As taxpaying parents, you’re hopefully familiar with some of the basic mechanisms that the U.S. government offers to ease the financial strain of raising a family—for instance, the dependent exemption, the child tax credit, and the 529 college saving plan.
If you’re a U.S. expat raising a family abroad, however, your tax return may involve some extra layers of complexity. Understanding how tax breaks work in an international context is the best way to maximize your tax savings. As you enter the 2017 filing season, here are 5 tips to consider:
1. Maximizing the Child Tax Credit
For expat tax filers, there are two main tax mechanisms designed to prevent double taxation—taxation in the U.S. and your country of residence. The first is the foreign earned income exclusion (FEIE) which allows expats to exclude a certain amount of income earned abroad ($101,300 for the 2016 tax year). The second is the foreign tax credit (FTC) which allows expats to use paid foreign taxes as a credit against their U.S. tax obligation. These mechanisms can reduce or even eliminate the U.S. federal income tax that would otherwise be due by you.
While there are advantages to both methods depending on your particular situation, the clear winner for expat parents is the foreign tax credit. According to recently enacted legislation, taxpayers who utilize the FEIE cannot claim the additional child tax credit (the portion of the credit that exceeds your tax liability), which is refundable up to $1,000 per child. This limitation does not apply, however, when the foreign tax credit is utilized. Thus, assuming that your creditable foreign tax exceeds your U.S. tax, reducing your tax via the FTC is the smarter choice.
2. Utilizing the College Tax Credit
For parents of college students, the American Opportunity Tax Credit (AOTC) offers a credit of up to $2,500 per eligible student for whom you pay tuition expenses. A 40% portion of the credit (up to $1,000) is potentially refundable.
If you’re an expat parent, you may not know that the AOTC is available for tuition paid not only to eligible American institutions but also to eligible foreign universities. If the university is on the list of institutions eligible to participate in a student aid program administered by the U.S. Department of Education, then it is generally an eligible university for purposes of the AOTC. The current list includes hundreds of foreign institutions located across the globe.
3. Appling for Tax Identification Numbers Early
Under a new law, parents cannot file an amended return to claim the child tax credit or AOTC for prior years that a qualifying child did not have an Individual Taxpayer Identification Number (ITIN) or Social Security Number (SSN). The credits will be disallowed unless the number was issued on or before the due of the tax return. As such, new taxpayer numbers should be applied for as soon as allowable to avoid losing tax benefits later on.
4. Participating in a 529 Savings Plan
A 529 savings plan gives parents the opportunity to make contributions to a special account dedicated to their children’s higher education expenses. While contributions to the plan are not tax deductible, plan investment earnings accumulate tax-free (for U.S. reporting purposes) until university costs are paid from the funds. Distributions from qualified universities are tax-free if the funds are used to pay for qualified education expenses, such as tuition, room and board, and textbooks.
Similar to the AOTC, a 529 savings plan is available not only for American institutions but for eligible foreign universities, as well. If the university is on the list of institutions eligible to participate in a student aid program administered by the U.S. Department of Education, then it is generally an eligible university for purposes of the 529 savings plan.
Keep in mind, however, that there are currently no U.S. tax treaties that recognize the tax-advantaged status of a 529 savings plan. Therefore, the tax advantages of the plan could be greatly diminished by virtue of the funds being subject to current taxation under relevant foreign tax law in the country in which expat parents live.
5. Filing International Tax Forms
As a general rule, children have the same obligation to file a U.S. income tax return as adults. The income threshold rules are somewhat different, but the filing obligation is otherwise generally the same.
What expat parents may not realize is that international forms apply to children as well. This may be particularly relevant with respect to Foreign Bank and Financial Accounts (FBAR). The associated IRS form reports financial interests in or signature authority over foreign bank accounts if the maximum values of the accounts exceed $10,000 in the aggregate at any time during the calendar year.
While maintaining joint accounts with kids or granting them signatory authority over bank accounts is not that common in the U.S., parents abroad often use this a means to minimize local inheritance taxes, transfer taxes, or other local taxes.
As an expat parent, you should consider whether banking activities involving your child triggers an obligation to file the FBAR form or other international tax forms, such as IRS Form 8938. Keep in mind that if your children cannot file or sign their own FBAR for any reason, then you must do so on the their behalf.
After spending the majority of their respective careers at two of the largest accounting firms (PwC and Ernst & Young), Joshua Ashman (jashman@expattaxprofessionals.com) and Ephraim Moss (emoss@expattaxprofessionals.com) founded Expat Tax Professionals, a firm specializing in the needs of U.S. citizens living abroad. You can visit the firm’s website at www.expattaxprofessionals.com.
