes in the UK are usually higher than in the US, so if an individual pays his or her taxes in the UK, then he or she may not have to pay taxes in the US after claiming a foreign tax credit for the UK tax paid.

Apart from special cases, if an individual wishes to claim a foreign tax credit, they must file form 116 with their US federal income tax return.