If you're an American citizen, receive American income, and reside and work in Italy as a member of a Board of Directors in an Italian company, you may be subject to a relatively high overall taxation (Italian and American).
Double Taxation Conventions offer taxpayers who live and earn wages in a foreign country a Foreign Tax Credit, a non-refundable tax credit for income taxes paid to a foreign government due to foreign income tax withholdings.
Although Italy is a member state to these bilateral agreements, this Convention can only partially mitigate your tax load.
American Citizens in Italy: two ways you can reduce your tax liability
This article will analyze two IRS provisions that can help an American citizen who lives permanently in Italy reduce American tax liability (most often to zero.): Foreign Earned Income Exclusion (FEIE) and Foreign Housing Exclusion or Deduction.
Foreign Earned Income Inclusion
Foreign Earned Income Inclusion allows a taxpayer to exclude from income tax up to an amount up to $107.600, an amount that is adjusted yearly for inflation.
To claim the foreign earned income exclusion, You must meet specific qualifications:
- You must be a U.S. citizen or resident alien;
- You must have a foreign earned income;
- You must be physically in another country and have a “Qualifying Presence” in a foreign country or fulfill the “Physical Presence Test.”
First of all, the citizen in question must live permanently in a foreign country: the term "foreign country" does not include U.S. possessions such as Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or the American Samoa Islands.
Secondly, the taxpayer should also consider that the salaries received by military or civilian employees of the United States government in American bases outside America do not qualify as income produced abroad. American bases abroad constitute American territory, also from a fiscal point of view.
Third observation: foreign income must be income from work, both dependent and autonomous (self-employment).
Therefore, all income deriving from financial annuities (interest, dividends, and capital gains), as well as retirement income, rental income, and income classified as other, are excluded from the FEIE.
It's important to note that the exclusion from taxation often resolves the question of the American tax debt since most people are unable to use all the FEIE: even in this case, however, the taxpayers must submit Tax Returns.
Therefore, as an example, an American citizen fiscally resident in Italy who receives only an employee income of $ 75,000 in 2020 will have to submit a Tax Return where he or she will indicate his "employment" income of $ 75,000. Upon presenting tax returns, this taxpayer will exclude this income from taxation for the same $ 75,000, making his or her taxable income equal to zero.
Even if the tax liability is zero, a U.S. citizen or Tax Resident is still responsible for filing tax returns.
Foreign Housing Exclusion
In addition to the Foreign Earned Income Exclusion mentioned above, a taxpayer can also use the Foreign Housing Exclusion or Deduction, which excludes taxation for the number of housing expenses.
The first thing to clarify is that
- Foreign Housing Exclusion is to be applied only by employees;
- Foreign Housing Deduction is to be used only by self-employed workers;
The second consideration is that the Foreign Housing Exclusion, applying to employees, is undoubtedly much more frequent than the Deduction. Only those employees who receive a specific part of their compensation package remuneration to pay for housing once they live in Italy can use this Deduction. The above scenario is common when American citizens move to Italy and negotiate a housing bonus and salary.
Therefore, the so-called Accidental American, born in America but moved to Italy at a young age, can certainly apply the FEIE. Still, this person can seldom use the Foreign Housing Exclusion: this would only be possible if the Italian corporation this person works for had foreseen it as a "bonus" for living expenses within the compensation package, which is quite rare.
The calculation must be made within Form 2555 and is quite complicated. We strongly suggest you contact us if you have any doubts or questions about your tax filing situation.