by Loren Gill
Did you know that serving in another country does not exempt you from U.S. tax responsibilities? Missionaries living overseas who are U.S. citizens must still file a tax return, regardless of where they live or in which country they earned the income.
“But my CPA told me to put the money into an IRA.” The voice on the other end of a poorly connected phone call sounded distraught. “He said I could put the money in and then use it when I purchased my first home. Now the IRS sent me a letter saying that I wasn’t allowed to have the IRA in the first place, and they are charging me lots of penalties.”
This missionary was unaware that his well-meaning but uninformed financial professional’s advice was good for someone living in the U.S. but horrible for an expat living elsewhere. When you live in other countries, the IRS allows for some tax breaks but takes away other incentives and credits.
For example, many missionaries hear that they aren’t required to pay income taxes if they live overseas and consequently don’t file. Unfortunately, this is not the whole truth. Expats are required to file returns just as though they had lived and earned their income in the United States. The foreign earned income exclusion (form 2555) is an election to exclude up to $99,200 (2014) from your taxable income. If you make that election, you must continue using it unless you revoke it, and if you revoke it, you cannot use it again for five years. In many cases, it is best not to use the election because you can end up excluding all of your earned income. This affects credits based on Adjusted Gross Income such as the child tax credit. It also creates a situation where you cannot contribute to an IRA because you must have earned income to contribute. The election only affects Federal income tax and does not reduce self-employment taxes. Most missionaries are considered self-employed and owe these taxes. There are many more examples of how the tax choices you make when living abroad can affect your bottom line.
Back to the missionary on the phone. He was facing penalties for pulling money out of his IRA for a first-time home purchase. Normally this would be allowed, but he wanted to purchase the home abroad, which disqualifies the distribution. In fact, he couldn’t have contributed to his IRA at all because he had excluded all his earned income. His CPA was unaware of either fact. In the end he faced penalties for trying to save for his retirement while living overseas. With proper restructuring, this missionary was able to keep his IRA penalty free and even receive refunds for years he had previously filed.
So what should you do? Each family situation is unique, so your tax strategy should be unique. Find a tax professional who understands and deals regularly with U.S. citizens living abroad.
What are some of the tax lessons you’ve learned while living overseas?
Loren Gill is a tax preparer located in Orlando, Florida, and specializes in overseas missionary taxes. Learn more at http://www.missionarytax.com/. They have prepared taxes for people in the mountains of Papua New Guinea, the deserts of Asia, the African savannah, and the Amazon jungle.
Loren is the son of missionaries and grew up overseas. Later he and his wife served as missionaries in Bolivia, South America for six years. During this time Loren became aware of the complexities missionaries face when filing taxes. After serving in Bolivia he trained in tax preparation and worked for five years with New Tribes Mission, filing taxes for thousands of New Tribes missionaries. He then went out on his own to be able to help missionaries in other organizations.