Your US Tax Return: How To Make Currency Conversion Work To Your BenefitFeb 12 • Categorized as Expat Tax Advice
To be compliant on your US tax return, the IRS requires that all income or deductions be reported in US dollars. This article will explain how Currency Conversion can impact your US tax liability. Having to convert your foreign earnings to USD may seem like a headache, but currency conversion can yield significant savings on your US tax return. By utilizing the most appropriate exchange rates, you are able to translate your overseas earnings into lower USD amounts thus decreasing your US expat tax liability and staying compliant with the IRS rules.
US Tax Compliance: Converting Earnings
Technically speaking, the IRS prefers that all income or expense be converted into US dollars on the date that the income or expense was received/paid using an IRS approved exchange rate. That said, they do not require you to use this method. You can choose to use the exchange rate on the day of the transaction, the monthly average or the annual average, to remain compliant on your expat taxes you just need to pick one method and use it across the entire tax return. While this may seem cut and dry, some US expats can find significant tax savings by using the right currency exchange.
For example, let’s say that you were paid a bonus of 10,000 EUR on December 31st 2010 year for good performance. Because this must be reported in US dollars on your US expat tax return you need to translate this amount to USD.
Using the exchange rate on December 31st, 2010, this amount is reported on US returns as $13,401. If you choose to accrue the item with the rest of your salary from 2010, you would use the annual exchange rate. Using the annual average exchange rate would translate your 10,000 EUR bonus into $12,739 in US dollars. By using the exchange rate on December 31st, you would earn more USD and have a taxable income that is $662 higher. As you would imagine the method you use to convert your foreign earnings to USD can have a significant impact on your USD earnings. Individuals who receive large bonuses, have higher incomes, or sell overseas assets (such as houses) can save considerable amounts of money on their US expat tax return while remaining in full compliance.
How to Convert Currency for the FBAR
The U.S. Department of the Treasury prefers you use the exchange rate at the end of the year when reporting your FBAR with Form TD-F 90-22.1. You can, however, opt to use any “generally accepted” exchange rate for your FBAR conversion, as per an announcement from the U.S. Department of the Treasury. Using the correct exchange rate may determine whether or not you are required to file the FBAR at all.
US Tax: Planning Ahead
It is good to plan ahead for currency conversion; by taking note of the exchange rate on the day you either make or receive payment and keeping it on file (a popular option is an Excel Spreadsheet), you reduce preparation time when it comes to calculating how to convert your earnings or expenses for US tax reporting. Dollarizing your income can yield significant savings, particularly for those expats in a country with a volatile currency. Of course the easier option is to hire an expat tax expert to prepare your taxes for you and make sure they look at the different options for exchange rates. If you have any questions about converting your earnings or expenses into US dollars for your US tax return, please contact us for US expat tax advice.