Unlike most countries, the US has citizenship-based taxation, rather than residency-based. Meaning, if a US person lives and works in Singapore (SG), they will likely pay tax to SG and the US. This is due to the US person simply being a US person (i.e., citizen or green card holder).
On the other hand, if a French person lives and works in SG, they will likely pay income tax to SG, but not France. Where they live (residency) determines where they pay tax to.
In this sense, US persons do not accrue as much benefit from living and working overseas in a low-tax jurisdiction. However, there are ways to decrease US tax liability.
One tool is the Foreign Earned Income Exclusion (FEIE).
What Is the FEIE?
The FEIE is a deduction allowing US expats to decrease their gross foreign earned taxable income by $120,000 USD (2023), consequently reducing US tax liability.
Example: Jane works at a tech company in SG earning $1,000,000 USD annually. She can utilize the FEIE (and other exclusions) to reduce her US taxable income. Her US taxable income would decrease from $1,000,000 to $880,000. At a 30% average federal rate, this saves ~$36,000 in US taxes!
Jane would pay tax to SG on $1,000,000 of income, albeit at SG’s lower rates.
Foreign Tax Credit:
While the FEIE is beneficial, it might not be best to elect it. Another available tool is the Foreign Tax Credit (FTC). The FTC decreases US tax liability dollar-for-dollar by the amount paid to a foreign country.
Example: Li is a US expat working in Germany earning $500,000 USD annually. With the country’s high tax rates, she pays an average rate of 40% to Germany ($200,000 USD). Li can utilize the FTC to reduce US tax liability up to $200,000. Excess tax paid to Germany can be carried forward to decrease future US taxes provided Li remains an expat or moves to a low tax country. If Li moves back to the US, the FTC is lost.
The FTC and FEIE cannot be used on the same dollar of income, which means, the first $120,000 USD of income can either be: (1) deducted or (2) not deducted and a credit is taken for tax paid on that income to the foreign country. If the FEIE is being used and then it is revoked in favor of the FTC, generally, the FEIE cannot be utilized for five years. Comparing the FEIE and FTC is valuable to derive the most savings this year and in the future.
Both Spouses Working:
Another advantage is that each spouse can use the FEIE up to $120,000. This differs from the Foreign Housing Exclusion where only one deduction is available per household. If both spouses work, each can deduct up to $120,000 on their joint return—$240,000 total.
Example: Jeff and Susan work in SG and each earns $250,000 USD for a total household income of $500,000. Only considering the FEIE, they can deduct $240,000, decreasing taxable income from $500,000 to $260,000. This significantly reduces US tax liability. Of course, they would pay tax to SG on their full income.
IRA & Roth IRA Contributions:
Many expats do not have access to a qualified employer retirement plan (e.g., 401k). Tax-favorable savings can be limited to an IRA or Roth IRA. The contribution limits are low ($6,500/person below age 50; 2023), but tax-deferred saving is still beneficial.
Taking the FEIE may prevent contributing to an IRA or Roth IRA, as there must be earned income that is taxable.
Example: Skywalker is transitioning companies and earns $120,000 USD. By using the $120,000 FEIE, his taxable earned income will be $0. Skywalker cannot contribute to an IRA or Roth IRA.
Next year, at the new company, if Skywalker earns $750,000 USD, his income will be too high to contribute directly to a Roth IRA. The Backdoor Roth savings tactic can circumvent this limit.
Foreign Earned Income:
The FEIE can only be utilized on foreign earned income (i.e., salary, bonus, commissions, etc.). The deduction is not allowed for unearned income (i.e., interest, capital gains, rental income, and retirement account distributions).
For US retirees living abroad, the FEIE cannot be used for IRA/401(k) withdrawals nor pension income. These are considered unearned income.
Filing A Tax Return:
To claim the FEIE, a tax return must be filed. If previous returns were not filed, the Streamlined Filing Procedures can help get into tax compliance.
There are pros and cons to being a US expat. When it comes to taxes, this same spirit applies. Knowing and applying the rules can help US persons take advantage of their unique situation and enhance their financial-personal life.
To learn more about how to plan for tomorrow please reach out to one of our wealth planners.
This material is intended for educational and informational purposes only. It is not intended to provide specific advice or recommendations for any individual. Additionally, you should consult with your Financial Advisor, Tax Advisor, or Attorney on your specific situation. The views expressed in the material are that of the author and do not necessarily reflect those of any market, regulatory body, State or Federal Agency, or Association. All efforts have been made to report or share true and accurate information. However, the information may become materially outdated or otherwise rendered incorrect due to subsequent new research or other changes, without notice. The author nor the firm are able to always verify the content from third-party sources. For additional information about the firm, please visit the MAS Website at https://www.mas.gov.sg/ and the SEC Website at www.adviserinfo.sec.gov. For a copy of the firm's ADV Part 2 Brochure, please contact us at email@example.com.