Having spent years helping U.S. citizens living and working in Hong Kong to manage their taxes, I have encountered three common misconceptions about foreign tax credits, Hong Kong retirement schemes, and foreign asset reporting. These can lead to costly errors and absurd IRS penalties. Here are three tips to help U.S. citizens living in Hong Kong avoid these common tax mistakes.
1. How Hong Kong taxes are accrued for the foreign tax credit.
Taxpayers in Hong Kong who cannot exclude all their income through the foreign-earned income and housing exclusions should take advantage of the foreign tax credit to prevent double taxation.
The foreign tax credit requires taxpayers to make a major decision: whether to take paid or accrued taxes. For most taxpayers, the consequences of this choice will last a lifetime, as they must use the same tax method for all future years.
Accrued taxes are a straightforward concept: An accrual results when an item has been incurred but not paid for. However, many taxpayers choose this option without being aware of how the IRS determines when taxes accrue. While working in a country with the same tax year as the United States, expats can accrue all the foreign taxes owed for that year. However, in countries with a different tax year, taxpayers cannot split and prorate the taxes that accrue. According to the IRS, foreign taxes cannot accrue until the tax year ends. Therefore, taxpayers in Hong Kong are unable to accrue Hong Kong taxes from April to December, since the Hong Kong tax year ends in March, which is after the U.S. tax year.
Here’s an example: Jim decides he wants to accrue his foreign taxes in Hong Kong for the 20X5 year. He will be allowed to accrue the Hong Kong taxes only from April 20X4 to March 20X5. The Hong Kong tax on income earned from April to December cannot be accrued, since the Hong Kong tax year ends on March 31, 20X6, which is after the US tax year of December, 31 20X5.
Taxpayers who are in their last year in Hong Kong and are accruing foreign taxes also should be aware that they will not get credit for the Hong Kong tax on income earned from April to December. This may mean they need to file an amended return so they can carry back the Hong Kong taxes that will accrue in March of the following year.