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April 8th, 2006:Greetings to all who have found this page. As I haven't had time to keep this site UP to date, I can no longer vouch for all of the information on this page. It should remain mostly correct, but I take no responsibility if any of this information has change. I'm sure that the fundamentals such as Form 2555 and Form 1116 remain the same. The links to these and other forms may be broken, but if you go to the IRS website at www.irs.gov, you can quickly search for, read, and download any forms or publications you may need.|
You have until June 15th to file from overseas. Good luck!
February 22, 2005:American Embassy American Community February Update includes the following paragraphs on the 2004 IRS exchange rate to be used on your IRS return. This is the first time that I learned that there is no real official average exchange rate! Choose the one that works best for you!
There is something that many Americans that begin working in Japan don't realize: even though you are making income in Japan, you still have to pay income tax to the United States Government!
IRS 2004 Exchange Rates
The IRS provided us with the following information on exchange rates for use with our 2004 Federal tax forms:
IRS will not post an exchange rate schedule on its web site.
Instead, here is the US Treasury rate from Financial Management Service (FMS):
Jan - March 2004: 104.02
April - June 2004: 110.19
May - Sep 2004: 108.82
Oct - Dec 2004: 103.11
Average 2004: 106.54
Other options: http://www.oanda.com provides exchange rates. People using that site should obtain the average exchange rate using the 'interbank rate' for the period January 1, 2004 through December 31, 2004. You input that information and the site automatically gives you the average rate for that period for any currency in the world. Per Oanda, the average exchange rate was 108.170.
If you go to http://www.newyorkfed.org/markets/fxrates, you can download the daily rates into an Excel spreadsheet and have the spreadsheet compute the average rate as 108.164.
Any of these rates could be used and accepted. If the IRS were to examine the return and ask how the exchange rate were computed, the individual would need to be able to show how the rate they used was computed. Since any of these are obtained from legitimate sites, they would be accepted.
Note that the Internal Revenue Service (IRS) office serving Japan is located in Philadelphia, and provides U.S. Federal tax assistance to Americans in Japan. The IRS office at the American Embassy in Tokyo closed on June 18, 2004. There is no one at the Embassy or our Consulates who can answer tax questions. However, a lot of information, including a list of paid tax preparers, is on our web site at http://japan.usembassy.gov/e/acs/tacs-7126b.html.
In addition, the IRS Home Page, http://www.irs.gov, has a lot of information available to answer many questions. Go to 'Individuals' and then 'Overseas Taxpayers' you will find a section of FAQ, which will take you to IRS Publication 54. Many questions of overseas taxpayers can be answered from that source.
In addition, if you have tax law and/or other general questions, you can contact IRS via e-mail via: http://www.irs.gov/help/page/0,,id=133197,00.html
November 29, 2004:Unfortunately, as of June 18th, 2004, the IRS offices in the United States Embassy in Japan have been closed. I'm not sure yet as to how the official exchange rate for 2004 will be calculated, but I will post it here when I know.
First, you need to get all your forms together.
January 15th, 2004:The official exchange rate for tax year 2003 is 113.873 yen to the dollar.
OK, so you've got your forms and paperwork ready, now let's get these taxes out of the way!
January 17th, 2003:There is something that many Americans that begin working in Japan don't realize: even though you are making income in Japan, you still have to pay income tax to United States government!
OK, most likely you won't have to actually pay taxes on any of your Japanese earned income, or at least very little, thanks to the deductions available to us expats. Regardless, you do have to file an income tax return each and every year. But don't worry, I got you covered. Just read the following information, and you should be able to finish your U.S. taxes in little more than an hour (if you can't, you probably need the help of a professional accountant, but I'll talk about that at the end.)
Please note that this information is current as of the 2002 tax filing year. I imagine the filing process won't change too radically over the years, but for the official information see the U.S. Embassy Tax Information site for the most up-to-date information.
First, you need to get all your forms together. From your company you will need an extra copy of the Œ¹?ò’¥Žû•\ (gensenchoushuuhyou) This is the Japanese equivalent of the W-2 earnings statement that lists how much you have earned, and how much in taxes you've paid throughout the year (if you worked in the United States during the course of the tax year, you'll need to get a W-2 form from your employers). You should receive one from your HR department with your first pay stub of the year, but you should keep this for your Japanese tax record retention purposes, and ask HR to make you an extra one. Don't just make a copy of this one, because United States law requires an original statement, that the HR department must stamp with the official inkan of the company. This is the only Japanese form you are likely to need for filing. The rest of the tax forms you will need can be found on the U.S. Embassy Tax Information site.
Here are the most common forms you will need (you will need Adobe Acrobat reader installed in order to view files in PDF format):
Form 1040 : The main form for tax filing. Note that you cannot use the Form 1040-EZ smaller form for filing because you will need to take the Foreign Earned Income Exclusion or the Foreign Earned Income Credit on your Japanese taxes, nor can you do electronic filing of your income taxes for the same reason.
Form 2555-EZ : The simplified form for the Foreign Earned Income Exclusion. Use this if you make less than $80,000 in Japan, and didn't have any significant income from self-employment ventures. Otherwise, you'll need to use the longer form.
Form 2555 : If you made over $80,000 you need to use this long form for the Foreign Earned Income Exclusion, that may also allow you to deduct housing expenses
Form 1116 : You need only concern yourself with the Foreign Earned Income Credit if you made a great deal more than $80,000. Instead of an exclusion of $80,000 on total Japan earned income, this option allows you to use the taxes you paid in Japan as credit against the taxes you owe in the United States. Since Japan taxes on high income are generally higher than in the United States (up to the 50% rate for income over 12,000,000 yen per year), you should do the calculations for both to determine which option allows you to pay the least in taxes.
To download instructions on these and other forms, see the IRS Forms and Instructions site.
Last but not least, you need the social security numbers of all your dependants. If you have a dependant spouse that is not a United States Citizen, you need to file Form W-7 for them to obtain a tax number in lieu of a Social Security Number.
One final thing to note before we begin: by living outside the United States, you are automatically entitled to a two-month extension in filing your income tax return. So if you're used to waiting until the last minute, you can now wait until June 15th instead of April 15th to get them out. However, besides procrastination, there is one very good reason and legitimate reason to delay filing taxes as long as possible, but I'll talk about that more when discussing the "Physical Presence test".
February 10th, 2003:OK, so you've got your forms and paperwork ready, now let's get these taxes out of the way! Just to let you know, as an overseas resident, you are automatically granted a two-month extension in filing your taxes, so you could actually put this off until mid-June, but I prefer getting this out of the way as quickly as possible. Your call. Anyway, let's start with the simplest case, a single American working in Japan making less than $80,000 a year, and add the special cases as we go on.
First, get the Form 1040 out. Fill out the header section and everything UP to Line 6d the normal way (I won't walk you through that; see the the IRS Forms and Instructions site for more information). Now we're on Line 7, your income. This is listed under the part labelled Žx•¥‚¢‹àŠz(shiharaikingaku) Right away you should see a problem: this amount is listed in yen, yet you have to list the amount in dollars. How do you convert this?
Answer: you need to get the official exchange rate for Japanese yen to the dollar from the IRS. You should be able to find this from the U.S. Embassy Tax Information site, although the 2002 rate has not been announced as of this writing (Update: 2002 tax rate is 123.90). For sample purposes, let's use the rate listed for 2001: 121.61 yen to the dollar. Now, let's suppose that our gross earnings in Japan for the year as listed was a nice round number like 4,000,000 yen. Using your calculator or a scrap of paper or your amazing brain or whatever, Divide 4,000,000 by the exchange rate 121.61. I'll save you the trouble and tell you the answer is 32892.031905270948...(and on and on and on...) Fortunately, the IRS let's us drop the decimal point in our calculations to make things easier on us, so let's do that and say that our earnings in dollars is $32,892.00 for 2002. This then becomes the value you enter in line 7.
Line 8 to line 20b are a whole bunch of other income fields, most of which probably won't apply to you. Most likely to apply to you is the 8a (the taxable interest you have if you have a savings account in the United States; you need a statement from your bank listing your interest earnings for the year)
Skim through these fields, and enter "0.00" for anything that doesn't apply.
Line 21 is where your Foreign Earned Income Exclusion comes into play, so take out Form 2555-EZ to fill out. This is most likely the most confusing part of the process, so pay close attention. To fill out this form, you have to determine whether you meet the requirements for this form by being a Bona Fide Resident (proving you have a residence in Japan) or passing the Physical Presence test (proving you were actually in Japan). The exclusion is pro-rated based on the amount of time you meet the requirement you've chosen, so you want to choose the option that gets you the biggest exception value. In general, it is best to choose the Bona Fide Resident option if you have worked in Japan for a full calendar year, because if you choose the Physical Presence Test, you have to exclude the days you were in the United States for vacation, business, visiting your family, or what not. However, if you moved to Japan within the past year, you have no choice but to use the Physical Presence Test.
The simplest case is the one where you've worked in Japan for the entire year past. Fill out parts I, II, and III as directed, as one who passes the Bona Fide Resident option. In Part IV on line 14, enter "365" as the number of days you meet the Bona Fide Resident status, entitling you to up to the full $80,000 Earned Income Exclusion credit. Answer "Yes" for line 15 and enter "1.000" for the multiplier. Repeat "80000.00" for the maximum benefit in line 16. Place the value you entered in line 7 of Form 1040 into line 17 of this form ("32892.00" from our previous example) Put the value of line 16 ("32892.00") into line 18; this will be the amount you can deduct from paying tax on. Then go back to line 21 of Form 1040. In the dotted line section, enter the text "Form 2555-EZ", and, remembering that we are still working on the "Income" section, enter this credit as a negative value ("-32892.00") Now, you are done with the Foreign Earned Income Exclusion!
Unfortunately, it is a bit more tricky for people who came to Japan from the United States in the middle of the previous tax year. Since you did not have a home outside of the United States for the entire tax year, you cannot meet the requirements of the Bona Fide Resident test, so you must pass the Physical Presence Test. To pass the Physical Presence Test, you must show that you've been out of the United States for at least 330 days of a 365 day period of time beginning in the previous tax year. Then, you can use the portion of the year you were outside of the United States to receive a partial deduction on your taxes. Here are three sample cases for 2002:
Case 1: You arrive in Japan on March 1st, 2002 and never return to the United States. On January 24th, 2003, you have been physically present in a foreign country for 330 days, so you can use this time frame to pass the Physical Presence Test. You will have been out of the United States for 306 of the 365 days of 2002, so the amount you can deduct from 2002 foreign earnings is (306 days/365 days) * $80,000 = $67,068.50
Case 2: You arrive in Japan on July 1st, 2002, and return to the United States from December 20th, 2002 to January 4th, 2003. On June 11th, 2003, you will have been physically present in a foreign country for a period of 330 days out of the previous 365, so you can use this time frame to pass the Physical Presence Test. You will have been out of the United States from July 1 to December 19th of 2002 for a total of 172 days of 2002, so the amount you can deduct from 2002 foreign earnings is (182 days/365 days) * $80,000 = $39,890.41
Case 3: You arrive in Japan on September 1st, 2002, and never return to the United States. On July 27th, 2003, you will have been physically present in a foreign country for a period of 330 days out of the previous 365, so you can use this time frame to pass the Physical Presence Test. You will have been out of the United States for 122 of the 365 days of 2002, so the amount you can deduce from 2002 foreign earnings is (122 days/365 days) * $80,000 = $26,739.73
Oh, one more thing to remember...you cannot file the Form 2555-EZ (or Form 2555 for that matter) using the Physical Presence Test until the Physical Presence Test timeframe has been realized. In other words, you can't claim the deduction until you've done your time. If you're under Case 1, then you can file after January 24th...no problems there. If you're under Case 2, then you can't file your taxes until June 11th, very close to our extended deadline. And if you're Case 3, you have to wait until July 27th, after the filing deadline has passed! Of course, filing a late tax return is still a no-no, but if you don't, you would have to pay taxes in both Japan and the U.S. on your income!
Fortunately, the IRS has already thought of this, and the solution is to file an extension before the tax deadline. Filing Form 4868 will give you an additional four months to wait to meet the Physical Presence Requirement and get you off the hook for filing the taxes past the deadline (there's also a Form 2688 to file if you need even more time, but that would only be necessary for those folks who started working in Japan in December 2002). From there, you can finish up the Exclusion paperwork much the same way as with the Bona Fide Resident test, except that Line 14 will be the number of days you meet the Physical Presence Requirement during the tax year, and Line 15 will that number divided by 365, rounded to three decimal places. Don't forget to take the final value of Line 18 on your Form 2555-EZ and enter it as a negative value on Line 21 of the Form 1040!
From there, for our simple case it's clear sailing. Add up the values from Lines 7 to 21 and place the result in Line 22. In our simple example, this should be zero, because the income of $32892.00 is completly cancelled out by our foreign earned credit of $-32892.00. You can most likely enter "0.00" for everything from lines 22 to 34, but you should give them a quick glance just to make sure none of that applies to you just the same. Line 35 should be what was on Line 34 subtracted from the total on Line 21, which in our simple example is just 0.00 - 0.00 = 0.00. Repeat this value on Line 36 on Page 2.
Now we just have to tidy things up and we're done. If you had any residual earnings from the United States, you can most likely wipe them out on Lines 38 and 40, where you enter your Standard Deduction ($4,700 for a single taxpayer) and Exemptions ($3,000 * the number you entered on line 6D, most likely "1") You'll most likely end up entering a negative number on Line 39, and "0.00" for Line 41. From there, it's zeroes all the way down to Line 61. If you worked in the United States during the tax year, now is the time to dig out those W-2 forms and enter the amount they deducted on Line 62, otherwise enter "0.00" Enter "0.00" for Lines 63 to 68, and the value from Line 62 in Line 69. Now compare lines 69 and 61. In the simple case, they are both zero, meaning you paid no taxes and owe no taxes, so all is well. If Line 69 is bigger than Line 61, congratulations, you're getting a tax refund! If Line 61 is bigger than Line 69, check over your calculations and figure out where you screwed up. ;-)
Sign your tax form and...congratulations, you're done! Make copies of all your forms for your records, then send the originals off to the Internal Revenue Service processing site for foreign returns (Internal Revenue Service Center Philadelphia, PA 19255-0215), and rest easy for another year!
If you are earning more than $80,000, then you will have to file Form 2555 instead of Form 2555-EZ that we've been using in the example. That's not too much more difficult, just a bit more verbose. If you are earning significantly more than $80,000, then you may need to consider also using the foreign income tax exclusion Form 1116 (or consider getting a wife and kids to get some extra dedections ;-), and you'll also need to determine how the Alternate Minimum Tax may affect you. If you own stock or other commodities...you might want to just give UP on this and find someone to help you with this tax stuff!
Anyway, good luck, and let me know if this helps or if there is anything else I should include to make this more helpful.