Managing taxes as a U.S. citizen or green card holder earning foreign income can be a complex process due to the United States’ taxation of worldwide income. Whether you’re working for a foreign employer or earning from foreign investments, understanding how to navigate U.S. tax rules is crucial to avoid double taxation and ensure compliance with Social Security and Medicare (FICA) obligations. This article provides a clear overview of how foreign income is taxed in the U.S., the application of the Foreign Tax Credit (FTC), and your Social Security and Medicare obligations based on your employment situation.
Introduction: Dual Tax Residency Scenario
Consider the case of a Brazilian citizen who moves to the U.S. on a green card while maintaining a salaried job with a Brazilian company. This individual faces dual tax residency—subject to taxes in both Brazil and the U.S. Since the U.S. taxes its residents and citizens on worldwide income, there are several important questions to address, including:
- How does the U.S. tax foreign income for U.S tax residents and citizens?
- How can you apply the Foreign Tax Credit (FTC) to avoid double taxation?
- What are the Social Security (FICA) obligations for foreign employees working in the U.S. or for U.S. companies?
Key Concepts and Terms
Worldwide Income and U.S. Taxation
As a U.S. resident or citizen, you are taxed on all income, regardless of where it is earned. This includes income from foreign sources such as wages from a foreign employer, dividends from foreign investments, or rental income from foreign property. Whether you’re earning income domestically or internationally, it must be reported on your U.S. tax return.
Foreign Tax Credit (FTC)
To avoid double taxation, the U.S. offers a Foreign Tax Credit (FTC) for individuals who have paid foreign taxes on their income. The FTC allows you to offset U.S. taxes with the taxes paid to a foreign country, but only to the extent of U.S. tax liability on that same income.
For example, if you owe $10,000 in U.S. taxes and have already paid $5,000 in foreign taxes, the FTC allows you to reduce your U.S. tax bill by $5,000. This leaves you with a $5,000 tax liability in the U.S. However, the FTC cannot generate a refund; it simply reduces the amount owed.
Foreign Earned Income Exclusion (FEIE)
For U.S. resident aliens or citizen living abroad for an extended period, the Foreign Earned Income Exclusion (FEIE) can reduce the amount of foreign income subject to U.S. taxation. In 2024, the FEIE allows eligible taxpayers to exclude up to $126,500 of foreign earned income. However, this exclusion does not apply to investment income or other passive income, and applying for it means you cannot claim the FTC on the SAME income.
Social Security and Medicare (FICA) Taxes
FICA taxes cover Social Security and Medicare contributions and generally apply to anyone working physically in the U.S. However, different rules apply depending on the employer’s location and whether a Totalization Agreement is in place.
For U.S. citizens working for foreign employers:
- Foreign Employers: If you’re employed by a foreign company and working outside the U.S., you are generally not subject to FICA taxes unless a Totalization Agreement is in place, coordinating Social Security contributions between the two countries.
- U.S. Employers Abroad: If a U.S. company or an American employer has a foreign affiliate, they may file Form 2032 to ensure that FICA taxes are withheld from the wages of U.S. citizens or residents working abroad.
For U.S. citizens working for U.S. companies:
Domestic Employers: Employees working physically in the U.S for U.S. companies must pay Social Security and Medicare taxes on all wages, regardless of where the work is performed.
Step-by-Step Breakdown: Taxing Foreign Income and Social Security Obligations
1. Reporting Worldwide Income
U.S. tax residents and citizens must report all income earned abroad, whether it’s from employment, investments, or business activities. For instance, if you are earning a salary from Brazilian company while residing in the U.S., that income must be reported to the IRS.
Example: If you earned $75,000 in Brazil and $20,000 in the U.S., you would report the full $95,000 on your U.S. tax return.
2. Applying the Foreign Tax Credit (FTC)
The FTC helps U.S. taxpayers avoid double taxation by allowing you to offset U.S. taxes with the amount of foreign tax paid, up to the amount of U.S. tax owed on the foreign income. However, the FTC only applies to foreign income taxes—not Social Security or other taxes—and the foreign tax must meet several criteria to qualify:
- The tax must be imposed on you.
- You must have paid or accrued the tax.
- The tax must be a legal and actual foreign tax liability.
- The tax must be an income tax or a tax in lieu of an income tax.
Example: If your U.S. tax liability on foreign income is $7,000, but you already paid $4,000 in foreign taxes, you can reduce your U.S. tax bill to $3,000 by applying the FTC.
3. Understanding the Foreign Earned Income Exclusion (FEIE)
If you live outside the U.S. for at least 330 days within a 12-month period or become a bonafide resident of a foreign country, you may be eligible to exclude up to $126,500 (for tax year 2024) of foreign earned income from your U.S. taxes. This can significantly reduce your taxable income, but it cannot be applied to passive income such as dividends or interest.
4. Estimated Tax Payments
The U.S. operates on a “pay-as-you-go” system, meaning taxpayers are expected to make estimated quarterly tax payments throughout the year if their tax liability less withholding and credits, exceeds $1,000. Failure to make these payments may result in penalties.
For individuals with foreign income, it’s essential to calculate estimated tax payments after accounting for provisions like withholding and credits, FTC or FEIE. You don’t need to wait until the end of the year to apply these credits and exclusions—adjust your quarterly payments accordingly.
5. FICA Tax and Social Security Contributions
If you are employed by a foreign company and working outside the U.S., you are not generally subject to Social Security and Medicare taxes (FICA). However, if you work for a U.S. employer while abroad, you may be subject to these taxes.
Totalization Agreements: The U.S. has agreements with certain countries to ensure individuals do not pay Social Security taxes to both countries on the same income. These agreements, known as Totalization Agreements, determine where you are subject to Social Security taxes.
Special Case: Foreign Government or International Organization Employees: Special rules apply to employees working for foreign governments or international organizations. In many cases, they are exempt from U.S. Social Security and Medicare tax obligations. Compensation for services performed within or outside the United States by an employee or officer (regardless of citizenship or residence) of an international organization is not considered to be wages for social security and Medicare tax purposes. For U.S. citizens, compensation for working for an international organization is reportable as income on their U.S. federal income tax returns and is subject to self-employment tax to the extent the services are performed in the United States.
Special Considerations for Foreign Property and Investments
1. Sale of Foreign Real Estate
If you sell foreign real estate, the gain from the sale is subject to U.S. capital gains tax, just as if the property were in the U.S. The IRS allows for the Section 121 exclusion on foreign principal residences, which permits you to exclude up to $250,000 ($500,000 if married, filing jointly) of capital gains, provided you meet the ownership and use requirements.
2. Reporting Foreign Brokerage Accounts
Income from Foreign bank and brokerage accounts are subject to the same U.S. tax rules as U.S.-based accounts. Income from foreign stocks, bonds, or dividends must be reported on your U.S. tax return. Additionally, if the value of your foreign accounts exceeds $10,000 at any time during the year, you must file an FBAR (Foreign Bank Account Reporting) and potentially Form 8938.
3. Foreign Inheritance
Inheriting foreign property or assets does not generally trigger U.S. income tax unless the inherited asset generates income. However, inheritance from a foreign person must be reported on Form 3520 if the value exceeds $100,000.
Key Takeaways and Recommendations
- Utilize the Foreign Tax Credit: If you are paying foreign income taxes, ensure you claim the Foreign Tax Credit on your U.S. tax return to avoid double taxation. Remember, the FTC only applies to income taxes, not to Social Security or other taxes.
- Consider the Foreign Earned Income Exclusion (FEIE): If you meet the physical presence or the residency requirements, the FEIE can help reduce your taxable foreign income by up to $126,500 – for tax year 2024.
- Plan for Estimated Tax Payments: To avoid penalties, ensure you are making appropriate estimated tax payments quarterly, after factoring in withholdings, deductions, credits, FTC or FEIE.
- Understand FICA Obligations: If you are working for a U.S. company or a foreign affiliate covered by Form 2032, you may still need to pay Social Security and Medicare taxes. Review any Totalization Agreements in place to prevent double contributions.
Navigating U.S. tax obligations on foreign-earned income can be complex, but careful planning and understanding of the Foreign Tax Credit, Foreign Earned Income Exclusion, and FICA obligations can help you optimize your tax situation. Whether you’re a foreign national with U.S. residency or a U.S. citizen earning abroad, consulting with a tax professional ensures you remain compliant and avoid costly errors.
For personalized advice and expert guidance on foreign income taxation, schedule a consultation with O&G Tax and Accounting Services here.
Additionally, be aware of the Corporate Transparency Act (CTA) compliance requirements. If you have a foreign-owned U.S LLC, you are required to report beneficial ownership information. Learn more about these requirements and how to file by contacting us today.
