Understanding and filing IRS Form 673 is essential for tax compliance and savings in the U.S. Americans must pay income tax to the Internal Revenue Service (IRS), no matter their location. Even those working outside the U.S. must pay income and social security taxes equal to those residing in the country.
These tax liabilities can burden employees and may result in double taxation. Thus, to reduce this liability, any American overseas working for a U.S. company can use Form 673 to claim tax exemption. IRS Form 673 can undoubtedly be confusing when you first see it. But it will look more reasonable once you break it down. So, read the article to know what Form 673 means and how to file it.
What is IRS Form 673?
IRS Form 673 is officially titled the "Statement for Claiming Exemption from Withholding on Foreign Earned Income Eligible for the Exclusion(s) Provided under Section 911." It is a form for taxpayers living in a different country seeking an exemption from the U.S. legislation withholding tax on their earned wages.
The form helps prevent the situation where you would have to pay taxes to both the United States and your residence country. Instead, it gives much-needed tax relief and ensures compliance for those who fulfill the eligibility criteria.
Related Read: How do taxes work when working remotely out of state?
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How Does Form 673 Work?
IRS Form 673 is crucial for U.S. expatriates to demand an exemption from having taxes withheld on their foreign-earned income up to a specified limit. It serves as formal notification to your employer and indicates your intent to claim the exemption, provided you meet the eligibility criteria.
The maximum foreign-earned income you can exclude from taxes is $120,000. However, keep in mind that it can vary based on your unique circumstances.
Here is a Form 673 example to clarify how it works. Say a U.S. citizen living in Spain is working for one of the U.S.-based companies. Then, according the U.S. tax regulations, the individual is obligated to pay taxes on the income earned from their American employer.
Upon completing Form 673, the employee can rightfully claim an exemption from the tax withholding requirement up to the $120,000 exclusion limit. Say the employee earns $100,000 in Spain. It means they can exclude the entire amount from federal income tax withholding.
Consequently, they can continue to earn the same wage without the employer withholding income tax and benefit from tax savings while residing abroad. Any income beyond the $120,000 limit would still be subject to withholding, but the exemption significantly reduces their overall tax liability.
Form 673 exclusively pertains to federal income tax withholding. Therefore, state taxes may apply to your foreign-earned income, depending on the state in which you reside.
Who Qualifies for Form 673?
Form 673 offers tax benefits to U.S. citizens living abroad and working for an American employer. The qualifications for individuals who can benefit from it include:
- You are a resident alien or U.S. citizen.
- You are working abroad.
- Your earned income is subject to U.S. taxes.
- You meet the physical presence or bona fide residence test.
It is vital to note that meeting the Form 673 requirements does not automatically exempt you from filing a tax return. You may need to file a tax return, even if you use Form 673, to exempt yourself from withholding taxes.
How to Fill out Form 673 and Submit it?
Form 673 has three parts to fill out to claim foreign-earned income. First, you must write your full name and Social Security Number at the top before moving to the sections.
Section 1: Qualification Information for Foreign Earned Income Exclusion
You will need to give adequate information to establish your eligibility for tax exemptions while living in a foreign country. There are two tests you can qualify under:
- Bona Fide Residence Test: Demonstrate you have been a bona fide resident of another country for a continuous period of at least 365 days or a full calendar year.
- Physical Presence Test: You have spent at least 330 days within a foreign country during a full calendar year.
You can only be eligible for tax exemptions if you meet the requirements of either of the tests.
Section 2: Estimated Housing Cost Amount for Foreign Housing Exclusion
The next section in Form 673 asks for your housing details. You must provide the relevant inputs for overseas housing exclusion. Although it contains nine items, not all may apply to you.
- Rent: Write the yearly rent amount you pay for your home.
- Utilities: Include expenses for water, electricity, and gas. Do not add telephone charges.
- Real and Personal Property Insurance: Report any cost you pay for real and Personal property insurance.
- Non-Deductible Occupancy Tax: If you pay occupancy tax that cannot be deducted under Section 164, enter it here.
- Non-Refundable Lease Fees: Include non-refundable fees you paid to secure a lease, for instance, application fees. Non-refundable security deposits should not be accounted for here.
- Household Repairs: List expenses for household repairs and regular maintenance.
- Estimated Qualified Housing Expenses: Add the expenses from line 1 to line 6.
- Estimated Base Housing Amount: Evaluate the estimated base housing amount for your qualifying period. It may vary depending on where your foreign home is located.
- Estimated Housing Cost Amount: Subtract line 8 from line 7 to calculate your final estimated housing cost amount.
Fill out the requested information for each housing-related expense. Remember to keep a record of your payments and supporting documentation. You may need them in case of an IRS audit or to support your claims.
Section 3: Certification
The last section in Form 673 provides certification. It requires you to base your claims on the previous Section formally.
- You confirm that the estimated housing costs calculated in Part II (Section 2) and any amounts reported on other statements with other employers do not exceed your total estimated housing cost amount.
- You promise to notify your employer promptly if you become disqualified for these exclusions due to any changes.
- You acknowledge that any exemption from income tax withholdings does not mean the IRS has determined that all amounts paid to you are tax-exempt.
Sign and date the form once you agree to certify these assertions. Please fill out IRS Form 673 correctly to avoid adverse consequences. Claiming an exemption for income that does not qualify the physical presence or bona fide residence test criteria may result in penalties, additional taxes, and interest.
Similarly, the IRS may assess extra taxes, with interest and penalties, if you exceed the maximum allowable exemption amount. Hence, double-check the information provided to ensure it is correct before you submit the form.
How to Submit Form 673?
The first and foremost step to submitting the form is to complete it. The employer must receive an accurately filled Form 673 to proceed with the following activities. They have the authority to discontinue withholding US income taxes on any eligible income you earn based on the information you provided.
Here is a small process you can follow once you complete the form:
1. Choose a Submission Method
Ensure you have correctly filled out all three sections. Once done, you can submit it in two ways:
- Hard Copy Submission: Deliver the printed and completed Form 673 to your human resources or payroll department. You can do it in person or by mail following your employer's guidelines.
- Electronic Submission: Check if your employer has an online portal or electronic document submission system. If they do, you can submit the form electronically through their system.
2. Communicate with the Employer
You must maintain open communication with your employer for any queries or concerns regarding your eligibility for tax exclusions.
Your employer will review the form after you submit it. They may contact you for clarification or disregard the form in case of inaccuracies.
Once your employer reviews and accepts Form 673, they will make the necessary adjustments to income tax withholding. It will ensure you do not have additional US income taxes withheld on eligible income.
Submitting Form 673 is critical to ensure you are not subject to unnecessary US income tax withholding while living and working in a foreign country. Therefore, completing the form accurately and complying with your employer's procedures is crucial.
How Often do I Fill out Form 673?
You must complete Form 673 for each tax year you spend in a foreign country. Completing the form is necessary for tax compliance and securing tax benefits and exemptions related to overseas living.
Penalties for not Filing Form 673
Not filing IRS Form 673 is not a legal violation. But it can lead to financial consequences and unnecessary financial burdens. Here are some drawbacks of failing to complete Form 673.
- Penalty Imposition: The IRS can impose penalties if you fail to file Form 673. The penalty is calculated at 20% of the taxes that should have been withheld but were not.
- Additional Tax Liability: The IRS may impose further penalties for non-compliance. These can vary in nature and severity and exacerbate the financial consequences of not filing Form 673.
- Interest Charges: Interest charges accrue on unpaid taxes over time. It can accumulate and increase the overall amount you owe to the IRS.
- Double Taxation: U.S. citizens living abroad or employed by U.S. companies may face double taxation. They could be taxed on their income by the foreign country where they work and by the United States.
File Taxes Compliantly with Skuad
Navigating the complexities of global tax compliance is daunting for international businesses. Whether you hire employees in the USA or any other country, filing all taxes, local and back at home, is necessary for compliance.
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Q1. Is it compulsory to file form 673?
No, Form 673 is not mandatory, but it can reduce your taxes on foreign-earned income. However, you must remember that your income earned will be subject to taxes if you fail to meet the eligibility requirements or choose not to file it.
Q2. How many times do I need to fill out form 673?
You must file Form 673 yearly if you meet the eligibility criteria to claim a tax exemption on foreign-earned income. Submitting the form to your employer to sidestep potential penalties is ideal.
Q3. Do I have to pay taxes if I live outside the U.S.?
Yes. The Internal Revenue Service specifies that the worldwide income of a U.S. citizen or a resident living outside the United States is subject to U.S. income tax, no matter where they live.