Future expat confused by foreign tax credits

[iamenu]

I am considering relocating to a foreign country with a tax treaty with the US which in theory prevents being double taxed but am having a hard time understanding how this works.

Background...I am retired, receiving social security and annuity payments; the annuity was purchased (invested in?) with money from my 401k so in the US both the annuity and SSA are taxable income.  I also have dividends and gains on non-retirement money (taxed when I earned the principal, but earning/gains are subject to tax.  All of my income is generated in the US and is passive income (at least as I understand it).

As I understand it, if I get residency in a foreign country and live there for 183 days or more, that country expects me to pay taxes to them.  The US will also expect me to pay taxes.  Do I do the foreign filing first, and if so, does the amount I paid to the foreign country reduce my US income on a dollar-for-dollar basis?  Is there a maximum amount of the credit that can reduce my taxes due to the US?

[SusanY1]

Yes, you will file the taxes with the foreign country first.  You will then receive a credit for those taxes paid unless the income.  The tax treaties vary from country to country so whether or not you will need to use them and file with a "tax treaty position" will depend on the specifics of that treaty.  The credit is somewhat dollar-for-dollar in that it reduces the tax owed on the same income taxed in both countries in that manner.  

However, it is likely that some of your income (such as the social security) will not be taxed in the other country.  When this happens, it is possible to still owe taxes on your US tax return, even though you've paid taxes to another country.   The tax credits also only apply "like to like" - meaning that taxes on your general income and taxes on your passive income create separate credits that can't be shared between the categories of income. 

There is no specific dollar amount to the credits you may claim, but they may not exceed the taxes owed on your US tax return (you cannot get a refund based on foreign taxes paid).  If you have more credits than you can use in one tax year, they can be carried over to the next tax year.  

While TurboTax cannot help you with the foreign tax return itself (with the exception of Canada, in our separate Canada product), it can help you with the foreign tax credits.  For your foreign return, we recommend working with someone in your new home country who is knowledgeable about US taxes as well, when possible, 

 

[iamenu]

Thank you!  I am considering Italy.

So if I understand…

My SSA will prob not be taxed on the italian return, but will on the US return.

My dividends and interest, capital gains, and retirement annuity will be taxed on the italian return.  I also include them on the US return as income.  But if I paid $1000 in taxes on them in italy, I enter that as a foreign tax credit and if my tax bill on these specific items in the US would be $900, I would pay zero to the US on them (and the extra $100 can apply to the next year).

If on the other hand Italy collected $700 in taxes on the annuity or divs/gains, and the US amount on those categories would be $900, I would owe the US the additional $200 plus my social security taxes?   

I def plan on getting an expat tax consultant but just want to be sure I wont suddenly have a huge additional tax bill!

[SusanY1]

In addition to a tax treaty, Italy also has a "Totalization Agreement" which relates to coordination of social security/social insurance payments.  So, in your case, your social security benefits may be taxable by Italy under this arrangement.  If so, then the agreement will also allow a credit or exclusion of those benefits on your US tax return.  

The rest of your understanding about how the credits work is correct. 

Italy generally has higher taxes than the US (though like the US, some types of income are taxed at different rates than others), so it is unlikely that you will have a balance due on the US after credits are applied (and/or any tax treaty claims are made.) 

However, there are many variables that come into play so there is no real guarantee.  You will want to prepare your Italian tax return before working on your US tax return.  This may mean that you will need to file an extension. 

To allow time for you to file the foreign return and receive documents in your new home, you are automatically granted an extension to file (but not to pay) of June 15th when you live abroad.

However, you may wish to apply for an additional extension to October 15th to allow additional time to get everything sorted.