Great News for Expats with Student Loans! The Foreign Earned Income Exclusion
Sep 14, 2017
The FBAR Wiz dedicates this post to those out there finishing their education and chasing their dreams. Expat students comprise a vital portion of the work force and this blog aims to help you avoid becoming entangled in complicated and costly IRS tax problems. In addition to reading this post, you should take 3 minutes to try out the free FBAR Wiz app to quickly and anonymously determine if you are obligated to report offshore assets and/or offshore accounts to the IRS. Moving abroad can be the adventure of a lifetime, but for those doing so with student loans, it is vitally important to understand the tax implications and for expats. For instance, it is wise to set up autopay (some loan servicers even offer a small discount for this) to ensure that you don’t miss any payments, and also to ensure that if your salary will be paid into a foreign bank once you move abroad you can easily transfer payments to your U.S. bank so that you do not miss any student loan payments. This may mean opening an account at a U.S. bank with a location where you are moving to before you move abroad (for instance, CitiBank and Chase have branches around the world). So, it is even more important not to default on your student loans while abroad, as this would have a complicated and far-reaching impact on your credit score, which in turn would affect your ability to get credit or buy a home later on. If you are moving abroad for work, having an income-based student loan repayment plan and claiming the Foreign Earned Income Exclusion could potentially reduce your monthly payments to zero. The Foreign Earned Income Exclusion Explained U.S. citizens and green card holders are still required to file U.S. taxes from abroad, however thankfully there are some exclusions which reduce or for most expats eliminate their U.S. tax liability. If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude from income up to an amount of your foreign earnings that is adjusted annually for inflation ($92,900 for 2011, $95,100 for 2012, $97,600 for 2013, $99,200 for 2014 and $100,800 for 2015). In addition, you can exclude or deduct certain foreign housing amounts. In particular, the Foreign Earned Income Exclusion lets expats who can prove that they live abroad in one of two ways to not pay U.S. tax on the first $100,000 of income. To qualify, expats must prove either that they spent at least 330 days outside the U.S. within a 365-day period that is either the tax year or that coincides with the tax year, or prove that they are a permanent resident in another country. Ultimately, expats may qualify to treat up to $101,300 of their income as non-taxable by the United States. Expats also may be able to either deduct part of their housing expenses from their income or treat a limited amount of income used for housing expenses as non-taxable by the United States. These great benefits are called the foreign earned income exclusion and the foreign housing deduction and exclusion. To claim the Foreign Earned Income Exclusion, expats have to file Form 2555 with their U.S. tax return. How the Foreign Earned Income Exclusion Impacts Income-Based Student Loan Repayment Plans Interestingly, for expats with income-based student loan repayment plans, if they earn less than the Foreign Earned Income Exclusion threshold ($102,100 for 2017), their Adjusted Gross Income would be zero, so their monthly repayments (which are calculated as a percentage of their declared Adjusted Gross Income) would also be zero. This may seem like a great idea at first glance, however there are consequences in the longer term to be considered. For example, if an expat stops making monthly repayments, interest will continue to aggressively accrue, leaving the expat with more to pay back later. However, for expats with an income-based student loan who settle abroad permanently, this can be a way to effectively write off the whole loan, as if they are earning under $100,000 (or a little over in fact, as income based repayments are actually calculated as a percentage of the difference between 150% of the poverty level and your Adjusted Gross Income) for the whole term of the loan (normally 20 or 25 years), they will end up paying nothing until the loan is forgiven. When the loan is forgiven though, the total value of the loan and the interest accrued is considered income, so there will be a one-off hit for income tax (and as it is not earned income, thus it cannot be excluded using the Foreign Earned Income Exclusion), however the value of the income tax owed would almost certainly be much less than the total value of the loan and interest. Also, during these years, if an expat is married to a foreigner who is also earning, the expat would probably be better off electing not to file jointly. So having an income based student loan repayment plan may be a useful way for expats to delay payments, or, if they settled abroad permanently write off their student loan entirely. A great place to start is checking out the free FBAR Wiz app to determine what your offshore filing obligations are.