Moving abroad from the U.S. after graduating from school, college, and university is a dream for many! And if you're considering moving to a foreign country, or are already living abroad, you are being smart by looking into your options to repay your student loans as an expat. But I don't want and will not burden you on this post with all the requirements you have to comply with to repay your loans, what I will do in this blog post is share with you the options and tax strategies that are legally available for you to reduce your tax payments and student loan payments from abroad.
Let's start, shall we?
One of the most useful repayment options by U.S. graduates is the income based student loan repayment plan.
If you’re already in the process of repaying your student loans and are able to get into an income-based student loan repayment plan, claiming the Foreign Earned Income Exclusion could potentially reduce your monthly payments to zero while you're living and working abroad.
Now you may be wondering, how exactly does this work?
Well, US citizens and green card holders are still required to file taxes in the United States while living and working abroad, however thankfully there are some exclusions that reduce, and for most expats even eliminate, their US tax payment liability.
The Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion is a tax strategy that allows expats who can prove that they live abroad to exclude about $100,000 from being considered taxable income, which essentially turns into not paying US taxes on any income that is below or about $100,000
To qualify for this strategy, US expats must prove that they are not US residents and that they are truly living abroad. This is done by passing one of two tests:
1. Physical Presence Test: This test is passed once a US expat can prove that they have spent at least 330 days outside the US in a 365 day period that overlaps with the tax year, or
2. Bona Fide residence Tes: This test is passed once a US expat can prove that they are a permanent tax resident in another country.
Once of of these two tests is passed, US expats can claim the Foreign Earned Income Exclusion by filing form 2555 with their US tax return.
The Foreign Earned Income Exclusion Impact on income-based student loan repayment plans
The interesting thing about the Foreign Earned Income Exclusion is that it substantially reduces the Adjusted Gross Income of expats by excluding about $100,000 of their income in the US. What this means is that for expats who earn less than around $100,000, and have no other income, their Adjusted Gross Income in the US would be zero. If they have an income-based student loan repayment program and claim the Foreign Earned Income Exclusion, this results in their monthly student loan repayment being zero because income-based student loan repayment programs are calculated as a percentage of their declared Adjusted Gross Income
Reducing payments this way may seem like a great idea at first glance, however there are important factors in the longer term that I should advise you to consider before using this strategy.
Consequences to be Considered
If you aren’t making monthly repayments to your student loans, interest will keep accruing on this debts, potentially leaving you with more to pay back later. This is more likely a risk that is faced by US expats who move abroad for a short period or with plans to move back to the US in the upcoming future.
However, for expats with an income-based student loan who settle abroad permanently, this can be a way to effectively write off their whole loan, as if they are earning under $100,000 (or even a bit more), they will end up paying nothing until eventually the loan is forgiven.
This could, however, be a risky strategy, as it is difficult to predict changes in your income and your country of residence over so many years, and if you fail to qualify for this repayment option in later years the loan may not be completely forgiven.
If the loan is eventually forgiven though, the total value of the loan and the interest accrued is considered income, so there will be a one-off hit for income tax.
The particular fact about the Foreign Earned Income Exclusion is that it only allows US expats to exclude income that has been earned. This means that passive income such as rental income, interests, dividends, etc. are not allowed to be excluded for this purpose. Therefore, once your student loan is forgiven, the total value of the loan and the interest accrued that is considered income can’t be excluded using the Foreign Earned Income Exclusion because it's not earned income.
While the value of the income tax owed will be much less than the total value of the loan and interest, the entire tax will be due and payable in one tax year and it may push you into a higher tax bracket for that year. This means that you should have enough money saved so that you're able to pay a higher one-time income tax as a result of this strategy.
Excluding all your income under the Foreign Earned Income Exclusion results in your Adjusted Gross Income being substantially reduced, and if your yearly income is around $100,000, or less, then your Adjusted Gross Income will be $0 in the US. This disqualifies you from being allowed to contribute to a Roth IRS account because you can't contribute to these accounts without having earned income.
Child Tax Credit
If you choose the Foreign Earned Income Exclusion, you will most likely not receive the child tax credit or the additional child tax credit. These are tax credits that you can claim for your children (now if you have any, or in the future) and in many circumstances it grants a refund as an additional tax credit for each child that is your dependent, and a U.S. citizen with a Social Security Number. Claiming the Foreign Earned Income Exclusion disqualifies expats from claiming this type of credit.
I strongly recommend expats to check their repayment terms with their loan provider to determine whether this is viable, and to constantly monitor how changes in their Adjusted Gross Income could impact their repayment programs.
In conclusion, having an income-based student loan repayment plan may be a useful way for expats to delay payments, or, if they settle abroad permanently, to write off their student loan entirely. However, this is a decision and strategy to be implemented after a thorough analysis of your particular circumstances, and preferably with a tax expert's advise.
If after reading this, you're interested in understanding your options and implementing this tax strategy for yourself, get in contact with me for a consultation and detailed explanation on how this tax strategy can work for you.
I'm more than happy to help you.