Clark Stott has been with Expat Tax Online since 2015. Being a dual national based in the UK, Clark has unique experience helping US citizens (and Accidental Americans) become tax compliant via the Streamlined Tax Amnesty program. Clark likes to help Americans in the UK keep their tax situations as simple as possible to avoid harsh IRS treatment.
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How can I tell if I have unearned income?
Unearned income includes earnings that don’t come from active work. Unlike wages or salaries, it’s typically passive and requires minimal ongoing effort.
Common types of unearned income are:
- Interest: Earnings from savings accounts, bonds, or certificates of deposit (CDs).
- Dividends: Payouts you receive as a shareholder from a company’s profits.
- Rental Income: Income from renting out property.
- Capital Gains: Profits from selling assets, such as stocks or real estate, that have appreciated in value.
- Royalties: Income from intellectual property, including books, music, patents, or trademarks.
How are different types of unearned income taxed?
The IRS taxes each type of unearned income uniquely:
- Interest Income: Taxed at your standard income tax rate, similar to wages.
- Dividends: Qualified dividends are taxed at the lower, long-term capital gains rate, while non-qualified dividends are taxed as regular income.
- Rental Income: Rental earnings are taxed at your ordinary rate, but expenses related to property management, like maintenance and mortgage interest, can be deducted, reducing your taxable amount.
- Capital Gains: The tax rate depends on how long you held the asset. Short-term gains (assets held a year or less) are taxed at your ordinary rate. Long-term gains (held over a year) get favorable rates—0%, 15%, or 20%—depending on your income.
Can unearned income impact eligibility for tax credits?
Yes, unearned income can impact eligibility for certain tax credits and deductions:
- Tax Credits: Certain credits, like the Earned Income Tax Credit (EITC), are intended for lower-income earners and have income limits. High unearned income can raise your adjusted gross income (AGI) above these thresholds, reducing or eliminating eligibility.
- Deductions: If unearned income raises your AGI, it may limit deductions for things like medical expenses, charitable contributions, and student loan interest.
What is the Net Investment Income Tax (NIIT)?
The Net Investment Income Tax (NIIT) is an additional 3.8% tax on specific types of unearned income, including interest, dividends, and capital gains, for individuals with high modified adjusted gross income (MAGI).
It applies if MAGI exceeds US$200,000 for single filers or US$250,000 for joint filers, adding a further tax layer on investment earnings for high-income earners.
Do US expats need to report unearned income?
Yes, as a US citizen living abroad, you must report all unearned income on your US tax return, even if it was earned in another country. This includes income from foreign rental properties, investments, and other passive income.
Failing to report unearned income can lead to IRS penalties and interest charges, so compliance is essential.
Can I use Foreign Tax Credits (FTC) on taxes paid on unearned income?
Yes, if you’ve paid foreign taxes on your unearned income, you may be eligible to claim the Foreign Tax Credit (FTC). This credit helps reduce double taxation by offsetting US tax liability on foreign income.
It’s especially beneficial for expats with foreign rental properties, dividends, or other investments that generate unearned income.
Is interest from savings accounts taxed by the IRS?
Yes, the IRS requires you to report any interest earned from savings accounts, whether these accounts are based in the US or overseas. This income must be included on your US tax return each year.
Additionally, if your foreign account balances total more than US$10,000 at any point in the year, you’ll need to file an FBAR (Foreign Bank Account Report). This report, filed separately from your tax return, provides the IRS with details of foreign accounts, including account numbers, balances, and bank information.
How are gains from investments taxed?
The IRS taxes capital gains on investments based on the holding period of the asset:
- Short-Term Gains: Profits from assets held for one year or less are taxed at your regular income tax rate.
- Long-Term Gains: Gains from assets held longer than one year are taxed at favorable long-term capital gains rates, generally 0%, 15%, or 20%, depending on your total income. For example, taxpayers in the lowest income bracket may pay no tax on long-term gains, while higher earners might pay up to 20%.
Do retirees receive tax benefits for unearned income?
Retirees often have access to certain tax advantages on unearned income:
- Social Security Benefits: Depending on total income, only a portion of Social Security income may be taxable.
- Investment Accounts: Distributions from Roth IRAs or Roth 401(k)s can be withdrawn tax-free when meeting certain conditions, keeping taxable income low during retirement.
Do I need to report rental income from overseas properties?
If you own rental property abroad, you must report that rental income to the IRS.
Here’s what to consider:
- Deductible Expenses: Certain property expenses, such as mortgage interest, property taxes, insurance, and maintenance, can be deducted to lower your taxable rental income.
- Foreign Tax Credit: If you’re paying taxes to a foreign government on rental income, you may qualify for a Foreign Tax Credit (FTC), which helps offset US tax on that income. This credit prevents you from being taxed twice on the same income, providing some relief when managing cross-border tax obligations.
How do I handle foreign currency for reporting?
The IRS requires that all income and expenses, including foreign income, be reported in US dollars. To accurately report, you’ll need to convert your foreign currency to US dollars. You can use the average exchange rate for the year or the exact rate on the transaction date.
You can find reliable exchange rates on the Treasury’s website, which publishes current and historical rates for tax reporting purposes.
Should I consult a tax professional?
Given the complexity of handling unearned income, especially when it involves foreign accounts, consulting a tax professional is a good idea.
A tax advisor experienced with expat or foreign income can ensure you’re correctly filing your FBAR, managing potential deductions, and using tax credits to avoid double taxation. This can also help prevent potential IRS penalties related to misreporting or underreporting foreign income.
