Form 1116: Claiming Foreign Tax Credit
How can you avoid having to pay tax in the US, as well as Australia?
Generally speaking, if you have income subject to tax in both Australia and the US, you will pay the higher of the two taxes, not both. We most commonly see that this means clients pay the Australian tax, not US. A key factor to ensure that there is no double taxation is the Foreign Tax Credit.
Foreign Tax Credit – how is it determined?
Foreign Tax Credit is based on the location of the individual earning the income. A US citizen or Green Card Holder earning a wage in Australia is a foreign source of income from the US point of view.
Is Foreign Tax Credit available to US citizens or Green Card Holders who are temporary residents in Australia?
This represents one of the trickier aspects of income of a foreign source. Take, for example, a US citizen or Green Card Holder living and working in Australia on a temporary work permit, such as the 482 visa. There is an Australian tax concession for people in that situation (known as temporary residents): whereas a full Australian resident would be taxed on their full, worldwide income, the temporary resident has some tax exemptions for investment income earned out of Australia. As an American living in Australia, you might have bank accounts in the US, shares in the US, or an investment property in the US. All of these could be earning income. However, as a temporary resident, Australia would not tax any of that income. That means that there would be no Foreign Tax Credit, potentially leaving you with a US tax liability.
If a US citizen or Green Card Holder has only Australian income and is paying the appropriate amount of tax to the Australian Tax Office, then that is likely to be enough to offset the US tax liability.
What are the benefits of not including your non-US spouse in your US tax return?
Not including your non-US spouse, other than listing, allows you the opportunity to structure your assets in the most tax efficient way possible. Assets in your non-US spouse’s name are taken out of the US tax exposure completely, representing a significant benefit to those liable to pay US tax.
What are the benefits of including your non-US spouse in your US tax return?
There can be more benefits available to you when filing jointly, such as tax credits, tax phase outs, and clawback rules. One example is the main residence exclusion, which goes from $250,000 USD to $500,000 USD when filing jointly. Joint filing happens more often when the non-US spouse is a low income worker, and low complexity in terms of bringing their income into your US tax return. There are circumstances where you may find it beneficial to include them to gain access to higher thresholds for additional tax payable or lower thresholds for additional credits.
However, adding a non-US spouse can make your tax return more complicated for little advantage. If you include a non-US spouse once, it is considered an election, meaning you have to include the non-US spouse in every return moving forward. The decision of how to file in these circumstances is therefore one which requires very careful consideration before voluntarily electing to include your non-US spouse.
Things to be aware of:
- Once you make the decision to include your non-US spouse in your US tax return, that decision is binding on future returns.
- You can only stop including your non-US spouse by making an application to stop doing so.
- Even if your non-US spouse is no longer your spouse, it doesn’t stop them being treated as a US resident for tax purposes once you’ve elected to do so!
- Seek professional advice to fully consider the tax benefits and disadvantages before making your election.
What about including a non-US spouse in your US tax return?
While the opportunity exists to file under the Married Filing Jointly status, we very infrequently see this as the preferred option. There are multiple filing statuses that can be used, for example, Married Filing Separate or Head of Household. We find that you can get to a fairly minimal, if not zero, US tax result by using the alternative filing statuses, without needing to unnecessarily include the non-US spouse.
More often, we find that it is to the US citizen or Green Card Holder’s advantage to not include their non-US spouse, and we most commonly see Married Filing Separate as the most advantageous filing status. However, every return is considered on a case-by-case basis.