The Importance of Making Quarterly Estimated Tax Payments for US Persons Abroad
When US persons move from America to a foreign country, one item that is often overlooked is the benefit of making quarterly estimated tax payments.
When employed in the US, employees typically receive bi-weekly or monthly paychecks that fund living expenses. However, before money is deposited into their bank account, an amount has already been withheld by the employer for federal, state, local, and FICA taxes. In this regard, tax is being paid throughout the year and come April 15, there typically isn’t too large of a tax bill.
However, when moving abroad, the paradigm shifts. Generally, employers no longer withhold US tax from every paycheck, and the responsibility falls on the employee to make payments throughout the year. Otherwise, there can be underpayment penalties, which we have frequently seen add-up to thousands of dollars lost annually.
One caveat is that there is a difference if moving to a high-tax jurisdiction (e.g., UK, Australia, Spain) or low-tax jurisdiction (e.g., Singapore, Hong Kong, UAE).
For a high-tax country, employees might pay more tax to that jurisdiction than to the US, thus accruing a foreign tax credit, which can offset US tax liability and potentially result in not owing any US tax. Sounds great to not owe US tax, right? However, by definition, if foreign tax rates are higher than US rates, then there is more tax to pay overall—it just goes to the foreign country, as opposed to Uncle Sam.
For low-tax jurisdictions, this is when making quarterly estimated payments is most essential, because there might be US tax owed, and it can be a substantial amount depending on foreign tax rates and income level.
Circling back to why it is important to make estimated payments, the IRS wants money throughout the year, so if quarterly estimates are not made, there are penalties based on (1) the shortfall between what should have paid and what was paid, (2) the number of days this shortfall persists, and (3) the federal short-term rate plus 3% which is updated quarterly. In other words, penalties continue to accrue daily, so if payment has not been made by the due date, there is still an opportunity to make a payment to mitigate penalties that are accruing. Moreover, in a high interest rate environment, these penalties are higher; as of this writing (October 29, 2023), the federal short-term rate is 5%, meaning, penalties are accruing at 8%!
This begs the question: how much should be paid in estimated quarterly payments? The US has a “safe harbor” provision wherein if quarterly payments of 90% of the current year’s tax liability or 110% of the previous year’s is made, no underpayment penalties will be owed even if income substantially increases and tax is owed at the end of the year (i.e., as long as this threshold is met, the taxpayer is “safe” from penalties).* Alternatively, we often run tax projections for clients to determine their potential tax liability and then adjust estimated payments to align with the projection. This is generally more of a complex calculation than for those living stateside because it must consider Singapore tax owed, the corresponding foreign tax credit, and local tax laws wherein some types of income are not taxable in Singapore but are still taxable in the US. Moreover, it must consider capital gains, Roth conversions, tax loss harvesting, higher than normal taxable interest due to high interest rates, and the like.
Stock compensation like Restricted Stock Units (RSUs) increases complexity. When living in the US, there is automatic tax withholding upon vest (e.g., 100 Apple RSUs vest of which 80 shares are received and 20 are withheld). However, while abroad, generally, there is no automatic withholding, which can result in a large year-end tax bill. One way to counteract this is to determine a percentage of vesting stock to be sold and use the proceeds to pay quarterly tax.
Estimated payments can be made directly on the IRS website, via mail, or through an online account. Accountants can also create estimated quarterly payment vouchers. Due dates are typically April 15, June 15, September 15, and January 15 of the following year.
Making estimated tax payments might not be the most enjoyable exercise, but it mitigates penalties, which can amount to thousands of dollars saved each year. Sometimes it is the ordinary, proactive steps like making estimated quarterly payments that can significantly strengthen a financial position and make a large impact overtime.
For more information on estimated payments, tax projections, and tax planning, please reach out to one of our Wealth Planners.
*Assumes Adjusted Gross Income (AGI) of $150k+ USD.
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