Greetings all! This is an article I wrote for AJET. It is geared toward people living in Japan, but the information is pretty universal. If you have any questions, please email us at firstname.lastname@example.org.
Navigating the Tax Waters During your Special Experience in Japan
By Kevin Matthews, CPA, PHR, MBA, MAcc
What an exciting time!!! That was the feeling I had, when I stepped off of the plane after arriving at Narita Airport. I had just flown Business Class (they did it Business Class back then) and then had a relaxing ride from Narita to Tokyo. We were greeted at the door by a man all dressed up with a top had and he opened the door for us. WOW!
Over the next few days, we would learn about what it took to survive and thrive as ambassadors of our nations to the country of Japan. In one of the seminars, it hit me… Taxes. I wasn’t worried as I had been filing my own taxes, but some of the people said it would be different in Japan. How hard could it be? Well, I found out really quick; it was hard.
Perhaps, it wasn’t so hard, but so different. I used to file my taxes using a 1040-EZ, but now I was told that I could no longer do that, because I was living in a foreign country. What were these differences? How is a US citizen or green card holder taxed, when living in Japan? Finally, how does the US prevent “double taxation?” These topics will be discussed as we explore how the JET can keep compliant with the tax laws of our home country.
WARNING: This article is not intended to make you a tax expert. If you need assistance, please seek out the advice of a CPA, Enrolled Agent (people who have passed a test with the IRS and have received a special status to represent people before the IRS) or a tax attorney. The information in this article is for general informational use only and should only be used after consideration of your specific situation.
What’s the Difference?
First question, how is it different? We will discuss this more into the second and third sections, but your taxes are going to get a little more complicated. First, you will have to complete additional forms and really consider your situation as you begin to ask how you will complete your tax filings. Because of the additional forms, filing your taxes on your 1040-EZ or 1040-A will no longer work.
Second of all, you are going to have to separate your income into pools of foreign income (i.e. income in Japan) and domestic income (income from back in the US). This is because only foreign income can be excluded or qualify for the foreign tax credit. Finally, as we will discuss in the third section, your taxes are more likely to get extended, because you are going to want to meet one of the residency tests, which will exclude your income.
The second question, how are US Citizens and Permanent Resident (or Green Card holders) taxed? While the first answer, which may come to mind is the “by the IRS,” this answer does not get to the point relating to your special situation. If you ask your French, UK or Irish colleagues about their tax requirements, they will likely tell you they filed a form with their home governments to say they are going to live abroad. This form stops their requirements to be taxed in their home country, while they live in the foreign country.
The US (and some other counties) does not work in this manner; instead, the United States taxes your worldwide income. This means that a dollar you make in Japan is taxed in the US, just as much as a dollar made back in your hometown.
One might say, “Worldwide Income? But that’s not fair!” In this case, Congress agrees and they offer some relief measures, which brings me to the third section: how does the US prevent double taxation. Taxed once in Japan and then once again in the US would not be a fair regiment, so Congress passed two sections to the tax law.
Foreign Earned Income Exclusion and the Foreign Tax Credit
The first section they passed was section 911. Section 911, which is better known as the Foreign Earned Income Exclusion (FEIE), was passed back in 1951. Back then there was no limit to the income. But over time, a limit was imposed and it has changed and in 1986, it was reduced to $70,000 of income. It was increased to $80,000 in 2002 in years after 2005, it was adjusted for inflation. Congress added a housing exclusion along the way to where we are today. For 2016 the FEIE is $101,300, which does not include the housing allowance amount. Since most JETs (at least when I was in) make less than this, I will not discuss the housing exclusion, which could raise this higher, but for our purposes, we will use the $101,300 number.
So how does someone qualify for the exclusion? There are two tests: The Bona Fide Residence Test and the Physical Presence Test. The Bona Fide Residence test requires that you live in a foreign country for an entire tax year (for all of us, that is January 1 – December 31) as a tax resident of that country. If you live in Japan and are subject to their tax scheme, then you will likely qualify for this test.
There is only one major thing: In order for you to qualify, you will have to wait to file your taxes until you have lived in Japan for an entire calendar year. For most taxpayers, this means you will not be able to file your 2016 tax returns until January of 2018! Yikes! If you go this route, you will have to extend your tax returns, not only by the standard 6 months, but you will have to file a Form 2350 to ask the IRS for an extension to the beginning of 2018.
The easier test and the one that I used when I was a JET, is the Physical Presence Test (PPT). The reason why it is more popular is because people qualify faster for the test. The way the test works is in order to qualify as a tax resident, you have to live outside of the US for 330 days out of 365 days. Now, this sounds easy, but the 365 confuses many people, because they think the 365 days have to be in the same calendar year, but it doesn’t!!!
Instead, your 365 days starts when you arrive in Japan (or any foreign country where you want to use this rule) From your arrival date, count 365 days later and as long as you have 330 days in Japan, you will qualify for this test and you can exclude your foreign income you earned in Japan (Japanese salaries). If you arrived in Japan in August 2016, you will likely be able to file your taxes in August of 2017, thus you can file them sooner and you will only have to request an extension through October 15 of 2017, which is an automatic extension and can easily be filed using a Form 4868. The major trip up on the PPT is how many vacation days you spend in the US. You only have 35 days you can be there, so be wise about your use of them and track carefully.
The second section they passed was section 901 or better known as the Foreign Tax Credit. If you pay taxes in Japan (I am not a Japanese tax expert, but when I was in Japan, they excluded us from filing taxes for the first two years in Japan), you can tax a tax credit on the taxes you pay in Japan.
My experience has shown Japanese income taxes to be higher than US taxes, so it could potentially be very valuable in removing your taxes on your foreign income in the US, but facts and circumstances are different for everyone. Before deciding on this course of action, it is recommended you seek council of a CPA, Enrolled Agent or a tax attorney.
Finally, there are many rules for people living abroad. A couple of those rules is as follows:
- People who are living abroad at the time of the tax return’s due date (April 15th) are granted a special two-month extension automatically for filing and paying. If you pay after April 15th, but before the end of the extension (June 15th), you will not pay penalties on your payment.
- If you open a bank account and have more than $10,000 in your foreign bank account, you will have a requirement to file a form FinCEN 114 to report the account. Your account will not be taxed, but MUST be reported and the penalties for not reporting is pretty stiff. If you have not filed a FinCEN 114 in the past and were required to, please seek out the guidance of a CPA, EA or tax attorney, but especially one who specializes in international tax, because there are relief provisions, but you have to apply on your own in order to get them. Starting in 2016, these forms are due on April 15 along with the tax return and can be extended for 6 months.
- If you have purchased investments in Japan, please seek out the advice of a CPA, EA or tax attorney, especially one who specializes in international taxes as there might be additional reporting requirements.
I know that the information in this article is a lot, and the last thing I want to do is to worry you about your taxes. First of all, have fun in Japan. Being a JET in Chiba City was one of the most rewarding experiences in my life and I would not be where I am today without those experiences. I loved being in Japan and look forward to the day I can return there for a visit to the place, where I experienced so much happiness.
Enjoy the moment. Enjoy the WOW! 20 years later looking back, as I am now, you will focus on the good times, provided that you take care of the tax returns as they require. If you have any questions, please feel free to contact either myself or IRS office at the US embassy. When I lived in Japan, they were very helpful in showing me what to do.
Remember, we can do taxes, while you live overseas and have contacts with tax accountants in foreign countries. We can meet your international tax needs!