February 23, 2016

A Tax Guide for People Retiring Abroad

Michael Hirschfeld

After years of the rush-hour grind, some retirees decide for a major change in life by resettling outside the US. While retirees may think they can leave all their past worries behind, one thing that will not go away is US tax liability. Unlike many countries around the world, the US imposes its income tax on the worldwide income of its citizens regardless of where they live. US estate– and gift–tax liability may also persist. Ignoring these taxes can lead to civil and criminal penalties and a headache for the next generation, so retirees need to focus on these issues. 

Resettling abroad offers a few limited income tax advantages. If a retiree relocates outside the US so as to take a new full time job, US tax law provides that $101,300 of 2016 income may be excluded from US income tax.  An added tax exemption is allowed for a housing allowance that the new employer may provide. Also, foreign income taxes imposed on income may allow the retiree to claim a foreign tax credit against his or her US tax liability that will offset US tax liability on the same income. Alternatively, a retiree may claim a tax deduction for the foreign taxes paid.  However, for the retiree who settled into some paradise in the Caribbean or elsewhere that has no taxes, these credits and deductions are irrelevant. 

Normally, an income tax return must generally be filed by April 15 of the following year (or that year's actual filing deadline, which for the 2015 income tax return, is April 18, 2016). One small consolation a retiree gets is that if such a person is residing overseas on April 15 (or the actual due date) then the retiree gets an automatic two-month extension to file their income tax return until June 15. Also, penalties for paying any tax late are assessed from the two-month extended due date of the payment (June 15). However, interest will still be owed the IRS on any tax not paid by the regular due date of the return (April 15). If a person qualifies for the two-month extension but is unable to file the return by the automatic two-month extension date, that person can request an additional extension to October 15 by filing Form 4868.

While taxes withheld by an employer on wages may have been the way many retirees used to pay taxes each year, a retiree may need to start paying estimated taxes on their income now that they aren’t having taxes withheld.  For each year, estimated taxes are due April 15, June 15 and September 15 of the year the income is earned, as well as January 15 of the succeeding year. Failure to pay estimated taxes can lead to penalties and interest being imposed. 

A person moving abroad may decide they will give up US citizenship so as to escape US taxes. Before a person acts too quickly, US tax law provides for an exit tax upon relinquishing US citizenship. The US treats many expatriates as if they sold all their assets in a taxable sale for cash equal to the fair market value of the assets. Any resulting gain that exceeds $693,000 is taxed in full in the year of the expatriation. A person needs to review these rules to determine if they may apply.

A retiree may also think they can move their Individual Retirement Accounts (IRAs) and other qualified accounts to a local foreign bank. However, US tax law may limit where those accounts can be moved so a retiree may still have to deal with their US bank or investment company.

The bottom line is that careful review of US taxes is needed before a retiree leaves the US. Assumptions that may seem logical in a non-tax world cannot be assumed. 

Michael Hirschfeld