What Is IRS Form 673? US Income Tax Exemptions For Expats Living Overseas
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If you’re a US citizen or resident alien living abroad and working remotely for a US employer, you might qualify for US income tax exemptions.
The US requires all citizens to pay income tax to the Internal Revenue Service (IRS), even if you earn the income while living abroad. That means American employers are required to withhold taxes from any American on their payroll. Unfortunately, Americans working abroad also have to pay the equivalent of income and social security taxes wherever they live—if you live in Canada for example, you also file a tax return with the Canada Revenue Agency. If you don’t take advantage of these exemptions, you pay double income tax—sometimes called expat tax.
To ensure you aren’t hit with twice the taxes from the US and the country you’re living in, you can fill out Form 673 to become exempt from US withholding tax from an American employer.
What is IRS Form 673?
The full name for IRS Form 673 is the “Statement for Claiming Exemption from Withholding on Foreign Earned Income Eligible for the Exclusion(s) Provided by Section 911.” The good news is that you don’t have to remember all of that.
What you need to know about Form 673 is that US expats fill it out to avoid double taxation. Form 673 is one component of tax benefits for Americans living abroad. Once you complete this form, your US employer will withhold less (or no) money out of your paycheck for US income taxes.
Expats working abroad may qualify for the foreign earned income exclusion (FEIE) if:
- They have foreign earned income or make money while living in a foreign country
- Their tax home is in a foreign country
- They are a US citizen living as a bona fide resident of another country for an entire year OR a US resident alien with citizenship in a foreign country that the US has a tax treaty with and has lived there for an entire year OR a US citizen or resident alien who spent at least 330 days in a foreign country in one year
Those completing Form 673 will likely also need to complete Form 2555 to determine their earned income exclusion earned through Form 673, as well as foreign housing exclusion or foreign housing deduction, which exempt taxes on expat housing expenses. Qualified taxpayers can receive an exclusion on up to $112,000 worth of income in 2022. Form 2555 will need to be attached to the taxpayer's Form 1040 or 1040-SR to receive the exclusion or deduction.
Who fills out Form 673?
US citizens working for a US company but living in a foreign country fill out Form 673 each year to ask their employer to exclude all or part of their wages from US income tax withholding while they’re working in a different country. That’s because by default, all US employers must withhold US income tax from any US citizen they employ.
On Form 673, you’ll check a box for a “Bona Fide Residence Test” or a “Physical Presence Test.” The Bona Fide Residence is for those who have lived in the foreign country for an entire year and plan on staying there for at least another year. The Physical Presence is for those who have lived in the foreign country for at least 330 days in a given year.
Once the employee fills out the form, they send it to their employer, who keeps it on file and makes the necessary payroll changes to stop withholding tax. If the employee’s situation changes and they return to the US (or fail to meet the qualifications for foreign income exclusion, usually because they spend too many days in the US), they fill out a Form W-4 to resume tax withholding.
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How do I fill out and submit Form 673?
Like every other form distributed by the IRS, Form 673 can seem daunting at first glance. Let’s break down what you need to know when filling out the form. Follow along with the form (PDF).
At the top of the form, you’ll enter your legal first name and middle initial, legal surname, and social security number.
Identifying the year
Form 673 Part I identifies the year you’re claiming an exemption for. You’ll write in the calendar year if you’ve been in a foreign country for a single year from January 1-December 31, or you’ll use the other lines if you want to use the exclusion for multiple tax years (e.g., you worked in a foreign country from August 2020 to September 2021, and you want to claim an exemption for both 2020 and 2021).
After identifying the year, you’ll indicate which residency status qualifies you for the deduction: the Bona Fide Residence Test or the Physical Presence Test.
Bona fide residence
The bona fide residence is for people who have been in a foreign country for a consecutive period of twelve months. Bona fide residents indicate the country they’re living in and the date they began their residency. If the resident decides to stay in the foreign country beyond the end of the tax year, they can indicate the day they anticipate returning to the US.
People who have been living in a foreign country for at least 330 days in a year will use the physical presence test. Residents will indicate the country they’re living in as well as the year or part of the year they’re abroad.
In Part II of Form 673, the resident will estimate their expenses while living abroad (e.g., rent, utilities, insurance, etc.). You may want to hire someone well-versed in international taxes to help you complete Part II to ensure you get the best deduction possible.
Part III of Form 673 has you certify that you filled out the form accurately. You’ll sign and date the form, then send it to your employer.
What comes next
Once your employer receives your completed form, they’ll withhold the correct amount of federal income tax from your pay. Unless the IRS determines you don’t qualify for the exclusions, you’ll see a bump in your next paycheck (and your bank account).
How often do I fill out Form 673?
You’ll need to fill out Form 673 for every tax year you spend overseas.
Other forms and responsibilities for US expats
Unfortunately, you can’t just complete Form 673 and call it a day. Some of the other forms you’ll need to fill out and file include:
US Federal Tax return: even if you weren’t physically in the US that year, you still need to fill out a Federal Tax Return as a citizen or resident alien. Form 673 will reduce the amount you’ll have to pay, but forgetting to file a federal tax return can get you into deep trouble for tax evasion.
US State tax return: If the state your company operates from requires employees to complete a state income tax return, then you’ll also have to complete a state return even if you never set foot in that state. For example, if your employer is based out of California, you’ll still need to submit a California state return even if you were working in Iceland.
Form 2555: As discussed earlier, this form is used to determine your FEIE and will be attached to your tax return.
FATCA Form 8938: This form is a statement of your specified foreign assets and should be completed if the total value of all your interest in specified foreign financial assets is greater than the appropriate reporting threshold.
Form 1116: This form is a statement claiming your foreign tax credit and should be completed if you are an individual, estate, or trust that paid or accrued foreign taxes to a foreign country or US possession.
FinCEN Form 114 or FBAR: This form must be completed by US citizens who have financial interest in or signature authority over a foreign financial account(s) if the total value of the account(s) exceeds $10,000 at any point in the calendar year.
Tax return in your country of residence: You’ll still need to be compliant with the tax laws of the country you’re residing in, so you’ll have to complete a tax return to report the income you receive while living abroad.
Penalties for not filing Form 673
You don’t break any laws if you don’t file a Form 673. If you work abroad and you don’t file Form 673, then you just won’t qualify for a tax exemption for the year. The most significant consequence of not submitting the form is getting hit with double taxes.
Consequences for filing Form 673 incorrectly
If you don’t complete Form 673 correctly, your employer will continue to withhold part of your pay for taxes. If you’ve submitted the form and your tax withholding doesn’t change, it’s possible that your employer had reason to believe that you didn’t qualify for the exemption. You can call your employer or have your CPA or accountant reach out to them on your behalf to see what the issue is.
If you filed the form and you weren’t eligible (for example, you didn’t stay abroad for over 330 days or you weren’t out of the country for a consecutive year), then you will have to pay the full amount of Federal and State income taxes required at the end of the tax year. If your employer stopped withholding tax funds from your paycheck, you’ll have to pay the difference back to the IRS. If at any point you realize that you won’t qualify for FEIE for a given year, it’s best to have your employer reinitiate your tax withholdings by providing them with a new W-4 form.
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