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U.S. Expat Mistakes: Part II



I have been on many online forums, message boards, and groups for U.S. citizen expats over the past few years. Most posts you see are ones with frantic U.S. citizens overwhelmed with U.S. tax rules & regulations they have to keep up with. This, in addition to keeping up with their resident country’s tax laws, must drive one crazy. These forums provide quick answers; no wonder they are so popular!

However, one has to exercise caution when relying solely on answers from these sites or on the internet. Each situation is unique and only an experienced tax professional in expat matters can correctly evaluate what steps need to be taken to stay in compliance with U.S. Tax Law.

We started out talking about tax mistakes U.S. expats commonly make in my post here. Today’s post is the second in the series on mistakes U.S. Expats make and we are going to focus on contributions to retirement accounts.

Individual retirement accounts or IRAs are great tools for saving for retirement with a winning combination of tax-deductible contributions and tax-deferred growth. IRA rules are written purely with U.S. tax code in mind and they may cause conflict with the tax codes of the countries the expats work and live in. Double taxation avoidance agreements (DTAA) may mitigate some of the burden, but most countries I know of will not allow an expat to save on local taxes by contributing to a U.S. IRA.

Some high-income earners may still be able to contribute to a U.S. IRA, the rules get complicated. We see a lot of self-prepared returns that have made excess IRA contributions and penalties on these are steep. Here are a few common mistakes expats make in relation to contributions into Individual Retirement Accounts (IRAs):

1. All Income is Excluded and an IRA Contribution Is Made

In order to make IRA (Traditional or Roth) contributions, one has to have earned income. If a taxpayer after currency conversions is able to exclude a 100% of his/ her foreign income using the Foreign Earned Income Exclusion rules u/s § 911, then they do not have any U.S earned income to make an eligible contribution to an IRA. These excess IRA contributions are taxed at 6% annually as long as the excess contributions remain in the IRA.

2. Not Taking Into Account Income Phase-outs for IRA Contributions

The flip side of point #1 is when a taxpayer has a high income and is still liable to U.S. tax after taking advantage of the Foreign Earned Income Exclusion rules. A Roth IRA contribution is possible in this case, however the taxpayer must consider the income phase-out to make sure he/ she is eligible to make this contribution.

This income is called the Modified Adjusted Gross Income or MAGI for short. The MAGI phase-outs for 2017 for making Roth IRA contributions are:

Single Filers—Phase out starts at $118,000 and ineligible at $133,000.

Joint Filers—Phase out starts at $186,000 and ineligible at $ 196,000.

3. Contributing to a Spousal IRA when filing as Head of Household

Many times high-income earners who have a non-citizen spouse may be able to file with a Head of Household status if they have children. There might be enough taxed income left over for them to contribute to an IRA, but the most common mistake we see that a contribution is made to a spousal IRA. One can contribute to a spousal IRA only if filing as married and joint.

4. Not factoring double taxation on deductible IRA contributions

The most common mistake expats make is making a deductible contribution into a U.S. IRA with money already taxed by the resident country. When the taxpayer takes a distribution from this IRA, he will be taxed on it again in the U.S.

This is generally true if the resident country’s tax rate is higher than that of the U.S. If the resident country’s tax rate is lower, double taxation may not be substantial, but accurate projections need to be made.

5. Opening foreign investment and retirement accounts without understanding expat tax obligations

I have written extensively on this here.

6. Missing Required Minimum Distributions on inherited IRAs

Penalties for not taking required minimum distributions are very high, it can sometimes be as much as 50% of the amount that should have been withdrawn. If you have an inherited IRA from an aged parent/ relative, you need to continue to take required minimum distributions based on a certain schedule.

A common mistake expats make is depending on the broker holding the account to make this calculation for them or being completely unaware of this requirement.

These are complicated provisions that is difficult for a lay person to understand and keep up with. If you are an expat and find that some or all of the above apply to you, drop us an email or call us and we can take care of you.

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I am Manasa Nadig, enrolled to practice and represent taxpayers with the Internal Revenue Service. I have been in the business of Tax Preparation & Tax Planning since 1999. My firm, MN Tax Solutions, LLC is based in Michigan, USA. Please connect with me on TaxConnections for more information about myself & the services provided by my firm.

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