US Federal Tax Issues to Consider Before Filing Your 2021 Tax Returns

Hello! We are Cross Border Wealth Advisors and are determined to help people simplify their financial lives when retiring abroad by offering financial solutions for wealth and portfolio management and tax preparation. I’m Victor Gersten, and I’m an expat myself. I’m a Certified Financial Planner and an Enrolled Agent with 14 years of experience in the financial services industry in San Diego, Ca. Furthermore, as an expat living in Spain, I have helped many expats to retire financially by sorting out the complicated legal, tax or investment questions that most expats have.

Just the same as American taxpayers living and working in the US, all American citizens and green card holders residing abroad and earning foreign-sourced income still have an ongoing requirement to file their US federal returns and pay US  federal income taxes due unless their gross income is below the minimum income threshold, which varies depending on the taxpayer’s filing status. 
For American taxpayers filing their 2021 tax returns in 2022, the standard deduction for married couples filing jointly for the tax year 2021 was increased to $25,100. For single taxpayers and married individuals filing separately, the standard deduction rose to $12,550 for 2021, and for heads of households, the standard deduction was increased to $18,800. American expats who earned less than these updated average deduction amounts during 2021 are not required to file a federal return unless they are married but file separately from a foreign spouse and earned $5 or more, or if they have net earnings from self-employment of $400 or more. 
For the tax year 2021, the top tax rate remains 37% for individual single taxpayers with incomes higher than $523,600  ($628,300 for married couples filing jointly), with the lowest rate being 10% for payments of single individuals with revenues of $9,950 or less ($19,900 for married couples filing jointly). 

Under US tax law, American citizens and green card holders living abroad are subject to US federal income taxation on their worldwide income, irrespective of where the payment was derived. So the revenue generated abroad by American expats is subject to US federal taxation, just as income generated by American taxpayers within the US is.  
A common situation that arises for American citizens and green card holders living abroad full-time is that, as they qualify to become residents of the foreign country in which they live, their foreign-earned income could potentially become doubly taxed – by both their foreign country of residence and the US. Fortunately, the IRS provides American expats residing abroad with several mechanisms to exempt most of their foreign income from US taxation and often wholly eliminate their US tax liabilities. 

To help mitigate this potential double taxation, US federal tax law provides a provision known as the Foreign Earned  Income Exclusion (FEIE) claimed on Form 2555. The FEIE allows a qualifying taxpayer (basically, an American citizen or green card holder who has resided abroad for at least one calendar year or been physically present outside the US for 330 days in 12 months) to exclude their foreign earned income from US federal taxation up to a certain income threshold,  which is adjusted annually. For the tax year 2021 (filing in 2022), expats are permitted to exclude up to $108,700 of income earned abroad from their US taxes.  
However, American expats should note that the FEIE only applies to foreign earned income; other income, such as interest,  dividends, capital gains, pensions, US-sourced income, etc., cannot be excluded using the FEIE are entirely subject to US  taxation. For a married American expat, if their spouse is an American citizen or green card holder and has foreign earned income, they can also claim the FEIE against their income, up to the same maximum exclusion amount cited above. 
Another necessary provision to help mitigate double taxation is the Foreign Tax Credit (FTC), claimed on Form 1116. Suppose a foreign country taxes an  American expat’s foreign income. In that case, the tax can be claimed as a tax credit on the US return,  reducing the US tax liability dollar-for-dollar, often substantially. However, American expats should note that the FTC cannot be claimed for foreign taxes paid or accrued on foreign earned income excluded using the FEIE. In other words, you can only claim the FTC for foreign taxes paid or accrued on the same income that the US is taxing. 

One potential pitfall that American citizens and green card holders residing abroad should be aware of is that investing in foreign mutual funds and ETFs can result in very costly US federal tax consequences for them. Shares owned by American taxpayers in foreign mutual funds or ETFs above a low threshold amount, which is an aggregate of $25,000 for a single taxpayer or $50,000 for married couples filing jointly, are considered Passive Foreign Investment Companies for US federal tax purposes, or PFICs, which are taxed very punitively by the IRS. Each PFIC must be reported annually on IRS Form  8621, which requires complex calculations and is very time-consuming to complete.