Living and investing abroad as an American offers unique opportunities but also comes with sometimes complex challenges. Navigating the tax systems of both the United States and your host country requires strategic planning and specialized advice to avoid double taxation and optimize your taxes. In this article, we outline nine tax efficiency strategies that can help American expats manage their finances effectively.
- Understand your tax obligations
- Utilize tax treaties
- Avoid double taxation
- Tax-advantaged retirement plans
- Currency considerations
- Investment strategies
- Estate and gift planning
- Trusts
- Seek specialist advice
1. Understand your tax obligations
US tax requirements
The United States taxes US citizens on their worldwide income, regardless of where they live. This means that even if you are living abroad, you must file an annual US tax return and report all your income, including wages, interest, dividends, rental income, and capital gains on Form 1040. Depending on your income and financial assets, you may also have to file additional forms such as Form 8938 to report your non-US financial assets, and the Foreign Bank Account Report (FBAR).
Host country tax requirements
You will also be subject to the tax laws of your country of residence. Each country has its own rules defining tax residence, often related to how much time you spend in the country each year or whether you maintain a home there. Some countries also have additional taxes such as wealth taxes that can affect your investment decisions, so seek advice from a financial planner and US and local tax professionals with experience working with US expats in that country.
2. Utilize tax treaties
The US has tax treaties with many countries, however they contain what’s known as a savings clause which limits the benefits of the treaty for Americans living abroad beyond. That said, some treaties do contain useful measure for expats. For example, some tax treaties respect some of the tax advantages of US pension plans. Additionally, the US has totalization agreements with several countries to coordinate social security coverage and benefits, ensuring that individuals are not required to pay social security taxes to both countries on the same earnings and can combine periods of coverage in both countries to qualify for benefits in the country where they retire.
3. Avoid double taxation
Foreign Earned Income Exclusion (FEIE)
The Foreign Earned Income Exclusion (FEIE) allows you to exclude a certain amount of your foreign earned income from US taxation. For 2024, the exclusion amount is $126,500. To qualify, you must meet either the Bona Fide Residence Test (being a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year) or the Physical Presence Test (being physically present in a foreign country for at least 330 full days during a 12-month period). You have to claim the FEIE on Form 2555 when you file your US taxes.
Foreign Tax Credit (FTC)
The Foreign Tax Credit (FTC) provides a dollar-for-dollar US tax credit for the amount of foreign taxes paid on income that is also subject to US income tax. This credit can be particularly beneficial if your host country has higher tax rates than the US, eliminating double taxation. You can claim the FTC by filing Form 1116 when you file your US tax return.
Make an informed choice between FEIE and FTC
It’s possible to claim both the FEIE and the FTC, but not on the same income. There are different benefits and drawbacks with each though, depending on your income types and levels, where you live, and other factors such as whether you wish to make IRA contributions or claim the US Child Tax Credit, so always seek advice.
4. Tax-advantaged retirement plans
IRAs and 401(k)s
Continuing to contribute to US retirement accounts such as IRAs and 401(k)s is possible as an expat, however you need to be aware of the contribution limits and eligibility requirements, especially if you are claiming the FEIE, which can affect your ability to contribute. Additionally, distributions from these accounts could be taxed by both the US and your host country, depending on local tax laws and treaty provisions.
Roth IRAs
Roth IRA distributions are tax-free in the US, but this favorable treatment may not be recognized by all countries. Only a few countries respect the tax-free status of Roth IRA distributions, so it’s important to understand the specific tax rules in your host country to avoid unexpected tax liabilities.
Host country retirement accounts
Depending on your host country, you may have access to tax-advantaged retirement accounts. However, seek advice regarding the US tax treatment of these accounts, as the US might not recognize the local tax benefits, and furthermore the IRS might consider them Passive Foreign Investment Companies (PFICs), which are subject to stringent US reporting and punitive US tax rates, in which case they should be avoided..
5. Multi-currency considerations
Living abroad often involves dealing with multiple currencies, which can affect your investments’ values and financial planning. For example, if your assets are in one currency but you’re either transferring to them or withdrawing from them in another, you will lose money each time you transfer internationally in fees and depending on exchange rates. Furthermore, currency exchange movements can affect the relative value of your investments and so your current or future quality of life. Using a specialist currency broker like Moneycorp or platforms such as Wise for international transfers can save you a substantial amount, as they provide better exchange rates and lower fees compared to banks.
6. Investment strategies
Avoid PFICs
Non-US mutual funds and ETFs and some non-US pension plans are often classified as Passive Foreign Investment Companies by the IRS. Investing in PFICs triggers complicated reporting requirements and unfavorable tax treatment. To avoid investing in PFICs, it’s advisable to focus on US-based investments or individual stocks that do not fall under the PFIC classification. Americans living in EU countries should note that many US investment products don’t comply with EU rules for EU residents investing, so expats living in the EU may find themselves with limited options. There are still opportunities though, so discuss your situation with a US expat specialist investment advisor.
Diversify your investments
Diversifying your investments across different asset classes, countries and currencies can help mitigate risks associated with currency fluctuations and varying economic conditions. A well-diversified portfolio helps provide stability as well as growth opportunities.
7. Estate and gift planning
Estate and gift planning for Americans with cross-border assets is more complex. In the US, as of 2024, estates valued at $13.61 million or less are exempt from federal estate tax. However, US citizens residing abroad or with assets overseas may be subject to foreign estate or inheritance taxes with lower exemption thresholds, depending on the rules in each country. Understanding these variations and planning strategically by having a situs will, international will, or a will in each country where you have assets can effectively minimize estate and transfer taxes. Each country has its own estate and gift tax laws, and leveraging tax treaties and structuring your estate to maximize exemptions and credits in both jurisdictions can optimize estate distribution and minimize taxes for your heirs.
8. Trusts
In the US, trusts are a robust method for managing and safeguarding assets, serving to administer assets during your lifetime and distribute them tax-efficiently posthumously. They bypass probate, minimize estate taxes, and enable structured support for your beneficiaries. However, many foreign countries don’t recognize these benefits, depending on the laws and rules in each country.
9. Seek specialist advice
Understanding the tax rules of two countries when you’re living and investing abroad requires expertise, and consulting with financial advisors and tax professionals who specialize in expat taxation can help you understand your obligations, optimize your taxes, and ensure compliance with both US and your host country laws.
By utilizing available exclusions, credits, and tax treaties, and seeking professional advice before investing, you can minimize your tax burden while achieving your financial goals and enjoying the experience of living abroad.
If you have any questions about financial planning or investing as an American living abroad, get in touch.
This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.