US citizens moving to the Cayman Islands still have to pay taxes back home but those living and working abroad may be eligible to exclude a certain amount of their foreign earned income from their US taxable income.
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Leaving the US to move to the Cayman Islands can be a big step for many people. However, there is one bit of your former life in the US that will remain virtually unchanged. US citizens or green card holders are subject to US taxation on their worldwide income even when they are not living in the US. This may sound like bad news to the US person moving to Cayman. However there is a bit of good news regarding taxation.
Income Tax Return
Qualifying US persons living and working abroad may be eligible to exclude a certain amount of their foreign earned income from their US taxable income. If a person meets the requirements discussed below, they should be able to take advantage of the following:
- A foreign earned income exclusion of a fixed dollar amount
- Housing exclusion for excess housing costs.
In order to qualify for the exclusions, an expatriate working in the foreign country must:
- Have a ‘tax home’ in the foreign country throughout the period of residence or physical presence
- Meet either the ‘physical presence test’ or the ‘bona fide resident test’.
The foreign earned income allowance increases each year. For example: in 2011 the allowance was US$92,900, in 2012 it went up to US$95,100, then in 2013 it increased to US$97,600, and in 2014 it was US$99,200. In 2015 it went over the $100k mark to US$100,800 and in 2016 it was $101,300, US$102,100 in 2017 and $104,100 in 2018, US$105,900 in 2019, US$107,600 in 2020, US$108,700 in 2021, US$112,000 in 2022 and now in 2023 it is US$120,000.
This means that if two individuals are married, and both work abroad and meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $240,000 for the 2023 tax year.
A common misunderstanding of US citizens and green card holders living in the Cayman Islands is that they do not need to file US income tax returns if their earned income is less than the foreign earned income and housing exclusions discussed below. This is entirely untrue. US citizens and green card holders living in Cayman must file a tax return and make an affirmative election regarding the exclusions even if their earned income is less than the exclusion amount.
For formal (or informal) advice on the foreign earned income and housing exclusions you can contact David Conen at KPMG or John Wagner at Omni Cayman. Please note that there will be a charge for formal advice.
Certified QuickBooks Pro Advisors offering professional outsourcing, US Tax filing, interim CFO, accounting and consulting services.
A tax home can be defined as:
- Principle place of business or employment, and
- Must be located in a foreign country to qualify for the exclusion.
Physical Presence Test
After it has been determined that the taxpayer's tax home is in a foreign country, the taxpayer must meet either the physical presence test or the bona fide residence test to qualify for the exclusion.
The physical presence test (also known as the PPT) requires that a US citizen or resident be physically present in one or more foreign countries for at least 330 days (approximately 11 months) during any period of 12 consecutive months.
The rule is simple but very precise. A qualifying day means a period of 24 consecutive hours beginning at midnight and ending the following midnight. In computing the minimum of 330 full days of presence in foreign countries, all separate periods of presence during the period of 12 consecutive months are totaled. If an individual travels from one foreign country to another over a route a portion of which is not within any country, and if the travel not within any country is less than 24 hours, the individual is deemed to be within a foreign country during the period of travel. A person in transit between two foreign countries can stop off in the United States for less than 24 hours and still have the travel day counted as a foreign day. Intent to stay or return and the nature and purpose of the stay abroad are irrelevant.
Any period of 12 consecutive months during which an individual satisfies the 330-full-days requirement, even though the period may comprise a part of a longer period of presence in a foreign country or countries, is permitted.
- The purpose of the taxpayer’s stay abroad is irrelevant.
- Partial days in a foreign country do not count as foreign days.
- Days need not be consecutive. The number of days can be interrupted by periods during which the taxpayer is not present in a foreign country or countries.
- Presence in any foreign country qualifies; accordingly, the 330 foreign days need not be in the taxpayer’s tax home country.
- The 12-month period may begin any day of the calendar month. It ends the day before the calendar day 12 months later.
- The 12-month period may begin (end) before or after arrival (departure) in a foreign country.
- Taxpayers may use two back-to-back or overlapping 12-month periods to qualify the entire tax year for physical presence.
Because of the preciseness of the PPT, a careful record of dates and times of travel along with appropriate, documented support should be kept updated at all times.
Bona Fide Resident Test
To qualify under this test, an individual generally must be a US citizen who has established a bona fide residence in a foreign country or countries for an uninterrupted period that includes an entire calendar year.
A calendar year is January 1st through December 31st. Other periods of 12 consecutive months do not fulfill the requirement (i.e. as for the PPT). US residents who are not citizens (resident aliens) may be able to qualify under this test if they are eligible for treaty benefits.
Bona Fide Residency is determined on a case-by-case basis. Following are some of the important factors to consider when using the bona fide residence test:
- Purpose of trip
- Nature of stay
- Length of stay
Exclusions are available for a part-year bona fide resident in the year of arrival and departure once the entire year test is met. That is, if the taxpayer arrives in a foreign country in June of 2022, the first qualifying period is January 1st to December 31st 2023 and thus, does not end until December 31st 2023. However, once this test is met, an exclusion is available for June through December 2022.
Temporary visits such as vacations, holidays, and business trips to the US will not interrupt foreign residency. Also, as a general rule, transfer from one foreign location to a different foreign location does not interrupt foreign residency.
An individual is not considered a bona fide resident of a foreign country if he or she:
- Makes a statement to the authorities of that country that he or she is not a resident thereof, and
- Has earned income from sources within the country that is not subject to income tax as a resident of that country.
Foreign Earned Income Exclusion
To be considered foreign, earned income must be received as compensation for services performed in a foreign country.
It is the place where personal services are performed that determines whether the income is foreign; not the place where actual payment for the service is made. If compensation for services performed abroad is received in (or from an employer in) the United States, that compensation is treated as a foreign source. On the other hand, if an individual performs some services in the United States, the compensation received for these services is treated as U.S.-source income not eligible for exclusion. When it is not possible to determine accurately what portion of an expatriate’s compensation is for US services, total compensation is allocated between US and foreign sources on the basis of business days.
Housing Exclusion or Deduction
In addition to the foreign earned income exclusion, expatriates also may elect to claim an exclusion for the "housing-cost amount," which is the actual foreign housing expenses for the calendar year in excess of a base amount.
This exclusion is separate from the foreign earned income exclusion and requires a separate election. Housing expenses include rent, utilities (except telephone), insurance, residential parking and repairs, but not mortgage interest and real estate taxes, which are deductible as itemized deductions. Housing expenses must be reasonable and are not deductible to the extent they are lavish or extravagant under the circumstances.
Housing costs do not include the cost of buying a house, principal payments on a mortgage, depreciation, purchased furniture, domestic labour or cable television. The base amount is equal to 16% of the salary of a US government employee at grade level GS-14, Step 1. This base amount is adjusted annually as federal pay levels change. If an individual qualifies under the bona fide residence or physical presence test for only a portion of the year, the base amount is prorated on a daily basis.