BUSINESS/FINANCE
Avoiding a Tax Surprise When Retiring Overseas
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 all of their assets were moved 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 U.A. taxes individuals based on citizenship, not residency. As a result, every U.S. citizen (and resident alien) must file a U.S. 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, substantially reducing or eliminating 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.
Also, retired taxpayers may have to file tax forms in the foreign country where they reside. They 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 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.
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, the U. S. Virgin Islands, American Samoa, or the Northern Mariana Islands.
Income From Social Security or pensions
If Social Security is your only income, 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, you should receive a Form 1099-R for each distribution plan if you have pension or annuity income.
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), from a part-time job or self-employment, for example, you may have to pay U.S. taxes on some of your benefits. Each country is different, and you may also be required to report and pay taxes on any income earned in the country where you retired.
Foreign Earned Income Exclusion
If you've retired overseas but take 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 incomes from U.S. income tax by using the Foreign Earned Income Exclusion (FEIE). In 2023, this amount is $120,000 per person. If two individuals are married and work abroad and meet either the bona fide residence test or the physical presence test, each one can choose the foreign-earned income exclusion. Together, they can exclude as much as $240,000 for the 2023 tax year.
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 12 months 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 U.S. 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 and apply to both treaty countries. Therefore, a U.S. citizen or resident who receives income from a treaty country and is 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.
State taxes
Many states also tax resident income, 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 for advice.
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 the Internal Revenue Service by the tax return's due date (including extensions).
Tejal Dhruve, CPA, LLC, a full-service tax and wealth management firm with offices in Wesley Chapel, Florida, and Dublin, Ohio, can be reached at (614) 742-7158 or email [email protected]
Estate Planning for Newlyweds
Estate planning might sound like something only your wealthy great-uncle Frank has to worry about. You may wonder how your worldly possessions could possibly qualify as an “estate.” Believe it or not, almost everyone needs to take care of some basic estate planning, especially newlyweds. Most newlyweds don’t want to think of the possibility of losing their spouse, but the fact is that losing your spouse could be an even worse experience without the proper estate plan in place.
Wills
If you only do the bare minimum of estate planning, make it a will. In your will, you can leave your property to your spouse or whomever else you’d like. You should also determine secondary beneficiaries in the event that both of you die at the same time. Your will should name a designated executor, the person responsible for making sure your wishes are carried out.
Without a will, your property is at the mercy of your state’s laws. Depending on which state you live in, this could leave your spouse out in the cold. Additionally, if you have children, your will should designate guardians in case you and your spouse die at the same time.
Avoiding Probate
While creating a will is a great first step in estate planning, it cannot help you avoid probate. Probate is the process of executing a will, and it can take months or even years, and cost up to 5 percent of the value of the estate. The time and money involved in probate is probably not what you had in mind for your beneficiaries. If you live in a community property state, your property will automatically transfer to your spouse at the time of your death (unless noted otherwise in your will or prenuptial agreement). In a common law state, however, you’ll have to make sure that you and your spouse hold large property in “joint tenancy with right to survivorship.” This will ensure that your spouse automatically acquires ownership upon your death.
Another method of avoiding probate is the use of living trusts. A trust is a separate legal entity that holds property, so anything within a trust is exempt from probate upon your death. Marital trusts are trusts that address the specific needs of married couples. There are several types to choose from, with options for various circumstances.
Prenuptial and Postnuptial Agreements
A prenuptial agreement is a contract made between two people before their marriage begins. A postnuptial agreement, as the name suggests, is created after the marriage takes place. Both agreements generally specify what property is held While creating a will is a great first step in estate planning, it cannot help you avoid probate by each party prior to marriage and how that property will be divided in the case of divorce or death of one spouse. Prenuptial and postnuptial agreements are especially useful for couples where one party owns a business, has children outside the marriage or has considerable property from before the marriage. These agreements can be helpful in determining property ownership, especially for couples living in a community property state who do not want all property evenly divided, or vice versa.
Beneficiary Designations
Certain property can be passed directly to beneficiaries without the use of a will or trust. For instance, life insurance benefits, retirement plans and bank accounts can all be left to your spouse when you die, as long as you name him or her as the account beneficiary. When you designate a beneficiary, your account becomes “payable on death,” thus avoiding probate court and fees. If you don’t want to leave an entire account to your spouse, you can split up the assets among various beneficiaries. It’s also a good idea to list secondary beneficiaries in case the primary beneficiary also dies. Naming beneficiaries on your accounts is fast and can be done without the help of a lawyer.
Living Wills
Your estate plan is not only a plan for your death, but also in case you were to become incapacitated. It’s important to determine what should happen to you and your property if you become unable to communicate or make decisions for yourself. A living will can specify health care treatments you do and do not want, and how you’d like to be treated in the hospital. For instance, do you want to be kept on life support? Do you want to be fed through a tube if necessary? Will you donate your organs? When and if the time comes, you won’t be able to answer these questions yourself. Avoid putting the decision-making burden on your spouse by listing your wishes in a living will.
Your estate plan should also include a power of attorney designation, which is the person to make decisions for you if you become unable to do so yourself. You’ll probably assign your spouse with power of attorney, because he or she is most likely to know your wishes. Even if you have a living will, your power of attorney can make decisions that aren’t specified there. For instance, the power of attorney can make financial decisions such as paying your bills or managing your money. You can invoke the power of attorney even if neither spouse becomes physically or mentally incapacitated — if one of you is out of town, for example, the other can sign important documents and make decisions on his or her behalf.
There are two major myths about estate planning. The first is that it is a grueling, depressing process. Getting your estate in order does not have to be difficult to complete. If you are relatively young and have a small estate, the process should be quick and can even bring couples closer to each other. The other myth is that your estate isn’t large enough to warrant an estate plan. If you’d like to override the state laws pertaining to property ownership, or if you’d like to ease the burden on your spouse in the event of your death, estate planning is definitely for you.
Seema Ramroop, financial planner at Prudential Advisors, can be reached at (813) 957-8107 or email [email protected]