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More on taxes: Additional Child Tax Credit

The other day, I was approached by an American tax lawyer who resides in Europe and specializes in expatriate taxation. He came across my blog and, having formed a largely valid impression of me as a person who is interested in the matters of taxation, contacted me with an offer to discuss something that he feels is largely unknown to the US expatriate population: the Additional Child Tax Credit (ACTC), which provides an opportunity to certain overseas American parents to obtain IRS refunds even when US tax liability is zero and no US tax payments have been made.

Right from the outset, I told him that I had no intention of leaving my long-time accountant (Love you, Mom!), but he was keen to talk to me regardless. His reasons were primarily those of publicizing this tax refund opportunity to any audience that he could find (fueled by his somewhat erroneous impression of my world-wide reach 😉 ). Me, I was as always just as keen to learn something new, and, in the spirit of tipping my hat to the source of information, I will be pointing you directly to Mr Les Edelman at the conclusion of this post.

So, what exactly is the Additional Child Tax Credit?

Basically, if you satisfy the following requirements, you can file Form 8812, and get up to $1,000 per child (under age 17 at year-end) from the American government seemingly for the sole reason of being an expatriate with no US tax liability.

You have to have:
(1) at least $11,750 of US-taxable earnings (non-excluded; read on for explanation),
(2) very low, or no net US tax liability (also explained in more detail below),
(3) US citizenship or US greencard status (one of the two parents is enough),
(4) children who are US citizens or greencard holders themselves.

Not every level of income is eligible. For a joint-filing couple, the child credits start to phase out at modified adjusted gross income (MAGI) above $110K, and would be reduced to zero for a family with two kids with MAGI of $150K; for a head of household, the credits start to phase out at MAGI of $75K (here, modified means you have to add back any income that was excluded on Form 2555).

Aside from the high-income phase-out, the reason that many low/moderate-income US expats don’t receive these credit-refunds is that they exclude their foreign earned income on Form 2555. This is related to condition (1) above, that you must have taxable earnings of at least $11,750. If you have excluded all your earnings on Form 2555, then you won’t meet this requirement. For this reason, it is often better for expats who pay foreign income tax to use the “foreign tax credit” (Form 1116) instead of the foreign earned income exclusion (Form 2555), or in the case of two working spouses, for at least one spouse to use the credit instead of exclusion, so that taxable earnings will be high enough to generate the ACTC. Since you pay your taxes in full in your host country, in any country where your effective (average) tax rate is greater than your US effective tax rate, your US tax liability will likely be reduced to zero regardless of whether you elect to exclude the $80K or not.

This obviously does not benefit everyone as a blanket rule. Depending on your tax situation, you may get greater refunds with straight-forward exclusion. But it is certainly worth consideration.

Careful consideration, I must add. Countries with low taxes will not provide you with enough cover to reduce your US liability to zero. And what is more important, if you elect not to use the foreign income exclusion one year (you “revoke”), you are then prohibited from re-electing the exclusion for five more years. Therefore, if your plans may include relocating to a low-tax country after some time in a high-tax country, the five-year wait to switch back to using the exclusion may be painful.

Conversely, though, if your future plans do not include residing in a low-tax country, you can even get ACTC through amending your past years’ tax returns (currently 2004 through 2006 are “open” for amending). So for a couple with 3 children that meet all the requirements, it may be possible right now (early 2008) to get up to $12,000 from the IRS ($3,000 x 4 years, 2004-2007).

Scrutinizing this further, – and it is here that this entire discourse may prove the most useful for customarily high-earning expats, – if you have two incomes in the family and your joint AGI puts you and your spouse above the threshold for obtaining ACTC, you may choose to do your US tax returns as married, filing separately. In that case, the person with the higher income would use the foreign exclusion, while the lower-earning spouse would elect not to, letting the foreign tax credit do its magic in reducing her US liability to zero and obtaining the desired additional child credit refunds. (Note that in many countries, UK one of them, there is no concept of a joint return anyway – each earner is liable for local taxes individually).

What’s more, for US parents (e.g., stay-at-home Moms) who are married to foreign nationals, reside in a foreign country and have little or no income of their own, you would think there is no obvious need to even file US tax returns. But, if the couple has at least one child with US citizenship/greencard and the foreign spouse’s income is within the appropriate range and pays adequate foreign income tax, it may actually make sense for the US spouse to elect to file a joint return with the foreign spouse (a “Section 6013(g) election”); they would then file a joint return which includes the foreign spouse’s income, claim a credit for his foreign taxes, and his income would be the basis for refundable child credits. The net effect: $1,000/per child into your pocket, based on the foreign spouse’s income. Surprising – but one hundred per cent by the rules.

Again, these scenarios are not automatic for everyone. I don’t have to tell you how notoriously complicated the US tax code is. But it merits consideration big time, certainly with some professional advice on hand.

I’ve only exchanged a couple of emails with him and then had a 20-minute phone conversation, but my impression of Les Edelman is of being very knowledgeable on this topic and on all other subjects of expatriate taxation. Les indicated that he would offer a free initial consultation to anyone who would like to review their situation. His contact info can be found on Edelman Tax website. If this sounds like something that you’d like to explore, feel absolutely free.

Posted in Expat Archive

4 Comments

  1. papa

    I am very impressed. Such deep research in the matter and undestanding the Tax law, force me to have two questions:1. Why you still need me as you long-term accountant? 2. Why you did not do your study in the Tax Law and change your field? Like council of Tax Law? Or may be become the professor in some Ivy League famous Law college?
    Again, I love you and proud of you.

  2. Ilya

    Mom (and why are you posing as Dad?), sorry to burst your bubble, but most of the substance in this post comes directly from one of Mr Edelman’s email messages to me – I only added some color and conversational transitions 😀

  3. Simon Hewitt

    You are a star for pointing this out!!!!

    I recently found out my American wife who lives with me in the UK needed to file expat tax returns back to 2002. I was a bit worried about penalties etc.

    After a *lot* of research into the US tax system, I was happy to reduce the tax liability to zero. But your blog and Mr Edelman’s advice means the IRS owe us £2,500!!

    Whether we we ever see it is another matter of course since some of it is outside the 3 year reclaim limit but since we filled all the forms to just transfer the balance forward to the next year, I’m hoping that in any future year where there is tax due, it can be offset.

    Thanks again!

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