Did you know that foreign income is still taxed by the United States? Millions of Americans who earn money abroad or plan to earn money abroad should be aware of their tax obligations. The United States is currently one of the only countries in the world that taxes based on citizenship, and not residency. However, there are some exclusions and foreign tax credits that can reduce your tax liability. Overall, reporting foreign income can be tricky. Here’s an overview of how to report foreign income at tax time.
What is Foreign Income?
First, let’s clearly define foreign income. Foreign income is any income you receive overseas. This can include the following:
Foreign wages: Foreign wages are wages paid to you for services rendered or goods sold. This can mean being employed by a foreign company or being self-employed but working abroad.
Foreign interest and dividends: Foreign interest is money earned through foreign bank accounts. Foreign dividends are payouts from foreign-earned stocks.
Foreign real estate: Foreign rental income is income earned on a property you rent out located in a foreign country. Alternatively, if you sell a property that is located outside the United States, you’ll need to report the gains or losses on the sale during tax season.
How Do I Report Foreign Income on My U.S. Tax Return?
If you earned foreign income, you would need to report it on Form 1040 when filing your tax return. You may also need to file other tax forms depending on what type of income you earned. For example, if you earned foreign interest and dividends, you’d report these on Schedule B of Form 1040. Foreign business income is reported on Schedule C. Most capital gains are reported on Schedule D. Rental property income is reported on page 1 of Schedule E. However, in more complicated tax situations, there could be additional forms to file, like Form 8938, Statement of Specified Foreign Financial Assets or Form 114, Report of Bank and Financial Accounts. In any case, you should speak to a qualified tax preparer about which forms your specific tax situation requires.
What is the Foreign Tax Credit?
Some taxpayers might worry about paying taxes twice on the same income. The Foreign Tax Credit (FTC) is one of two safeguards that help American taxpayers avoid this issue. This credit allows American expats, or U.S. citizens who live abroad, to offset foreign taxes paid abroad dollar-for-dollar. For example, if you’re an American expat who paid income taxes to the foreign country where you reside, the FTC gives you a tax credit to use on your U.S. income tax return.
Requirements
To claim this credit, you must be the following requirements:
The tax must be imposed on you. This basically means that if your resident country does not require income taxes to be paid, you do not qualify for the FTC.
You must be the one who paid or accrued the tax. This means if you have not paid the tax or accrued it, you do not qualify for the FTC.
The tax must be the legal and actual foreign tax liability. This means that if the tax is not legal, and you are not required to pay it, you do not qualify for the FTC.
The tax must be an income tax. This means that if the tax is another type of tax besides income tax, you do not qualify for the FTC. The IRS has specific rules on what they deem to be a foreign income tax. Be sure to check with your tax preparer for clarification.
How to Calculate the Foreign Tax Credit
Calculating your maximum FTC can be tricky, but essentially you can divide your foreign taxable income by your total taxable income (including U.S. income). Then take this quotient and multiply it by your U.S. tax liability. For example, if you earned $50,000 in Spain and another $10,000 in U.S. income, you’d have a total taxable income of $60,000. Let’s also assume you had a U.S. tax liability of $12,000. You would take your foreign income of $50,000 and divide it by your total taxable income of $60,000 to get 0.83. You would then multiply 0.83 by your U.S. tax liability of $12,000 to get your maximum FTC of $10,000.
Additionally, the FTC can carry over to the next tax year or carry back to a previous tax year. Unused FTC amounts can be carried over for up to 10 years. Taxpayers can claim the FTC by filing Form 1116.
What is the Foreign Earned Income Exclusion?
The other safeguard that helps American taxpayers avoid paying taxes twice on the same income is the Foreign Earned Income Exclusion (FEIE). The FEIE allows you to exclude all or some of your foreign earned income on your U.S. tax return, including salaries, wages, bonuses, commissions, and self-employment income. It does not include passive or investment income. The FEIE is available to U.S. expats who meet one of the following requirements:
Work outside the United States as an employee
Work outside the United States in a self-employed or partnership structure
Pass the Bona Fide Residency Test. This requires being overseas for work for longer than one year and having a permanent place of work in the foreign country.
Pass the Physical Presence Test. This requires living outside the United States for 330 full days out of the year.
U.S. taxpayers must use Form 2555 to claim the FEIE and can exclude up to $120,000 of foreign income for the 2023 tax year. The amount is due to increase to $126,500 for tax year 2024. Married couples filing jointly can exclude up to $240,000 as long as both spouses meet either the bona fide residency test or the physical presence test.
Help Reporting Foreign Income
Reporting foreign income can get complicated very fast. While this article covers several topics related to foreign income, it really is just the tip of the iceberg and applies to most simple tax situations. American taxpayers who live in the country, as well as expats, who earn foreign income should seek best practices regarding foreign income from reliable and knowledgeable tax professionals. If you need tax help, Affordablecan assist.
These days it is very common for individuals to have regular income, as well as supplemental income. While regular income earned through an employer typically has taxes withheld, some supplemental income does not. If you earn supplemental income, it’s important to learn how it is taxed and when. Here is a brief overview of supplemental income tax.
What Is Supplemental Income?
Supplemental income refers to additional earnings received beyond one’s primary source of income. It typically includes money earned from part-time jobs, freelance work, investments, rental properties, or other side ventures. The purpose of supplemental income is to supplement or add to the individual’s main source of income, providing extra financial support or flexibility. Even if you only work a regular 9 to 5 job, you may still earn supplemental income through any of the following sources:
Some taxpayers do not have regular income through an employer. Instead, they may earn supplemental income through contract work or through a business. Some examples of supplemental income for these groups are:
Schedule E income
Ridesharing service
Sales made through an online shop
Direct sales
How Is Supplemental Income Taxed?
How supplemental income is taxed depends on how the income is classified. For example, income reported on Schedule E will usually consist of estates, trust, real estate rental income, royalties, partnership and S corporation income, and residual interests in real estate mortgage investment conduits (REMICs).
Estates and Trusts
Beneficiaries pay tax on the income of the estate or trust they inherit at their regular income tax rates and at capital gains rates for any capital gains they receive. In addition, if the estate or trust does not distribute all the income to the beneficiaries it will pay tax on any undistributed income.
Royalties
If you are paid royalties for the use of any of your intangible assets, you will receive a Form 1099-MISC that tells you the amount of royalties to report on Schedule E. Royalties are taxed at your regular income tax rate.
Business Income from Partnerships and S-Corps
Taxes for S-Corps pass through to shareholders. Additionally, taxes for partnerships pass through to the partner’s personal income. The tax rate will depend on personal income rates.
Real Estate Rental Income
The tax rate for rental real estate varies from 10% to 37%, depending on your filing status and taxable income.
Tax Rates
Supplemental income for employees is based on personal income tax rates. However, the amount withheld will vary depending on whether your employer pays it out with your regular wages or separately. If it’s combined with your wages, the amount withheld will typically be withheld like wages. If they are paid out separately, employers can withhold at the IRS’s flat rate of 22%. Finally, taxpayers who earn $1 million in supplemental income, it will be taxed at 37%.
You should report supplemental income earned through gig, contract, or freelance work on your individual tax return using Schedule C. In addition, if you receive any 1099 Forms, you should use these to calculate your total income through independent work.
Tax Help for Supplemental Income Earners
Tax policy can change every now and then. If you earn any type of supplemental income, you should stay up to date on all the most recent changes in taxation rules. For example, in 2024 the rules for reporting income earned through Form 1099 are changing drastically. Being unprepared for a change in policy could lead to all sorts of issues. Examples include a large tax bill to an IRS audit. When in doubt, your best bet is to speak to a trusted tax professional to avoid a stressful tax issue. Regardless, if you need tax help, Affordableand our team of experts are here.
Being your own boss can feel freeing and powerful. However, with great power comes great responsibility, especially when it comes to taxes. Taking care of all business aspects on your own means you should be prepared to handle all the financial work that comes with the new adventure. Here’s a brief tax guide for the self-employed.
Get Financially Organized
There’s nothing worse than scrambling for income and expenses during tax time. Staying organized throughout the year can save you time and money. You’ll want to maintain accurate records including:
Income statements with invoices, receipts, Forms 1099, etc.
Purchase invoices
Receipts for travel, transportation, entertainment, and gifts that are business-related
A breakdown of your assets, including purchase price, cost of improvements, depreciation deductions, etc.
Employment tax records
Know Your Responsibilities
You are already responsible for the success of your business. However, you also need to know your financial responsibilities to maintain your business. This includes paying self-employment taxes and quarterly estimated tax payments. If you earned $400 or more in 2022, you need to pay self-employment taxes. The current rate for self-employment tax is 15.3% of your net earnings, which consists of social security and Medicare tax. The good news is that since in a typical job, the employer is responsible for paying half of this tax, you’ll be able to deduct 50% of your self-employment tax during tax time.
Unfortunately, you won’t have an employer to withhold tax from your self-employed income. That said, you’ll need to make estimated tax payments by each quarterly deadline:
April 18, 2023
June 15, 2023
September 15, 2023
January 16, 2024
You should make estimated tax payments if you expect to owe more than $1,000 in federal taxes for the year. If you do not make these payments, you could face underpayment penalties.
Take Advantage of Tax Deductions
As a business owner, you have the benefit of writing off expenses that most employees cannot, as long as they are ordinary and necessary for business operations. You can write off advertising costs, supplies, legal fees, repairs, vehicle expenses, business travel and entertainment, and even more if you operate your business from home. If you aren’t eligible to participate in your spouse’s workplace health plan, you can typically pay for your own health insurance and deduct your premiums.
Those who have a business loan or business insurance can also deduct the loan interest and insurance premiums. If you only take advantage of one deduction as a business owner, you should consider the one for self-employed retirement plan contributions to an SEP-IRA, SIMPLE IRA, or 401(k). These accounts can reduce your tax bill at tax time and help you accrue tax-deferred investments gains in the future. Be sure to look into all tax deductions available so your taxable income is reduced.
Tax Help for the Self-Employed
Running a business, whether small or large, has immense opportunities for financial success. However, all of that hard work and prosperity can be taken away if you do not file your taxes correctly. In the worst-case scenario, owing the IRS taxes and not being able to pay can result in a tax lien, which can shut down your business. If this is your first year as a business owner, start off right by knowing your tax responsibilities. If you’ve had your business a while but need tax help now, we can help. Affordable Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
Real estate investments can be very complex, especially when it comes to tax reporting. However, there are general tax implications for common scenarios. Here, we will discuss some of these benefits:
Who is responsible for payroll taxes? CEO David King and Lead Tax Attorney Philip Hwang discuss everything you need to know regarding payroll taxes, including tips on what to do if you find yourself in trouble with the IRS.
The desire or need for extra income has become increasingly prevalent. Side gigs have been a popular method of supplementing earnings but with this comes more reporting during tax time. When is a side business treated as a business in the tax world, and when is it treated as a hobby?
Real estate has long been considered one of the greatest long-term investments. Further, with the trend of minimalist living, many are turning their primary residences into rental properties. While turning your home to a rental property comes with passive income and tax benefits, it’s important to note the tax implications as well.
While there is no guaranteed method of avoiding audits, there are things to steer clear of that could trigger an IRS audit. The Senate recently approved nearly $80 billion in IRS funding, with $45.6 billion for enforcement, which could lead to more audits. Here are some things that the IRS has historically viewed as “red flags,” which could increase the chances of an audit for taxpayers.
Reporting a Business Loss
The IRS will surely be more inclined to audit a taxpayer who reports a net business loss, even if the loss is small. Reporting losses year after year will only increase IRS interest in your tax returns. Remember, it is mandatory to report all earnings in a tax year. However, it might be helpful to reconsider which expenses should be deducted from your tax return. Reporting even a small profit could reduce the chance of being audited by the IRS.
Being Vague About Expenses
When it comes to expenses, the more detail the better. This is especially true when categorizing them on your return. Try to avoid listing expenses under “Other Expenses” as this will lead to more scrutiny from the IRS. It may even be helpful to provide supplemental documentation explaining why certain expenses drastically increased or decreased for that year. Doing so can give potential auditors a valid explanation for such occurrences and possibly avoid a tax audit. Additionally, rounding dollar amounts are red flags for the IRS. You should always use exact dollar amounts on your tax return.
Filing Late
Some taxpayers believe that filing late can actually decrease the risk of being audited. However, filing on time, as well as paying on time, can help establish a history of IRS compliance. This will be far more beneficial in the long run.
Claiming Excessive Deductions
It is best to avoid any excessive expenses. For example, deducting the cost of your breakfast and lunch each workday may not be acceptable to the IRS. Excessive deductions for your donations to charitable organizations can also increase the chances of being audited. Inflating business expenses can result in being audited, especially if you try to claim large amounts for business entertainment or claim a vehicle that is used for business purposes 100 percent of the time. Also, remember to only claim the home office deduction for the portion of your home that is used exclusively for business purposes. When claiming this deduction, you will need to figure out how much square footage in your home is dedicated to your business. For tax year 2023, the rate for the simplified square footage calculation is $5 per square foot, with a maximum of 300 square feet or $1,500.
Keeping Poor Records
Even the simplest tax situations require adequate records. If your finances are more complicated, then detailed records are necessary. Some taxpayers may feel inclined to estimate their expenses because they did not save receipts or documents. Unfortunately, the IRS views this as a red flag. It’s important to make sure you have detailed records for the past three tax years at minimum. Having items like your previous tax returns, medical bills, business receipts, real estate documents, and investment statements can help substantiate your claims and avoid an IRS audit.
Choosing the Wrong Filing Status
Your filing status (single, married filing jointly, married filing separately or head of household) determines how you treat many tax decisions. it affects what forms you’ll fill out, which deductions and credits you’ll take. It ultimately determines how much you will pay (or save) in taxes. Select the wrong status, and it will trigger a cascade of mistakes–maybe even an audit. On top of that, if you decide to file jointly with your spouse, this means you’re responsible for their errors. This includes deliberate falsehoods on your partner’s return, so make sure that you’re comfortable with what it says.
Tax Relief for Those Being Audited
The chances of being audited are low, but those chances increase when the IRS notices red flags. The audit process can be very stressful. It is a tedious process that requires collecting information regarding your income, expenses, and itemized deductions. Failing an audit can result in a huge, unexpected tax bill. It’s best to seek assistance from experts who can help you avoid an IRS audit. Our team of qualified and dedicated tax professionals can help.
