Moving Abroad After 50: What Changes With the IRS

You still file, every year

Almost every country taxes people based on where they live. The United States taxes its citizens on their worldwide income regardless of where they live. A US citizen who moves to Italy, Portugal or Mexico continues to file a US return every year, alongside whatever the new country requires, for as long as she holds the passport.

That does not mean everything is taxed twice. It means the two systems have to be coordinated, and the coordination only works if it is planned.

The exclusion most retirees can’t use

The best-known tax break for Americans abroad is the foreign earned income exclusion, which removes a substantial amount of income from US tax. The key word is earned. It applies to wages and self-employment income.

A retiree typically has neither. IRA and 401(k) withdrawals, pensions, Social Security, dividends and capital gains are not earned income, so for most retirees the exclusion provides little or nothing.

What actually prevents double tax

The mechanism that matters for retirees is the foreign tax credit. When the new country taxes a piece of income, the tax paid there is generally credited against the US tax on the same income.

Where the new country’s rates are higher than US rates, the credit often eliminates the US bill. Where they are lower, the difference is still owed to the United States. Either way, two returns are needed and the credit has to be calculated correctly.

Your Roth, your pension, and the local bank’s fund

A Roth IRA is a creation of the US tax code. A new country has no obligation to recognize its tax-free status, and some do not, taxing growth or withdrawals as they would an ordinary investment account. The same question applies to traditional IRAs, pensions and Social Security, and the answer depends on the country and any tax treaty.

The more expensive trap is local investment funds. Most non-US funds fall into a US tax category with punitive rules and a separate annual filing for each fund. The general approach Tiffani Lindstrom, CPA recommends is to keep investments in US accounts and US-domiciled funds, and use the local bank for day-to-day spending.

The accounts you have to report

Once the combined balance of foreign accounts exceeds $10,000 at any point in the year, a separate report is due. That includes a balance that crossed the line for a single day, such as the account the proceeds of a house purchase passed through. A second, related form is filed with the return once foreign assets exceed higher thresholds, which are more generous for people who live abroad.

Neither report collects tax. The penalties for missing them can be severe, which is why they catch careful people.

If you keep the US house

Not everyone sells. Keeping the US home and renting it out is common, and it changes the picture. Rental income remains taxable in the United States, and the new country of residence may tax it as well, with the foreign tax credit again coordinating the two. Depreciation claimed while the house is rented is treated differently from the rest of the gain when it is eventually sold, and a house that stops being a main home can lose part or all of the home-sale exclusion over time. Keeping it is often a reasonable decision. It is worth making deliberately, with the numbers in front of you.

Do the big things before you go

Between deciding to move and becoming tax resident elsewhere, a person is still only a US taxpayer. That window is usually the cheapest time for large transactions: a Roth conversion, the sale of the US home, or realizing gains. Done afterwards, the same transactions can be taxed by two countries under rules that do not line up.

State residency deserves the same attention. Some states are reluctant to let residents go, and leaving without properly ending residency can mean filing there for years afterwards.