10 Shocking Facts About Expat Taxes That Every Californian Needs To Know

From double taxation risks to unexpected reporting requirements, expat taxes are riddled with nuances that could leave Californians caught off guard. For example, did you know that even if you earn your income entirely in a foreign country, you may still need to file a U.S. tax return? Or that failing to report foreign bank accounts can lead to hefty fines? As the state with the highest number of residents seeking opportunities abroad, California expats must equip themselves with the right knowledge to ensure financial security and compliance.

This article uncovers 10 shocking facts about expat taxes every Californian needs to know. Whether you’re planning a move abroad, already living overseas, or simply exploring your options, these insights will empower you to make informed decisions, avoid pitfalls, and embrace your global lifestyle with confidence. Let’s dive into the hidden truths and surprising rules that shape the expat tax landscape for Californians.

1. U.S. Citizens Must File Taxes Regardless Of Where They Live

The United States employs a citizenship-based tax system, which means that U.S. citizens are required to file taxes on their worldwide income, regardless of where they reside. Unlike most countries that tax based on residency, the U.S. system ensures that even if you’ve moved to another country and earn all your income abroad, you must still report it to the Internal Revenue Service (IRS). This often surprises expats who assume they no longer have U.S. tax obligations after leaving the country.

Failing to file U.S. taxes can have serious consequences, including penalties and interest on any unpaid taxes. Moreover, filing requirements don’t depend on whether you owe taxes—if your income exceeds the filing threshold for your filing status, you must file a return. For married expats filing separately from their foreign spouse, the income threshold can be as low as $5, which catches many off guard.

However, filing taxes as an expat isn’t all bad news. The U.S. offers certain provisions like the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit to help offset the burden of double taxation. These provisions, while helpful, require meticulous record-keeping and proper filing to ensure compliance and maximize benefits.

2. The Foreign Earned Income Exclusion (Feie) Isn’t Unlimited

The FEIE allows U.S. citizens living abroad to exclude a portion of their foreign-earned income from U.S. taxation. For 2023, this amount was set at $120,000 per individual. While this can significantly reduce taxable income, it isn’t a blanket exemption and has its limits. For instance, income exceeding the exclusion threshold is fully taxable in the U.S., and the exclusion doesn’t apply to passive income such as dividends or rental income.

To qualify for the FEIE, you must meet either the physical presence test (spending 330 days in a foreign country within a 12-month period) or the bona fide residence test (establishing a long-term residence abroad). Proper documentation is essential, as the IRS scrutinizes these claims. Expats who frequently travel between countries or return to the U.S. periodically may find it challenging to qualify.

Additionally, the FEIE doesn’t eliminate other U.S. tax obligations, such as Social Security or Medicare taxes for self-employed individuals. If your total income includes significant foreign earnings beyond the exclusion limit, planning for the remaining tax liability is crucial to avoid unpleasant surprises.

3. Double Taxation Is A Real Risk

One of the most daunting challenges for U.S. expats is the risk of double taxation—paying taxes on the same income to both the U.S. and the host country. While the U.S. tax system includes mechanisms like the Foreign Tax Credit to mitigate this risk, navigating these rules can be complex. For instance, the Foreign Tax Credit allows you to claim a dollar-for-dollar credit for taxes paid to a foreign government, but it only applies to income taxes and has limitations.

The risk of double taxation often depends on the tax treaty (if any) between the U.S. and your host country. Some countries have agreements that make it easier to avoid being taxed twice, but not all forms of income are covered under these treaties. Additionally, if the host country’s tax rate is lower than the U.S. rate, you may still owe taxes to the IRS.

Proactive tax planning is essential for expats to avoid overpaying. This includes understanding the tax system of your host country, taking advantage of applicable exclusions and credits, and working with a tax advisor who specializes in expat taxes. Staying informed can save you significant time, stress, and money in the long run.

4. California State Taxes Can Follow You Abroad

For Californians, the tax burden doesn’t necessarily stop with the federal government. California has some of the strictest residency rules in the country, and unless you take definitive steps to establish residency elsewhere, the state may still consider you a tax resident. This means you could be required to pay California state taxes on your worldwide income even while living overseas.

To sever ties with California, you need to establish a new domicile and demonstrate that you no longer intend to return. This involves more than just moving—it requires actions like closing California bank accounts, transferring your driver’s license, and avoiding property ownership or extended visits in the state. The Franchise Tax Board (FTB) closely scrutinizes expats to ensure compliance, and audits can be both time-consuming and costly.

The consequences of failing to cut ties can be significant, as California’s top marginal tax rate is among the highest in the nation. For expats earning substantial income abroad, staying classified as a California resident can lead to a hefty state tax bill. Consulting a tax professional familiar with California’s residency rules can help ensure you’re not inadvertently caught in the state’s tax net.

5. Reporting Foreign Bank Accounts Is Mandatory

Expats with foreign bank accounts need to be aware of the Foreign Bank Account Report (FBAR) requirement. If the total value of your foreign accounts exceeds $10,000 at any point during the year, you must file FinCEN Form 114 to report these accounts. This reporting obligation applies to all foreign financial accounts, including checking, savings, investment, and retirement accounts.

Failure to file an FBAR can result in severe penalties, even if you owe no U.S. taxes. Penalties for non-willful violations can reach $10,000 per account per year, while willful violations can lead to fines of up to $100,000 or 50% of the account balance, whichever is greater. Criminal penalties are also possible for egregious cases.

Accurate record-keeping is essential to comply with FBAR requirements. This includes maintaining account statements, understanding currency conversion rules, and being mindful of reporting deadlines. Many expats mistakenly believe that small or inactive accounts don’t need to be reported, but the $10,000 threshold applies to the aggregate value of all accounts combined.

6. FATCA Adds Another Layer Of Reporting

The Foreign Account Tax Compliance Act (FATCA) imposes additional reporting requirements for U.S. citizens with significant foreign assets. If the value of your foreign financial assets exceeds certain thresholds—$200,000 for single filers living abroad or $400,000 for married filers—you must file Form 8938 along with your U.S. tax return. Unlike the FBAR, which focuses solely on foreign accounts, FATCA covers a broader range of assets, including foreign trusts, investments, and business interests.

Failure to comply with FATCA reporting can result in steep penalties, starting at $10,000, with additional fines for continued non-compliance. These penalties are separate from those associated with FBAR violations, meaning expats may face a double financial hit for failing to disclose foreign assets properly.

Navigating FATCA requirements can be daunting, particularly for expats with complex financial portfolios. Professional assistance can help ensure that all assets are correctly reported, minimizing the risk of penalties and aligning your filings with both FBAR and FATCA rules.

7. Self-Employment Taxes Still Apply

Self-employed expats face an additional tax burden in the form of U.S. self-employment taxes, which include contributions to Social Security and Medicare. These taxes are calculated at 15.3% of your net self-employment income, even if you don’t receive any U.S. benefits while living abroad. This requirement applies regardless of whether your host country also taxes your self-employment income.

However, the U.S. has totalization agreements with certain countries that may exempt you from paying self-employment taxes in both countries. These agreements allow you to contribute to just one country’s Social Security system, but the rules vary depending on the country and require certification to claim the exemption.

Self-employed expats must also contend with additional reporting requirements, such as filing Schedule C to report business income and expenses. Keeping detailed records of your business activities and understanding your obligations under both U.S. and host-country laws is essential to avoid costly mistakes.

8. Certain Countries Have Totalization Agreements With The U.S.

Totalization agreements are bilateral agreements between the U.S. and other countries designed to prevent dual Social Security taxation and coordinate benefits. These agreements allow expats to pay Social Security taxes in only one country, typically where they work, while still maintaining eligibility for benefits in both countries.

Currently, the U.S. has totalization agreements with more than 25 countries, including Canada, Germany, and Japan. To benefit from these agreements, expats must obtain a certificate of coverage from the relevant authority in their host country or the U.S., depending on where they want to contribute.

Understanding totalization agreements is particularly important for self-employed individuals and those nearing retirement. These agreements can impact the amount and type of benefits you’ll receive, as well as where you’re required to pay Social Security taxes.

9. Housing Expenses Might Be Deductible

The Foreign Housing Exclusion allows expats to deduct certain housing expenses, such as rent and utilities, from their taxable income. This exclusion is an extension of the FEIE, and eligibility depends on meeting the same residency tests. However, the exclusion is subject to limitations based on the location and cost of living in the host country.

For example, high-cost cities like London or Tokyo may have higher exclusion limits, while lower-cost regions have more modest caps. Expenses like luxury housing or property purchases typically don’t qualify, so it’s essential to understand what can and cannot be deducted.

Claiming the Foreign Housing Exclusion requires filing Form 2555 along with your tax return and keeping detailed records of your expenses. This benefit can provide significant tax relief for expats living in expensive cities but must be calculated carefully to ensure compliance with IRS rules.

10. Failing To File Can Lead To Severe Penalties

Failure to file your U.S. taxes as an expat can result in harsh penalties, even if you owe no taxes. Non-filing penalties can reach 5% of the unpaid tax for each month your return is late, up to a maximum of 25%. Additionally, failing to report foreign financial accounts under FBAR or FATCA can result in fines that far exceed the value of the unreported accounts.

In extreme cases, non-compliance can lead to passport revocation under the FAST Act, making it difficult for expats to travel or return to the U.S. Criminal charges are rare but possible for egregious violations.

The good news is that the IRS offers programs like the Streamlined Filing Compliance Procedures, which allow delinquent expats to catch up on their taxes without facing penalties, provided they can demonstrate non-willful failure to comply. Taking advantage of these programs can help expats rectify their status and avoid further complications.

Conclusion

Living abroad offers incredible opportunities, but managing expat taxes is an unavoidable responsibility for U.S. citizens. From understanding your obligation to file taxes worldwide to navigating the complexities of FBAR, FATCA, and state residency rules, being proactive is key to staying compliant and avoiding financial pitfalls.

These 10 shocking facts highlight the importance of staying informed and seeking expert advice when needed. Tax planning, proper record-keeping, and awareness of available exclusions and credits can help reduce your tax burden and ensure peace of mind.

Whether you’re new to life as an expat or have been abroad for years, understanding and addressing these tax obligations will empower you to enjoy your global lifestyle without unnecessary stress.