Are you approaching retirement age and wondering where you can retire to make your retirement nest egg last longer? Retiring abroad may be the answer. But first, it’s important to look at the tax implications because not all retirement country destinations are created equal.
Taxes on Worldwide Income
Leaving the United States does not exempt U.S. citizens from their U.S. tax obligations. While some retirees may not owe any U.S. income tax while living abroad, they must still file a return annually with the IRS even if they transferred all of their assets to a foreign country. The bottom line is that you may still be taxed on income regardless of where it is earned.
Unlike most countries, the United States taxes individuals based on citizenship and not residency. As such, every U.S. citizen (and resident alien) must file a tax return reporting worldwide income (including income from foreign trusts and foreign bank and securities accounts) in any given taxable year that exceeds threshold limits for filing.
The filing requirement generally applies even if a taxpayer qualifies for tax benefits, such as the foreign earned income exclusion or the foreign tax credit, that substantially reduce or eliminate U.S. tax liability.
These tax benefits are not automatic and are only available if an eligible taxpayer files a U.S. income tax return.
Any income received or deductible expenses paid in foreign currency must be reported on a U.S. return in U.S. dollars. Likewise, any tax payments must be made in U.S. dollars.
If you decide to start a side business while in retirement and are self-employed, you may claim the foreign earned income exclusion on foreign earned self-employment income. However, the excluded amount will reduce your regular income tax but will not reduce your self-employment tax. You must pay self-employment tax on all your net profit, including any amount excluded from income.
In addition, taxpayers who are retired may have to file tax forms in the foreign country in which they reside. You may, however, be able to take a tax credit or a deduction for income taxes you paid to a foreign country. These benefits can reduce your taxes if both countries tax the same income.
Nonresident aliens who receive income from U.S. sources must determine whether they have a U.S. tax obligation. The filing deadline for nonresident aliens is generally April 15 (e.g., April 15, 2023).
FBAR Reporting
U.S. persons who own a foreign bank account, brokerage account, mutual fund, unit trust, or another financial account are required to file a Report of Foreign Bank and Financial Accounts (FBAR) by April 15 if they have:
- Financial interest in, signature authority or other authority over one or more accounts in a foreign country, and
- The aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.
A foreign country does not include territories and possessions of the United States such as Puerto Rico, Guam, United States Virgin Islands, American Samoa, or the Northern Mariana Islands.
Income from Social Security or Pensions
If Social Security is your only income, then your benefits may not be taxable, and you may not need to file a federal income tax return. If you receive Social Security, you should receive a Form SSA-1099, Social Security Benefit Statement, showing the amount of your benefits. Likewise, if you have pension or annuity income, you should receive a Form 1099-R for each distribution plan.
Retirement income is generally not taxed by other countries. As a U.S. citizen retiring abroad who receives Social Security, for instance, you may owe U.S. taxes on that income but may not be liable for tax in the country where you’re spending your retirement years.
However, if you receive income from other sources (either U.S. or country of retirement) as well, from a part-time job or self-employment, for example, you may have to pay U.S. taxes on some of your benefits. You may also be required to report and pay taxes on any income earned in the country where you retired.
Each country is different, so consult a local tax professional or one who specializes in expat tax services.
Foreign Earned Income Exclusion
If you’ve retired overseas but work at a full or part-time job or earn income from self-employment, the IRS allows qualifying individuals to exclude all, or part, of their incomes from U.S. income tax by using the Foreign Earned Income Exclusion (FEIE). In 2022, this amount is $112,000. If you qualify for the exclusion, you won’t pay tax on up to $112,000 of your wages, and other foreign earned income in 2022.
Income earned overseas is exempt from taxation only if certain criteria are met such as residing outside of the country for at least 330 days over a 12-month period, or an entire calendar year.
Tax Treaties
The United States has income tax treaties with many foreign countries, but these treaties generally don’t exempt residents from their obligation to file a tax return.
Under these treaties, residents (not necessarily citizens) 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. These reduced rates and exemptions vary among countries and specific items of income.
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 subject to taxes imposed by foreign countries may be entitled to certain credits, deductions, exemptions, and reductions in the rate of taxes of those foreign countries.
Affordable Care Act
Starting in 2014, the individual shared responsibility provision calls for each individual to have minimum essential coverage for each month, qualify for an exemption, or make a payment when filing his or her federal income tax return. Under tax reform, the penalty for the individual mandate was eliminated starting January 1, 2019.
U.S. citizens or residents living abroad for at least 330 days within 12 months are treated as having minimum essential coverage during those 12 months and thus will not owe a shared responsibility payment for any of those 12 months. Also, U.S. citizens who qualify as a bona fide resident of a foreign country for an entire taxable year are treated as having minimum essential coverage for that year.
State Taxes
Many states tax resident income as well, so even if you retire abroad, you may still owe state taxes–unless you established residency in a no-tax state before you moved overseas.
Some states honor the provisions of U.S. tax treaties; however, some states do not. Therefore it is prudent to consult a tax professional.
Relinquishing U.S. Citizenship
Taxpayers who relinquish their U.S. citizenship or cease to be lawful permanent residents of the United States during any tax year must file a dual-status alien return and attach Form 8854, Initial and Annual Expatriation Statement. A copy of Form 8854 must also be filed with Internal Revenue Service (Philadelphia, PA 19255-0049) by the tax return’s due date (including extensions).
Giving up your U.S. citizenship doesn’t mean giving up your right to receive social security, pensions, annuities, or other 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. Suppose you are a nonresident alien receiving social security retirement income. In that case, SSA will withhold a 30 percent flat tax from 85 percent of those benefits unless you qualify for a tax treaty benefit, in which case 25.5 percent of your monthly benefit amount is withheld.
Consult a Tax Professional Before You Retire
Don’t wait until you’re ready to retire to consult a tax professional. Call the office today and find out what your options are well in advance of your planned retirement date.