What Is Double Taxation: How It Works & Ways to Avoid It

Double taxation is when the same income is being taxed by more than one jurisdiction, most often by two different nations.  For global citizens, particularly American expats, this is a common problem and can greatly impact your finances if not addressed correctly.

What Is Double Taxation?

Double taxation arises when there is a dual claim over a single income by two tax authorities.  It usually arises in two modes:

1. Corporate Double Taxation

• Occurs whenever a corporation is taxed on its earnings and again whenever shareholders pay tax on the dividends they receive.
  
  

2. Double Taxation Internationally

• Occurs when someone earns income in a foreign country but lives elsewhere—both nations could tax the same income.
  
  
• For expats in America, it's a problem since America taxes its citizens on global income whether they live there or not.
  
  

When Does Double Taxation Affect Expats?

If you're an American abroad, it's possible you'll face double taxation if:

• You work for a local company and pay local income tax.
  
  
• You have a business abroad.
  
  
• You get investment income (dividends, capital gains, interest).
  
  
• You get taxed on pension or retirement benefits both locally and by the US.
  
  

Even if you are a tax resident in your new country, the IRS still requires a return annually, including reporting of all income.

How Double Taxation Works: A Simple Example

Suppose an American expatriate works in Germany and earns $100,000. Germany taxes the earnings at 35%. The IRS would likely tax the same income as well, adding another tax burden.

Without relief strategies, the taxpayer could end up paying German and U.S. tax on the same salary.

Ways to Prevent or Mitigate Double Taxation

Luckily, a few legislative provisions prevent or mitigate double taxation for U.S. expatriates:

1. Foreign Earned Income Exclusion (FEIE)

• Excludes a maximum amount of earned foreign income from U.S. tax (e.g., $126,500 for the 2024 taxation year).
  
  
• Requires satisfying either the Physical Presence Test or the Bona Fide Residence Test.
  
  

2. Foreign Tax Credit (FTC)

• Permits a dollar-for-dollar credit on U.S. taxes for foreign taxes paid.
  
  
• Suitable for those with high foreign tax rates higher than the U.S. tax rate.
  
  
• Commonly used in combination with, or as an alternative to, FEIE.
  
  

3. Tax Treaties

• More than 60 countries have treaties with the U.S. to avoid double taxation.
  
  
• Treaties specify which country may tax certain income (e.g., pensions, interest, dividends).
  
  
• Most treaties have tie-breaker rules for residency and exemptions from certain income.
  
  

4. Totalization Agreements

• These apply to social security taxes, not income tax.
  
  
• These treaties prevent individuals from contributing to two nations' social security plans simultaneously (e.g., U.S. and Australia, U.K., Germany).
  
  
• Vital for expat self-employed individuals.
  
  

Special American Expats Considerations

• Reporting is still necessary: Even when no U.S. tax is payable under FEIE or FTC, expats must file Form 1040 and supporting forms such as 2555 or 1116.
  
  
• FBAR (FinCEN 114) and FATCA (Form 8938) might be applicable for reporting foreign assets and accounts.
  
  
• Self-employed foreign workers can still be liable for U.S. self-employment tax, which FEIE does not exempt, except when there is a totalization agreement.
  
  

People Also Ask (PAA)

Can you be taxed twice on the same income?

Yes. This occurs when two nations both have taxing rights on the same income. Tax treaties and credits, however, generally minimize or eliminate the effect.

Do expats from the U.S. pay taxes twice?

Yes, often— but with tax credits and exclusions, they usually don't pay twice on the same income. Filing requirements still exist in both nations.

Why is a tax treaty needed?

A tax treaty lays out rules for determining which nation may tax certain kinds of income. It prevents double taxation and tax evasion.

How do I prevent double taxation when I'm abroad?

Use the Foreign Earned Income Exclusion, Foreign Tax Credit, or take advantage of treaty provisions. Professional tax assistance is strongly encouraged.

Is double taxation illegal?

No, it's legal. Governments offer legal methods (such as credits and treaties) to minimize or eliminate the burden.

FAQs

Which forms prevent double taxation for U.S. expats?

• Form 2555 (Foreign Earned Income Exclusion)
  
  
• Form 1116 (Foreign Tax Credit)
  
  
• IRS Form 8833 (if claiming a treaty position)
  
  
• Form 1040 is always necessary
  
  

Do tax treaties necessarily eliminate double taxation?
No. Treaties assist but are not comprehensive. Every treaty is unique, and not all are complete relief.

Can I make an FEIE/FTC choice?
Yes. Based on your circumstances, you can select either or both. FTC is usually preferable in high-tax nations.

Do dual citizens face the same double taxation risk?
Yes, if one of their citizenships is in the United States, they are still obligated to report and can run the risk of double taxation.

What are the consequences if I don't file my U.S. return as an expat?
You can be subject to penalties, loss of eligibility for exclusions, and risk of future audit or revocation of passport.

Conclusion

Double taxation is a real obstacle for anyone who resides or works overseas, but it's not an insurmountable one. American expats are especially subject to a rather complicated tax regime in which overseas income itself can impose IRS obligations.

However, clever resources such as the FEIE, FTC, and tax treaties can reduce or even eliminate double taxation altogether.

If you're not sure what to do, work with a tax professional who knows international and U.S. expat tax law. Strategy is everything when it comes to retaining more of your income.