Guide to Foreign Tax Credit, Foreign Tax Treaties and Foreign Housing Exclusion

Tax exclusion and tax credits are the gateways to long-term financial stability. As you go up to higher income brackets, you’ll be expected to pay higher taxes and take on greater financial burdens. Scandinavian countries and much of the developed world charge an average of 23% income tax rates across the population. As someone who makes $1,000,000 a year, you’d have to pay $250,000 in taxes to the government; a quarter of your annual income. Although $250,000 may not seem like much, but if you project tax payments across years and account for increasing incomes, taxes can really add up. 

With regards to your long-term financial stability, you should devise a tax strategy that minimizes tax payments. You can’t avoid paying taxes entirely, but you can definitely reduce the taxes owed to your respective governments. Tax credits, foreign tax treaties and foreign housing exclusions tools to reduce tax burdens. Diversifying your holdings, shifting businesses overseas and investing in foreign property can significantly bring down tax payments. As you learn how to capitalize on tax differences across borders, you’ll save hundreds of thousands of dollars which will add to your finances in the long run.

At a personal level, I have always been skeptical of high taxation. I think governments are oppressive when they charge taxes on the wealthy. You’ve spent significant time and energy to accumulate a certain amount of wealth and to have the government take a chunk out is unfair. Governments present rationales like income redistribution and income equality to justify high taxation, but I hardly see this happening. Besides the failure of income redistribution through taxation, I don’t see why economic inequality is your problem. It’s a failure of state institutions that inequities sprout up in the first place and you don’t need to punish people for it, instead, the state needs to reflect on failures to overcome them. 

When the state fails to protect your rights and acts contrary to your personal beliefs, it’s time to begin looking out for yourself. Despite the failures of the state, it isn’t all bad; you still have constitutional rights to safeguard your wealth from taxation. The IRA has developed tax exclusion and tax credit policies that allow you to save up on tax payments. Additionally, foreign tax treaties present tax-saving potentials which can effectively supplement your tax strategies. I thought it would be best if I present these opportunities in simpler terms because otherwise, the law is too convoluted to understand on its own. 

Tax Avoidance And Tax Evasion

When people come to me for advice, they’re often worried that taking advantage of tax avoidance strategies is illegal. I want to reiterate that tax evasion is illegal but tax avoidance is absolutely above board.

Tax Avoidance

Tax avoidance is the use of legal means to minimize your tax burdens. The real problem is a lack of awareness of avenues to save up on tax payments. The United States government offers people various tax rebate and tax credit opportunities, which it also hides from them. 

Information about tax rebates and credits should be common knowledge to give people all the chances to preserve their wealth, but sadly only a tax specialist can tell you of these.

In the United States, you get tax exclusions for home maintenance, property investments, IRAs and many other financial instruments. These aren’t significant, but these give you a fighting chance against a state that would flush your money down the drain. I just feel that if more people knew about domestic tax avoidance strategies, it’s a short step from there to understanding foreign tax avoidance strategies also.

It’s unfortunate that tax avoidance is privileged information that’s restricted to certain obscure professions. The lack of knowledge on tax-saving strategies is a sign of how the state wants to impose higher taxes to prevent you from becoming financially successful. Be that as it may, you should know that the 2018 tax reforms were the single greatest boon to the American wage earner. With lower tax rates, increases in tax deductions and dependent credits, this was the first time I felt that the US government really cares for the people. 

Since options like the Tax Reforms are designed and advocated by the state, these can’t ever be illegal. You should take advantage of any and all opportunities presented by the state to protect yourself. You are responsible for your long-term financial well being and you should learn everything there is to know about tax exclusion strategies. Wherever you’re stuck, people like me are always an email away. 

Tax Evasion

Tax avoidance requires you to declare your entire income and assets to the state, then uses the law to reduce the tax burden. It isn’t illegal because the state knows where your money comes from and you’re using prescribed laws to protect yourself. Tax evasion, on the other hand, involves hiding your income from the state and is, therefore, a form of lying. If you don’t document your income and file tax returns, all your income is technically unlawful because the state can’t regulate it. 

When people hide their incomes, of course, they’ll need to pay fewer taxes because the government doesn’t even know that the income exists. This is an illegal form of tax avoidance because it uses unlawful means to reduce tax burdens. The real difference between tax evasion and tax avoidance comes down to the ways in which you minimize tax payments. 

Here is a great interview with Mark Nestmann – Why Americans Shouldn’t Have Negative Views Towards Offshore Investing

How Do Foreign Tax Treaties And Credits Come In?

The United States government currently enforces multiple tax treaties with countries around the world. Tax treaties are agreements between multiple countries to reduce the incidence of double taxation on taxes paid by the natives of either country. If you’re working in Panama and getting paid by a local company, you may be required to pay income taxes to the US and the Panamanian governments. You would wonder why you should pay income tax twice on the same income and this double income tax is eliminated between tax treaties

Suppose that you shift your business to an overseas location that the US is in a tax treaty with and you get your income from this business. If you pay a lower income tax in the offshore location, the tax treaty will exclude your income from any further income tax payment. With the tax benefits offered by the tax treaty you will be left with greater disposable income at the end of the year. 

If you are shrewd with your business and land ownership, by investing in foreign countries, you will save huge sums of money through tax treaties. The benefits from tax treaties are guaranteed by the state and you won’t have to worry about engaging in illegal activity at all.

Understanding Foreign Tax Treaties

The United States government currently has enforceable tax treaties with countries from across the entire world. The list of tax treaties includes Scandinavia, Asia, Europe and South America. The terms of all these treaties reduce tax rates on corporations and individuals alike to protect them from double taxation and create better tax terms for each. Some of these treaties completely exclude people from paying taxes and others offer tax credits for them. 

Even if you’re working abroad, you’re required to pay taxes to the United States government for any income earned abroad. These tax treaties eliminate the need to pay taxes to the government but you’ll still have to show your income to the state. Any resident from the United States or a treaty resident shall enjoy tax benefits through the tax treaties.  

The benefits you can enjoy from a tax treaty include: 

  • Tax credits
  • Tax deductions
  • Tax exemptions
  • Tax rate reductions 

Different taxes apply to individuals and corporations. You should not forget to combine the different forms of tax exclusions and deductions with tax credits to minimize your tax liability. There are ways that you can reduce income taxes by transferring property ownership to your personal corporations. If you move to countries with lower tax rates and which have tax treaties with the US, you can significantly reduce your taxing amounts. When you use all available tax laws to your advantage, you can preserve a large percentage of your overall income.

I will describe the different tax tools at your disposal in detail and also present ways to use them in the most effective ways. By the end of this article, you should fully understand how foreign tax credits and exclusions can help you preserve your finances.

Understanding Tax Credits

Before we can understand how foreign tax credits work, it’s important to know what tax credits are.  When taxes are paid, you usually get a tax rebate which is essentially a refund on extra tax payments. The United States government offers people tax credits, rather than tax rebates, and deducts the amount of total payable taxes for the coming year. For example, if you had to pay a total tax of $100,000 and you qualify for a tax payment worth $1000, then you will have to pay $1000 less the total amount of taxes accumulated for the next year. If your tax for next year also amounts to $100,000, you will only have to pay $99,000 in the next year. 

There are two kinds of tax credits people can avail; refundable and non-refundable credits. 

Refundable Tax Credits

Assume that you qualify for a tax credit of $1,000 during any year and your total taxes are $900. In situations where your tax credits exceed the amount of payable taxes, the government will carry forward the tax credit to the next year.  When your tax credit is carried forward, something like this will happen: 

Let’s say in the next year you have to pay $900 again and you have $800 as tax credits. The United States government will add the previous years remaining tax credit to the current year’s tax credit to further reduce the taxes you have to pay. So, if the current year tax credits are $800, the government will add the $100 from the previous year to the current year’s credit to make a total of $900 in tax credits. When the government has added last year’s credits to this year’s, your total tax payments will go down to $0. 

Alternatively, it is also possible that the government sends you a check for the amount of credits that are leftover. In a situation where you have $1000 in tax credit and you only had to pay $900 in tax, then you will receive a check for $100.

Non-Refundable Tax Credits

As opposed to refundable tax credits, you don’t get paid if you have credits in excess to your tax payments. If you qualify for a non-refundable tax credit, then with $1000 in credits and $900 worth of tax payments, neither is the $100 carried forward nor are these refunded as checks. Even though you don’t get paid for these extra tax credits, you should still avail non-refundable tax credits because they still reduce your tax payments. 

How Do Foreign Tax Credits Work? 

Foreign tax credits are applied exclusively to any income (investment or otherwise) earned in foreign lands. Foreign tax credits also include refundable and non-refundable credits, which work the same way as described above. If you earn from countries which have a tax treaty with the US, you won’t have to pay any taxes to the United States government. 

As a citizen of the United States, as a general rule, you’re required to pay taxes on all incomes earned whether domestic or foreign. Foreign tax credits are deductibles in federal income tax amounts if you’ve already made payments to the government of the country you got paid in. Foreign tax treaties enforce higher tax credits between the US and the other party in the treaty, while you might not qualify for a tax credit if there is no tax treaty in effect.

Making The Most Of A Foreign Tax Credit

SDIRAs allow people to invest in offshore locations and even allow foreign custodians to manage investments. Income tax applies to IRA returns just as it is applied to any other form of income. If your SDIRA makes investments in foreign businesses or industries located in tax treaty partner countries, then you could avoid paying income taxes to the US government. Foreign tax credits are even more beneficial when the foreign country has lower capital gains tax rates than the US because this reduces your overall tax payments. 

Let’s say your SDIRA is located in Japan and you make capital gains from investments in the country at a 12% capital gains tax rate. The US has the highest income tax rate of 37%, but it also has a tax treaty with Japan. If you’ve paid 12% tax to the Japanese government, you’ll qualify for tax credits in the US and might have to pay a lower absolute amount of money as tax to the federal government.  

SDIRAs are just one example of reducing your tax liabilities through foreign tax treaties. You can buy property abroad to qualify for a foreign housing exclusion and you could also incorporate offshore to reduce your overall tax payments. 

The United States has some of the highest corporate tax rates in the world while Ireland has one of the lowest. Incidentally, the US has a tax treaty with Ireland as well. You have to pay 12.5% corporate tax rates in Ireland, while you pay 21% in the US. Any corporate income taxed in Ireland, will not be taxed at the same rates in the United States because of the foreign tax treaty between Ireland and the US. With the benefits of the foreign tax treaty, you’ll have to pay fewer taxes compared to the amounts you would pay if your business was based in the US. 

Foreign tax treaties often benefit corporations more because of their higher tax burdens. As such, I often advise people to incorporate in tax havens or in tax treaty nations. If you play your cards right, you can save millions in taxes. 

What Are Foreign Housing Exclusions?

Owning property in foreign lands qualifies you for either foreign housing exclusions or foreign housing deductions. 

Applying For Tax Deductions

If you’re self employed in a foreign land and own a home, then you qualify for a tax deduction from your total income based on the amount of money spent on housing. This doesn’t include the money spent on food or money spent on luxury goods. Since you’ll have to pay property tax, pay rent and possibly other forms of taxes, US federal taxes become a form of double taxation. To prevent double taxation, the government will deduct certain tax amounts from your overall tax payments to reduce your tax liability.

Applying For Tax Exclusions

You’ll qualify for tax exclusion if you housing is paid for by an employer. If you’re working for an employer in a foreign land, they might make housing payments for you. Your employer will make tax payments, rent payments and any other tax relevant to your housing. Additionally, the employer will deduct a certain amount from your salary to pay for any taxes or payments incurred in finding you housing. 

The foreign housing tax exclusion essentially excludes that amount being deducted by your employer for your housing from your taxable income. As the taxable income amounts become smaller, your tax liabilities also get smaller. When reporting taxable income to the US government, you should not report the amount of money your employer deducts from your income for housing.

Making The Most Of Foreign Housing Tax Exclusions

Many countries around the world allow you to buy up property and also let you retire abroad. Panama, for example, gives people citizenship in return for investing in property in the country. If you hold on to you US citizenship, in addition to the Panamanian citizenship, then you can apply for tax deductions to reduce your overall tax amounts. 

Similarly, if you set up an offshore company and hold property in its name, then you can actually qualify for a tax exclusion altogether. If the property and the company are located in a tax treaty nation, you will qualify for lower tax rates, tax deductions and tax exclusions. There are any number of ways to take advantage of tax exclusions, deductions and treaties; it’s only a matter of finding the right combinations. 

Some Things To Remember

The foreign housing exclusion and deduction depend on certain clauses referring to the foreign earned income tax exclusion laws. You would do well to read up on how foreign housing exclusions and deductions change with foreign income exclusions devise effective tax strategies. 

Please read: 6 Countries Where It’s Easy to get a Residency Visa

Our Ultimate Guide to Going Offshore is a must read. You won’t be disappointed.

Please reach out to our team for offshore tax services. We are here to help!

And lastly, It’s Time to Leave the United States!

I hope you got real value from our Guide to Foreign Tax Credit, Foreign Tax Treaties and Foreign Housing Exclusion. There are multiple tax deduction laws that you can use to your advantage. Financial success relies in knowing the full advantage of all possible ways that you can use to reduce your tax liability. Economic circumstances are often determined based on diplomatic and political events which you can use to your advantage. With the work of foreign tax treaties and foreign housing inclusions, you can enjoy a huge proportion of your disposable income.

You need to remember that tax havens don’t enter into tax treaties because there isn’t any tax paid in those countries. Although tax havens are also a great way to save on taxes, these aren’t the only avenues to save taxes through. With some mindfulness on your part and with some smart financial moves, there is no telling how easily you can save up money. In the context of long term financial success and preserving your economic liberty, you should take advantage of all diplomatic and financial loopholes that you find. 

The perpetual traveller frees himself from all unnecessary financial burdens through shrewd financial planning. Foreign tax credits, housing exclusions and tax treaties are the avenues that the perpetual traveller uses to make sure that he saves himself from financial exploitation.

About The Author

Mikkel Thorup host of The Expat Money Show

Mikkel Thorup is the host of The Expat Money Show podcast and the author of #1 Best-Selling book Expat Secrets on Amazon. He has spent nearly 20 years in continual travel around the world, visiting more than 100 countries including Colombia, North Korea, Zimbabwe, and Iran.

His goal is to help Expats like you to generate additional streams of income, eliminate your tax bill, and take advantage of offshore structures so you can travel the world freely and never have to worry about money again. For more information on his legal (but creative) tax strategies for Expats watch this free video.

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