Wednesday, June 10, 2015

Correct order for doing your taxes for US citizens living in Spain

Remember that Spain will give you credit for taxes paid in the US, except for those you pay because you are a US citizen.
The correct order of doing things is this:
  1. Calculate how much you would owe to the US if you were not a US citizen, resident in Spain. This only applies if you actually have US source income. For example, if a Spaniard has a brokerage account in the US, they would file a 1040-NR return using the rules established in the US/Spain tax treaty for how much tax the US gets to keep on US source income. Generally the rules are:
    1. Salary for work in the US: complicated. Read tax treaty
    2. US Bank interest: nothing
    3. Tax exempt dividends in mutual funds: nothing
    4. Capital gains dividends in mutual funds: nothing
    5. Ordinary dividends in mutual funds: 15% (no difference between qualified vs non-qualified)
  2. Make an estimated payment for these taxes in the US. This is important since you cannot take a credit for foreign taxes paid in Spain unless you’ve actually paid them.
  3. File your Spanish taxes (before June 30), using the taxes you calculated as the foreign withholding.
  4. Put the 1040-NR calculations aside and fill out a regular 1040. Use the taxes paid in Spain as a foreign credit on your US taxes. The complication ensues when you need to adjust the gross income so that your foreign tax credits don’t erase the minimums you calculated back in step one.

18 comments:

Anonymous said...

This seems complicated... Is there any alternative to this process?

What about filing taxes in Spain first and then in the US, I believe there is a 15 day window to do this but not sure...

Thanks,

santcugat said...

You do file in Spain first, then in the US. The 1040-NR is just an exercise to figure out how much of a tax credit you can take for US taxes in Spain.

If you don't have any US source income, then you don't need to calculate the non-resident US taxes first.

For example, if you only own mutual funds that invest outside the US, even if the fund itself is in the US, then it's not US source income.

Juan said...

You mention pay estimated taxes. Does it make a different if you pay more or less than actually the 1040-NR computation says?

santcugat said...

You can only take credit on your Spanish taxes for money you've actually paid to the US government. If you pay less, in theory the Spanish government could deny your credit. EFTPS.gov is the easiest way to make your payment.

Anonymous said...

What if you don't take any credit on your Spanish tax return? If you pay taxes on your worldwide income, including U.S. Income, and then take a foreign tax credit in your U.S. Tax return, wouldn't you end up with the same net outcome?

Something is probably not right with my reasoning, but can't see what. That's how I was planning to do it. Please let me know what I'm missing.

Thanks.

santcugat said...

You don't legally have to take any credit for US taxes on your Spanish return, but then you will overpay your Spanish taxes. You can only apply a foreign tax credit for taxes that you are legally obliged to pay, not more.

Eg $100 of US non-qualified dividend income at maximum marginal rates:
- US reserves the first $15 according to tax treaty
- Spain gets up to $27 (maximum rate on savings income) with foreign tax credit for $15 = $12
- For US citizens, you pay $39.60 (39.6% maximum marginal rate) with credit for Spanish taxes ($12), so you pay $27.60 in the US.

You total taxes are is $12 for Spain and $27.60 for the US. Total = $39.60

If you do Spanish taxes first without credit, you pay $27 in Spain, but then can only apply $12 of that in the US (since you were only legally required to pay $12 in Spain), so you still pay $27.60 in the US, so now you've paid a total of $54.60.

Not illegal, but not optimal either.

Anonymous said...

Thanks for detailed explanation and the example,
this is very useful and complements perfectly your also very useful entry a while back:

http://www.lostinsantcugat.com/2014/05/using-tax-treaty-re-sourcing-on-us.html

santcugat said...

Thanks!

Juan said...

Really useful.

So the same (qualified) dividend would be paid at 15% if you are US resident, and 40% if you are Spanish resident (according to your formula)

Is not there are a way in the 1040 to say this income is because dividend. Does it need to be considered as foreign income to get your tax credit?

santcugat said...

Spanish residents pay the treaty rate of 15% on US dividends (qualified or not).

You can only take a foreign tax credit against foreign income, however the Spain/US tax treaty allows you to consider US source income foreign, but only to the extent of avoiding double taxation.

Juan said...

What I'm saying is do *not* consider it as foreign income. Do *not* take the credit in 1040

Pay $15 in the USA
Pay $12 = $27-$15 in Spain.

Is it legal?

Is some other cases, it may make sense to doing re-source and consider it foreign income to get a foreign credit, but in this case, it seems better to avoid it if you can (if your are paying it at a high marginal US income tax bracket)

santcugat said...

How can you only pay $15 in the US if you are a US citizen and don't take a foreign tax credit?

The only case I could see that is if you have a low US marginal rate with qualified dividends, long term capital gains or tax exempt income.

Juan said...

Perhaps I'm missing something but my idea is that in the US you declare the $100 as US sourced income (never as a foreign income). Let's say they are qualified dividends.

A) You pay $15 because is what the treaty says (in the 1040NR)
B) You do the regular 1040, you should pay $15 (qualified dividends are taxed at 15%).

Can't you somehow credit A when you pay B? Or just because being a non-US resident you are expected to pay it twice?

santcugat said...

Yes, you are right, if you can your actual US tax paid on US source dividends to below what a non-resident alien would have paid, then who cares.

The maximum Spain will let you take a foreign tax credit for is whatever rate you are paying in Spain on that income. They can't give you credit for taxes you pay only because you are a US citizen, but the default US withholding for non-residents (without the tax treaty) is 30%, and it's not mandatory to take advantage to the tax treaty.



Anonymous said...

The bottom line is that the total tax money you should pay is (usually) no more than the greater of:

- The tax you have to pay to the US government because you are a US citizen
- The tax you have to pay to the Spanish government because you are a Spanish resident.

Then you can do it in a couple of different (but legal) ways, using or not the treaty, and depending on the rates you are taxed at, to shift more of your tax money to one side or another. So at some point you may have to decide which government deserves more your hard earned money, the US or Spain (or it is going to make a better use of it).

Anonymous said...

The bottom line is that the total tax money you should pay is (usually) no more than the greater of:

- The tax you have to pay to the US government because you are a US citizen
- The tax you have to pay to the Spanish government because you are a Spanish resident.

Then you can do it in a couple of different (but legal) ways, using or not the treaty, and depending on the rates you are taxed at, to shift more of your tax money to one side or another. So at some point you may have to decide which government deserves more your hard earned money, the US or Spain (or it is going to make a better use of it).

santcugat said...

Sort of right. The main restriction are:
1) On your Spanish return: you can't take credit for taxes you paid to the US purely because you are a citizen, only if this is MORE than you would have paid if you were NOT a US citizen.
2) On your US return: you can't take credit for taxes you paid in Spain on US Source income unless you use the tax treaty.

Simple version: Spain doesn't give a shit that you are a US citizen, and you can't use that to pay less taxes in Spain. The US does care, and allows you to treat US source income as foreign income if it lets you avoid double taxation.

Icaru said...

It sounds like you are talking about Spanish "federal" taxes. What about the provincial taxes? Andalucia applies a 48% tax rate for income bracket + the federal taxes. Any way to lessen the provincial taxes? Also read somewhere that people 65+ who are drawing payments on their SS, annuities and/or pension income get a reduction depending on their age when they started taking payments. True?