Readers, this is something that’s pretty critical, and I’m amazed how many folks get it wrong. An overseas American must file a tax return, in practically all circumstances. That is to say, the exemptions from filing are very, very few. They are almost always the filing exemptions that you have back home (make under $9,350 as a single person, etc.)
There is a lot of confusion about Section 911, which is the Foreign Earned Income Exclusion. Many people think that the section says “you don’t have to file if you have under $90,000 of income earned overseas.” Sometimes you hear a number between $72,000 and $80,000, which were older limits. For 2009 it’s $91,400. But the gist of the advice is that you don’t have to file. And guess what? No, that’s wrong. You do!
In order to claim the foreign earned income exclusion (FEIE), that income must appear on a your tax return (usually Line 7 or the 1040 unless it’s self-employment income). And then you claim the exclusion using Form 2555. If you don’t do it this way, you don’t get the FEIE. The IRS (Treasury Department) can come at you for any and all amounts owed, and I believe the rule is that if they contact you first, you can’t turn around and claim the FEIE. You would owe Uncle Sam the full bill, and your only relief would be the income taxes you paid to the foreign government. (No credit for consumption taxes.)
So if you think not filing is some brilliant maneuver, think again. You make the situation much worse for yourself. You make it worse for the rest of us (since suddenly there’s this notion that all the American expats overseas aren’t filing!). You frankly threaten the continued existence of the exemption, since it then looks from a political standpoint like very few people take it, and it’s instead something that encourages non-compliance with tax laws.
If you ever expect to get anything out of America in the future, that unfiled return leaves the whole matter open, permanently A filed return closes the year for audit after three years in most cases.
I’ve made the point here and on the Bogle site before that simply because someone takes FEIE doesn’t mean they don’t pay taxes. As you know, if you’re honest with Japan and pay up regular taxes plus the social insurances, it’s a chunk of change. And since taxes affect relative prices, even in places where the taxes would be lower, it is almost as a rule that the cost of living will be much higher. (The non-taxed money is out there in the general economy bidding up prices.)
People in most other countries understand this. But we always have that set of dopey Congressmen who pride themselves on their ignorance. (Look what’s going on with the health care technicals bill in the Senate this week. They’re blocking fixes they didn’t even want in the original bill—like the Nebraska “Cornhusker Kickback”. But that’s an aside.)
One last matter: on this Making Work Pay Credit. I personally asked for the credit, even though the Schedule M form suggests that overseas earners, even ones making under the MAGI, can’t count their earned income as “earned income’. I know that some of the readership here and on Bogle put the question to the IRS’ International Taxpayer Advocate, and so I am confident that the service will bring Schedule M in line with what Congress appears to have passed.
And again, my support for my position is:
1) The definition of earned income in Section 32 (Earned Income Credit) includes foreign earned income. You can’t take the Earned Income Credit if you have excluded foreign earned income because another part of the Section 32 specifically prohibits it.
2) The IRS under the Bush Administration paid out the 2008 stimulus credit, which was based on the same definition of “earned income” as the Making Work Pay Credit.
3) An authority such as Commerce Clearing House, in their extensive review of the 2009 stimulus package, did not indicate that FEIE claimers were excluded. In fact, they point out that the definition for the Making Work Pay stimulus is the same as it was for the 2008 Bush stimulus.
So this “not getting” was something made up between Obama’s bill being passed last year and somebody at the IRS creating Schedule M. I think it was a mistake, but I am asking you to do your own research on it.
It’s important that the Service get it right because there is another (2010) Making Work Pay Credit that you would be able to claim in 2011.