State & Expatriate Tax Tips - Tax Professionals Member Article By Tiffany Gaskin
Posted by Tiffany Gaskin

State & Expatriate Tax Tips

State & Expatriate Tax Tips

As an expat, you are constantly reminded that you must file a federal tax return each year to comply with the IRS. However, an equally important requirement for some expats can easily be overlooked: filing state taxes. Since each state has its own governing body (and with its various laws and regulations), the requirements differ depending on where you live before moving abroad. Here are some things you need to know to answer the question: Do I have to pay state taxes if I live abroad?


U.S. State Taxes: Living Abroad

Whether or not you have to file state taxes while living abroad depends on the state where you live and whether you still have ties to the state. If you're considering moving overseas, this guide will help you make informed tax decisions to avoid further tax liability before moving outside the United States.

In some cases, you won't have to pay a state expatriate fee if you live abroad. In fact, some states do not charge income tax.


Here's how to find out if you need to file state taxes while living abroad:

1. Determine if you are a resident of the state for tax purposes.

If you meet the following criteria, you are likely to be considered a resident of the state while living abroad:

  • Keep your identity card or driver's license or your voting rights as they are.

  • You maintained a residence in the state (place of permanent residence).

  • You resided in the state at any time during the tax year.

  • You return to the state whenever you return to live in the United States.

  • Your relatives live in the state while you are abroad.

2. Determine if you have income in your home state:

  • Income from working in the state is almost always taxable in the state.

  • Other income from a state source, such as pension income or state benefits, may be taxable if you are a resident or native of the state.

  • Each state determines residency requirements, but most states consider you a nonresident if you have lived outside the state for more than 6-months.


U.S. Expat Taxes: Which States Are Exempt from Income Tax?

Fortunately, for some U.S. taxpayers, state income tax does not exist. For expats living in other countries, this is great news because it means that regardless of whether you are a resident of the state and have income generated in that state, you will not be subject to state taxes for expatriates.

It is important to note that although they do not have income taxes, these states still derive their income from other sources, such as property tax and sales tax.

Currently, these states do not tax wages:

  • Alaska

  • Florida

  • Nevada

  • South Dakota

  • Texas

  • Washington State

  • Wyoming

Additionally, these states levy income tax only on dividends and interest:

  • New Hampshire and Tennessee

Which states require Americans living in other countries to file a tax return?

In general, several states require you to file a state tax return only if you reside in the state during the tax year, and usually only state tax income that was generated within the state. Income from sources received while abroad may sometimes be taxed in the state, such as pension payments or investment income (interest and dividends). Consider state source income when planning for expat taxes, as this income may create a tax filing requirement for you.

Some states make it difficult to pay taxes abroad.

However, there are four states with less clear rules. These are sometimes referred to as "sticky" states because the conditions for filing a state tax return as an expat can be a bit complicated:

  • California

  • South Carolina

  • New Mexico

  • Virginia

In strict states, minor nuances related to the completion of official residency can trigger a filing requirement. Specifically, these states consider you a native or resident of the state if you have at least one or more of the following ties to the state:

  • Investment or Bank accounts held in the state

  • Dependents who remain in the state (spouse or children)

  • Driver's license or state-issued I.D. card

  • The mailing address of the state (mailbox or home of a parent)

  • Property Ownership

  • Voter registration (including absentee ballots)

These four states have very strict definitions of residency compared to other states and tax revenue worldwide. You must report all of your income on the state tax return and pay state taxes, even if you didn't reside in the state during the year.


How to Avoid State Taxes While Living Abroad

In order to avoid paying state income tax while abroad, you must give up your residence in any state that collects income tax and establish a new residence in a state without an income tax.

Please note that strict states treat moving abroad as temporary leave unless you can remove your ties to the state. These states only recognize moving to another state (not another country) as a change of residence. Therefore, it is imperative that you properly sever ties and establish a new residence in a tax-free state before moving abroad.

Although every state is unique, following the steps below can help you avoid paying state taxes for expats while living abroad.


1. Set up residence in a tax-exempt income state

Domicile is a tax term for your real and permanent residence. You can only have one address at a time. Also, your domicile will remain in effect until you establish a new domicile elsewhere, which is why leaving your state of residence while living abroad can be so complicated.

The establishment of permanent links in the new state (and country) of origin will indicate the new state of origin. Including:

  • How active are you in a local business?

  • The location, use (rented or owned), and size of your home at each location; if you have more

  • Where do you spend your time?

  • Where you keep your valuables, such as safe deposit boxes, bank accounts, account statements, etc.

  • Where your family lives, community, the location of the children's school, and social, and religious ties

  • Your profession / where you work

  • Other elements that could indicate your future intention

2. Cut all possible ties with the state residence you wish to leave

If you intend to return to your home state, it may still be considered your home. You should therefore cut as many ties as possible by doing the following:

  • Close bank accounts in your home country, open a bank account abroad

  • Find medical and financial professionals in your country of residence

  • Join associations (business, social or other) in your new state and abroad

  • Move your family abroad

  • Obtain an I.D. card in your new state and/or country

  • Register to be eligible to vote in your new state as an absentee voter

  • Sell your car or change your license plate

  • Sell your old house and buy or rent a new house

Certainly, there are benefits to maintaining a U.S. bank account, registering in-state voters, and more when moving overseas. Therefore, moving to another state before going abroad can help you avoid paying state taxes while enjoying these benefits.


Are you moving abroad? Plan your state taxes in advance

State tax planning can be tricky, so it's important to take precautions before moving overseas. Doing things like changing your state residence, moving with your entire family, and severing ties with your state as much as possible are all ways to avoid having to pay state taxes while living abroad.

Since state taxes for expats can be complex, it's good to consult an expat tax professional for the tax assistance needed to determine your needs.


Do you still have questions about how to file state taxes abroad?

As a citizen of the United States living abroad, you may be familiar with the most common forms of expats. For example, Form 2555 (excluding foreign income) and Form 1116 (foreign tax credit) are fairly easy to understand. But if you're an expat with a shareholder investment, you may also need to complete disclosure forms that must be filed under a very specific tax rule, such as Form 8621.


Should I submit IRS Form 8621?

First, the PFIC (Passive Foreign Investment Company) or QEF (Qualified Electing Fund) in question must be a foreign company. "Foreign" means entities that have been incorporated in countries other than the United States or its territories.

As we will see in more detail, a foreign company is a PFIC if it meets an income or activity test. If at least 75% of the company's annual gross income comes from investments such as interest, dividends, capital gains, royalties, etc., then it is a PFIC. A business meets the asset test if at least 50% of its average assets are produced or maintained to generate passive income.


So I need to File IRS Form 8621?

If you are an indirect or direct shareholder of a PFIC, you must file IRS Form 8621 for each year in which:

  • Recognition of a gain from the direct or indirect sale of PFIC shares or

  • You receive certain direct or indirect distributions from a PFIC, or

  • Make reportable elections on Form 8621.

Form 8621 Examples and Exclusions

Please note that your ownership may be direct or indirect. If you hold shares in a PFIC, you are a direct owner. Check your investments carefully, as one of your mutual fund or escrow accounts may include shares in a PFIC, thereby becoming a direct owner, which may require the submission of Form 8621.

As an example of Form 8621, if your property is in a PFIC that is also a Foreign Controlled Corporation (CFC), this is an exception to the rules and regulations that may apply, and you may not have to file Form 8621.


How Qualifying Election Funds (QEFs) Can Affect U.S. Expat Tax Rates

Expatriate investors holding PFIC shares generally choose to pay according to QEF rules. If you choose to opt for QEF, you will need to submit a separate Form 8621 for each PFIC in which you hold shares. And you will want to collect the number of shares of each class of shares you hold at the beginning of the year, changes in the number of shares of each class and the dates of change, and the number of shares of each class that you hold at the end of the year preceding its presentation. 

Remember: Depending on the type of business you have, other forms may be required (such as Form 8858 or Form 8865). Finally, you should review the new requirements of the Tax Cuts and Jobs Act, as Section 965 also covers many foreign investment taxes.


Beyond Form 8621 Filing Requirements

In addition to the Form 8621 filing requirements, other forms may need to be submitted. Suppose you have an interest in a foreign partnership or foreign LLC. In that case, you may consider filing rules for Disclosure Form 8865 (for foreign partnerships) or Form 8858 (for foreign LLCs taxed as non-trust entities) to ensure that you meet all your U.S. tax filing requirements.


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Tiffany Gaskin
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