How to Handle State Taxes as an Expat
As a US expat living abroad, taxes can get confusing. You might have a mix of different income sources, you might have moved halfway through the year, and you might be totally uncertain on how to manage US taxes.
On a federal level, you’ll be required to file an income tax return no matter what. But what about the state in which you used to reside? Are you still required to file a state-level income tax return? Are you going to owe state-level taxes on the money you made as an expat?
This guide will introduce you to the basics.
Income Taxes as an Expat: An Overview
Before we dig into state-level income taxes specifically, let’s go over the income tax requirements for expats overall.
For starters, all US expats will need to file a federal-level income tax return, every year, with no exceptions. Even if you don’t believe you’re going to owe federal income taxes, you will need to file this documentation to remain in compliance with the IRS. Most expats will not owe federal income taxes, and some will even end up with a refund, but it’s important to file the proper paperwork.
If you make money from a US employer while you’re living overseas, the income you make will be subject to federal income taxes. This is treated as ordinary income, so it isn’t afforded any special treatment just because you’re living somewhere else.
However, if you make money from a foreign source, you will likely be able to exclude some (or all) of that money with the Foreign Earned Income Exclusion (FEIE). The FEIE is intended to relieve the burden of taxes on people who are already paying a different kind of taxation on that income; in other words, if you earn this income in a foreign country, and pay taxes to that country’s government, you shouldn’t have to also pay taxes to the United States. Through this program, as of 2019, you can exclude up to $105,900 of foreign income. Note that this doesn’t include income from US sources.
In addition to the FEIE, you may be able to qualify for a Foreign Tax Credit (FTC). You won’t be able to stack these benefits; in other words, if you’re claiming $90,000 of excluded income with the FEIE, you won’t also be able to subject that income to the FTC. However, if you earn $125,000, you may be able to apply an FTC to the difference.
If you’re self-employed, you will be responsible for paying a self-employment tax on your income, regardless of whether you earned it through the US or a foreign entity. Self-employment taxes are directed to Social Security and Medicare programs, which are ordinarily split between an employee and an employer. You may be able to reduce the amount of self-employment taxes you owe, through deductions and other incentives, but you should prepare to pay it if you’re a freelancer, independent contractor, or small business owner.
But what about state taxes?
High-level, you are not necessarily obligated to file a state-level tax return; some states require all citizens, including expats, to file an income tax return, some states never require anyone to file an income tax return, and others have more complicated, nuanced regulations. The only state that matters is the most recent state in which you lived.
We will examine these states in turn.
States That Do Not Collect Any Income Taxes
There are currently 9 of 50 US states that do not collect state income taxes, or only collect taxes on interest and dividends. Wyoming, Washington, Texas, South Dakota, Nevada, Florida, and Alaska collect no individual state-level income taxes, so you won’t have to worry about them at all. If you’ve moved from Tennessee or New Hampshire, you will only need to file a state-level income tax return if you’ve earned interest or dividends on assets held in the state.
If you’re considering moving abroad, it may be in your best interest to first move to one of these income tax-friendly states. Because the only state that matters is your most recent residence, this is a fairly easy trick to pull.
States That Require Tax Returns
Some states are much more aggressive when it comes to collecting state income taxes. They see individual taxpayers as a necessary asset to support state-level government programs, and will do whatever it takes to keep people paying their dues. New Mexico, Virginia, South Carolina, and Colorado are generally regarded as the worst states in terms of state income tax collection.
When moving abroad, you will need to prove to these states that you don’t intend to return; if you do this to the state’s satisfaction, you may be able to forgo the need to file a state-level income tax return. If you can’t prove your intention of permanent residence, or if you do intend to come back, you will need to file a return.
The state will likely consider you planning to return if they can prove your current voter registration, active state driver’s license, active state-present mailing address, or utility bills in the state. It may be in your best interest to first relocate to another, more expat-friendly state, before moving overseas.
Gray Area States
We’ve listed 9 states that are expat friendly, almost never requiring a state-level return, and 4 states that are expat-unfriendly, where you’ll likely need to file a state-level return. The 37 other states sit somewhere in the middle. Generally speaking, these states are willing to release you from residency status, so long as you’ve lived in another country for more than 6 months. However, you’ll still need to prove your external residency.
Even if you’re required to file a state-level income tax return, you may only be responsible for paying state-level income taxes on income generated in the state. If your only sources of income are foreign, you may file a return without having to pay additional state-level taxes.
Be aware that every state has different requirements, so it’s not wise to simply assume that you understand the requirements in your state. Specifically research the rules regarding US expats in your state, and approach your tax return accordingly.
Penalties for Late and Missing Returns
Though every state is slightly different, most states have the same filing deadlines as your federal-level income tax return. If you face extenuating circumstances, you may be able to file for an extension.
If you miss the deadline and follow up in a reasonable amount of time, you may be able to file a late state-level tax return with no penalty. However, if you are significantly late with your return, or you do not pay the state-level taxes you owe, you will likely face both a civil, monetary penalty, and depending on the severity of the offense, criminal charges.
Other Reporting Requirements
States don’t have much of an interest in expats, but the federal government has a number of reporting requirements for US expats. In addition to needing to file a federal income tax return every year, you may be responsible for completing an FBAR report, which will notify the federal government about foreign accounts you currently hold. Be sure to familiarize yourself with all rules and regulations for US expats if you want to avoid a penalty.