Do you have to file?

Some people don’t, but basically, yes. Anyone making more than $8750 is supposed to file. Depending on where the income came from, even some people who make less have to file. Some dependents must file as well. And even if you are exempt from filing for some reason, it’s generally better to file a tax return every year, in order to receive a refund of withholding amounts, qualify for certain tax credits, and/or establish a beginning date for the “period of limitations” for that return.

Do you have to pay?

In general, yes. All U.S. citizens or resident aliens are liable for income tax on worldwide income, no matter where it is generated or where you live. In general, most individual income tax codes and procedures apply to all taxpayers, no matter of your resident or filing status. However, the rules governing the need to report income and pay tax on it depend greatly on your specific situation. Although the general regulations are based on gross income levels (see this , page 6), there are numerous special rules that could apply: rules.

Filing dates & basic instructions

The standard due date for your 2007 individual income tax return is April 15, 2008. U.S. citizens or resident aliens living outside of the United States and Puerto Rico automatically receive a two-month extension (until June 16, 2008) to file and pay their tax. No penalties will apply, but you will be charged interest on any unpaid amount. You need to prove in your return that you meet the requirements. here (page 6). In addition, anyone can request a 6-month extension (until October 15, 2008) by filing Form 4868. However, this extension doesn’t extend your time to pay, and penalties and interest will apply on amounts not paid by April 15.

Taxpayer's have the option of filing Form 1040, 1040A, 1040EZ, 1040NR or 1040NR EZ, however if you are living oversees you will most likely file Form 1040. There are additional schedules you have to fill out if you intend to itemize, if you report interest and dividend income, or if you have your own business or are self-employed. The instructions for form 1040 tell you what schedules you will need. Also, you can call the IRS at local numbers in Europe or in the U.S.: see here. You may also benefit from itemizing if your health expenses, moving expenses, and charitable donations total more than the standard deduction.

If you work for a foreign company or for someone who does not deduct taxes and Social Security contributions from your pay, you need to make quarterly estimated tax payments. Due dates for 2008 quarterly estimated individual income tax payments are as follows:

• 1st Quarter - April 15, 2008
• 2nd Quarter - June 16, 2008
• 3rd Quarter - September 15, 2008
• 4th Quarter – January 15, 2009.

Taxpayers can make estimated tax payments or pay their tax return balance due electronically via the Internal Revenue Service’s EFTPS system, at no cost: here.

Overseas exemptions and credits

Foreign Earned Income Exclusion + Housing Exclusion/Deduction
For 2007, if you are a U.S. citizen or resident alien living abroad, you may be able to exclude up to $85,700 of your foreign earned income. To qualify, you must meet these requirements:

• Your “tax home: must be in a foreign country
• You must have foreign earned income
• You must be considered a “bona fide resident” or “physically present” in a foreign country during the year.

In addition, you may be able to exclude or deduct certain foreign housing expenses. The amount is calculated by taking your qualified housing expenses, which are capped by standard rates for different countries, and then reducing them by the annual base amount, which for 2007 is $13,712.

Some other factors to keep in mind:

• Employees of the United States government are not eligible.
• You must disclose the election to take the exclusion on the first tax return for which it applies, and use Form 2555 or Form 2555-EZ.
• The exclusion is allowed for each taxpayer and figured separately; i.e. one spouse can elect to use while the other doesn’t (for instance, if one spouse works for the U.S. government and the other works on the local economy).
• If you exceed the maximum excluded amount, your next dollar of taxable income is taxed at the marginal rate applicable to taxable income including the excluded amount.
• By taking the exclusion, you are reducing your earned income amount. Since a number of other calculations are based on earned income, taking the exclusion could mean that other deductions or credits will no longer apply for you, such as IRA contributions and the child tax credit; see here (chapter 4).

Foreign Tax Credit

In lieu of, or along with, the foreign earned income exclusion, you may be in a position to offset your U.S. income tax with credits for taxes paid to other countries. Some factors to keep in mind:

• Use Form 1116 to report foreign income and related taxes. This form was adjusted in 2007 and now has only 5 income types. A separate Form 1116 is filed for each income type and each country – and if the Alternative Minimum Tax (AMT) applies to the taxpayer, a separate AMT Form 1116 is generated.
• You must have paid or accrued foreign income taxes during the year.
• The credit is reduced by various scale backs, which compare income earned in the States vs. foreign countries, and foreign tax vs. U.S. income tax. In no case can the credit be more than your U.S. tax liability.
• Unused credits can be carried forward to future years. See here (page 40).

Non-resident alien spouses

If one spouse is a U.S. citizen or a resident alien, and the other is a nonresident alien, and your tax home is in a foreign country, the income of the nonresident alien spouse is not subject to U.S. income taxes. However, in many situations it is advantageous for the nonresident alien spouse to be treated as a U.S. resident for income tax purposes and be included on a “married filing jointly” return. This is accomplished by including a declaration signed by both spouses to the joint tax return in the first year. The choice remains in effect until suspended, and once suspended, it cannot be chosen again in most cases. See here (page 7).

What if you’re self-employed?

The U.S. government has “binational Social Security” agreements with a several foreign countries to facilitate the collection of social security taxes for their citizens no matter where they live. In countries with no agreement, U.S. Social Security and Medicare taxes do not apply to wages for services you performed as an overseas employee, unless you meet four exceptions – the most relevant being that you worked for an American employer or foreign affiliate. See here (page 8)

Self-employment tax, on the other hand, is the same for U.S. citizens or resident aliens, no matter where they live or work, and applies to worldwide self-employment income. Thus, even if you claim the Foreign Earned Income Exclusion as a self-employed worker abroad, you must pay self-employment tax on your entire earnings. See here (chapter 3); also see Form 1040, Schedule SE.

Paper filing vs. online filing

80 million tax returns were filed electronically last year, and the IRS eventually wants all files to be “e-filed.” For 2007 tax returns, the IRS is providing a free e-filing service called “FREE FILE” if your adjusted gross income is $54,000 or less. here

If you don’t qualify, the IRS has numerous authorized “e-file” partners that provide e-filing for a reasonable fee. 2007 individual income tax returns can be electronically filed up to the extended due date of October 15. here

It should be noted that beside income limitations, many individuals will be unable to file electronically due to the need for specific information that must be provided and verified by the IRS. For example, your return will be rejected if the IRS cannot match your social security number or your employer information with their records. So, even if you intend to file online, don’t wait until the last minute.

If you intend to file by mail, your return must be postmarked by April 15. Make sure you post it in some way that gives you a receipt, especially if you live somewhere where the mail system can be unreliable.

What’s new for 2007 and 2008?

The IRS has consolidated a number of processing centers, so the address for mailing your return may have changed. Double check the mailing address provided in your tax return instructions, or click on this link: here .

In December, Congress approved a one year “patch” for the Alternative Minimum Tax (AMT) that delayed the scheduled decrease of AMT exemption amounts for the 2007 tax year. About 20 million households with taxable income between $75,000 and $200,000 would have been affected by this change, resulting in $2,000 of additional tax on average per household. The rules will now be similar to those from 2006, but Congress will have to address the issue again for future years. A side effect is that the IRS needs time to update their systems for the “patch” and will not be able to process returns with AMT implications until approximately February 11. here

The IRS has expanded the options for taxpayers covered by a retirement plan to take Individual Retirement Account (IRA) deductions. In 2007, individuals filing single returns will still be able to take a deduction if their adjusted gross income is below $62,000 ($103,000 if married filing jointly or qualified widow). In 2008, these levels will increase by $1,000 and $2,000 respectively, and the amount of the deduction rises from $1,000 to $5,000 ($6,000 if age 50 or older) for each taxpayer. here

Starting in 2007, the IRS is also allowing a “once in your lifetime” tax-free distribution from IRAs to Health Savings Accounts. here

In 2008, current personal exemption and itemized deduction phase outs will be reduced; the 5% capital gain tax rate will be reduced to zero; the rules for reporting and figuring tax on your children’s income will change; and a number of tax benefits are scheduled to expire, including deductions for educator expenses and college tuition fees, and the election to include nontaxable combat pay in earned income for purposes of the Earned Income Credit. here (page 5).

Proposed “New Economic Growth Package” for 2008

With a potential of a recession in the U.S. on the horizon, the administration and Congress came to terms on a new economic growth package.� The� act was signed into law on February 13th and� includes roughly $50 billion in business tax incentives, which will allow businesses to write off up to 50% of the cost of new equipment investment in 2008. The idea is that businesses will use this opportunity to expand their operations and hire more employees.

The act also calls for another $100 billion of individual tax relief, intended to spur consumer spending. In 2008, tax rates for the first $6,000 ($12,000 for married taxpayers) would be cut from 10% to zero for taxpayers with adjusted gross income of $75,000 ($150,000 for married taxpayers). In addition, another $300 per dependent would be provided. Rebate checks (reflecting the tax savings that would be reported on 2008 tax returns next year) would be issued as soon as this May. A typical qualifying family of four could receive as much as $1,800. here

Links Most the information for this article came from the IRS website, www.irs.gov. They have a new online service called 1040 CENTRAL, that provides current and relevant information about preparing U.S. individual income taxes.

Specifically for U.S. citizens or residents living abroad, check out Publication 54 . If you are an alien with U.S. income of some type, look at Publication 519, U.S. Tax Guide for Aliens, here .

You also might be surprised to find out how much is accessible from Google – but be sure to back it up with official information from the IRS.

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Frederick McGough is a U.S. certified public accountant and the principal of NorthStar Consulting Services, based in El Salvador. He provides U.S. financial, accounting and tax services to various individual, corporate, governmental, and NGO clients in the States and Latin America. He can currently be contacted online at frederickmcgough@gmail.com .