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REFUNDABLE TAX CREDITS

September 15, 2020

By Joshua Ashman, CPA & Nathan Mintz, Esq.

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US Expats Can Expect Refunds from the IRS in These Situations

A number of clients have asked us whether a U.S. expat can receive a tax refund from the IRS despite living overseas. While the answer to this question can be nuanced depending on the circumstances, the general rule is that living overseas does not preclude an expat from entitlement to a refund that is otherwise due to the individual.

One of the main ways an expat can receive a refund from the IRS is by claiming refundable tax credits. Two of the more common refundable tax credits claimed by expats are the child tax credit and earned income credit.

Refundable Tax Credits – Child Tax Credit and Earned Income Credit

In order for a tax return to result in a refund, the taxpayer needs to have refundable tax credits that exceed his or her tax liability.

A common example of a refundable credit is the additional child tax credit of $1,400 per qualifying child, which may be reduced depending on your overall adjusted gross income. The full child tax credit totals $2,000, but the remaining $600 portion is not refundable (i.e., it can only be used to reduce your tax liability).

While the child tax credit is not affected by the fact that you live overseas, it becomes unavailable if you use the foreign earned income exclusion to reduce your taxable income. The credit is not made unavailable, however, if you instead utilize foreign tax credits to reduce your taxable income.

Another example is the earned income credit, which is a credit for certain low-income taxpayers. An expat’s use of this credit is quite limited, because you (or your qualifying child) must have lived in the U.S. for more than half of the filing year to qualify for the credit. Like the additional child tax credit, it becomes unavailable if you use the Foreign Earned Income Exclusion to reduce your taxable income.

Refundable Tax Credits - A Real-Life Example

Let’s take the Newtons as an example of a US expat family (father, mother, and two children) who recently moved to London.

The Newtons’ only income is Mr. Newton’s salary, which is taxed at a higher rate by the HMRC in the UK than the IRS in the US. His salary is below the phase-out threshold for the child tax credit.

In this case, the Netwons can use the foreign tax credit to eliminate their U.S. tax liability. They can also claim refundable child tax credits totaling $2,800 ($1,200 x 2 children) and expect a check in the mail from the IRS for the refundable tax credit.

A New Refundable Tax Credit for 2020

We note that this year’s Stimulus Payments, given in response to the Coronavirus pandemic, have put a new potential refundable tax credit in play for US expats.

If you’ve read our blogs on the Stimulus Payments, you’ll recall that this year’s Stimulus Payments were technically designed as an advance payment against your 2020 tax refundable credit amount, even though the IRS used 2019 or 2018 tax return information to determine your payment amount. It’s therefore possible that if your 2020 circumstances are such that you are entitled to more than your stimulus payment based on your 2019 or 2018 circumstances, you can claim the balance of the credit when filing your 2020 tax return.

Examples of changing circumstances could include, for instance, a significant reduction in your income from 2019 to 2020, or the birth of a child in 2020.

Other Potential Refunds

In addition to refundable tax credits, an expat taxpayer may also find that he or she is due a refund because of previous so-called “backup withholding” on U.S. source payments. In general, U.S. source passive-type payments such as interest from a bank or dividends from an investment will be subject to backup withholding (generally at the rate of 28%) by the payer under a number of circumstances, which are delineated in IRS Publication Topic 307 Backup Withholding. If income tax has been withheld through backup withholding you should generally be able to claim it back on your tax return for the year in which you received the income.

Other examples of tax refunds include, for instance, over-withholding by a withholding agent, over-withholding by an employer, and over-payments of estimated tax payments.

How We Can Help with Refundable Tax Credits

Tax refunds are not uncommon for our clients because of the beneficial tax provisions afforded citizens overseas, such as the foreign exclusion and foreign tax credits. Many of our clients dreading a heavy tax bill are pleasantly surprised to find that a tax refund is actually due to them.

Expats should keep in mind that the IRS has been known to focus its audit attention on tax credits, especially refundable tax credits that put money in the hands of taxpayers. It’s therefore important to file your return timely and accurately.

At Expat Tax Professionals, our team of experts will carefully prepare your tax return, so that if you end up getting audited, your return will withstand the scrutiny of the IRS.  If you are a U.S. expat who needs help with tax return preparation, please contact us and we’ll get the process started immediately.

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