U.S. Taxes While Living in Spain

Living in a foreign country is a dream for many people. The fascinating culture, ancient architecture, a completely new cuisine, the weather...it can be a truly exhilarating adventure. But as with most things, there is the mundane legal side of life that also has to be taken into consideration. One of the major challenges facing U.S. expatriates living in Spain is understanding their tax obligations. The following information should help you to navigate this minefield and familiarize yourself with the system.

U.S. tax obligation for expats

In contrast to many other countries, the United States taxes its citizens on their income – regardless of where they are living in the world. This income encompasses not only wages, dividends and rental income but also capital gains. As a result, Americans are still required to file a tax return (Form 1040, annual deadline April 15th) in the U.S. every year – even if they are living in Spain and paying Spanish tax.

Many U.S. expats are unaware of this, as they are under the impression that, as they are living in Spain, they only need to pay tax there. Unfortunately, this is not the case.

There is, however, no need to panic! You may have heard horror stories about double taxation, but the U.S. tax system actually contains methods of protection which are specifically designed to prevent American expats from paying taxes twice on the same income. Although it is necessary for you to actively claim these protections, the vast majority of expats thereby discover that they owe very little – or even nothing – in U.S. taxes. We shall go into this later on in the article.

The Spanish tax system

The Spanish tax system is progressive, which means the more you earn, the higher your tax rate. The tax rates are separated into bands between €19,000 and €47,000. If you are resident in Spain, you are obliged to pay Spanish tax. You are considered a tax resident of Spain if:

• You live in Spain for more than 183 days in a calendar year.
• The center of your economic interests is in Spain (i.e., you earn most of your income there).

As with the U.S. system, tax residents of Spain must pay taxes on their worldwide income, whereas non-residents only pay tax on the income earned within Spain. If you have the status of Spanish tax resident, you must therefore report all your income – including income earned in the U.S.

As mentioned above, there are protection methods in place which help to prevent U.S. expats being subjected to double taxation, i.e., being taxed by both the U.S. and Spain on the same income. In the following, we look into these in more detail. At the bottom of this article, we have included a list of links to e.g. the IRS website, where comprehensive information on these topics can be found.

U.S.-Spain Income Tax treaty

The U.S.-Spain Income Tax Treaty helps to determine which country is entitled to tax specific types of income. The treaty allocates taxing rights between the two countries and ensures that, in many cases, double taxation can be avoided. Generally speaking, if you are subject to taxes in both countries, the treaty enables you to claim a foreign tax credit or an exemption in order to reduce your U.S. tax bill.

Foreign Earned Income Exclusion (FEIE)

One of the major benefits for U.S. expats is the Foreign Earned Income Exclusion (FEIE). The FEIE allows U.S. expats to earn up to $126,500 (for 2024, subject to annual inflation adjustments) without being liable for U.S. tax. To qualify for the FEIE, you must fulfill the requirements of one of the two following tests:

• Bona Fide Residence Test: You must be a resident of a foreign country (such as Spain) for an uninterrupted period that includes an entire tax year.
• Physical Presence Test: You must be physically present in a foreign country for at least 330 full days during a 12-month period.

If you qualify for the FEIE, a portion of your foreign-earned income can be excluded from U.S. taxation. However, it is important to remember that the exclusion only applies to earned income and not to other types of income such as dividends, interest, or capital gains.

Foreign Tax Credit (FTC)

If you are paying taxes in Spain, the Foreign Tax Credit (FTC, Form 1116) might also be of help. The FTC converts the sum that has been paid in foreign taxes into a credit that can be used to lower your U.S. tax liability. It calculates the total amount of taxes paid, thereby converting the total to USD, and applying the dollar amount to your U.S. tax liability. By using the Foreign Tax Credit, expats can therefore prevent double taxation. The FTC can be used in combination with the FEIE, but you cannot claim a credit for taxes paid on income that is excluded under the FEIE (see IRS website for detailed information).

Foreign Bank Account Report (FBAR)

The Foreign Bank Account Report (FBAR) must be filed if the total value of your foreign financial accounts exceeds $10,000 at any point during the calendar year. The FBAR is filed separately from your tax return, using FinCEN Form 114, and must be submitted by April 15th every year.

It is crucial to keep an eye on your financial accounts as even one dollar more than the $10,000 threshold leads to an obligation to file the FBAR. Failure to do so can result in substantial penalties.

FATCA

In addition to the FBAR, U.S. expats are also subject to FATCA (Foreign Account Tax Compliance Act). FATCA was enacted in 2010 in order to combat tax evasion; as a result, foreign bank accounts and other overseas assets must be declared to the IRS if the total value of those assets exceeds certain thresholds.

In order to fulfil the FATCA reporting requirement, Form 8938 must be filed along with your annual tax return (Form 1040). Form 8938 requires you to disclose foreign bank accounts, brokerage accounts, and other specified foreign assets. The reporting thresholds for FATCA are higher than for FBAR. As an example, if you are living abroad, you must file Form 8938 if your foreign assets exceed:

• $200,000 at the end of the year or $300,000 at any point during the year for single persons
• $400,000 at the end of the year or $600,000 at any point during the year for married couples filing jointly

Once again, it is important to stress that it is crucial for you to keep a check on your financial assets, as failure to file Form 8938 can result in significant penalties.

Spanish tax deductions and exemptions

The Spanish tax system offers a number of tax deductions and exemptions for residents, which can reduce your overall tax liability. Examples include social security contributions, pension-plan contributions, and some mortgage interest payments. Furthermore, Spain offers tax deductions for dependent children and family members.

However, as a U.S. taxpayer, you will probably still need to report your Spanish income and to pay U.S. taxes on it. It is therefore important to know how U.S. and Spanish tax laws work and how they interact with one another. It is highly advisable to seek advice from a tax professional who is familiar with both systems.

Self-employment taxes for U.S. expats

If you are self-employed while living in Spain, you are still required to pay U.S. self-employment taxes (social security and Medicare) on your net income, in addition to any Spanish taxes. Your social-security contributions will be handled by the Spanish social-security system, but as U.S. expats must still contribute to U.S. social security if they are self-employed, this can result in social-security obligations being doubled. A totalization agreement exists between the U.S. and Spain; this helps prevent double contributions to social security, and generally allows you to only pay into one country’s system – either the U.S. or Spain, but not both.

Obtaining professional help

Navigating the minefields of U.S. and Spanish tax laws can be extremely complicated. The necessary reporting of earnings, assets, etc., the myriad of different forms and the diverse types of protection and exemption can be overwhelming for persons without in-depth knowledge of the systems. As a result, many expats obtain help from a tax professional who specializes in international tax law. An expert can help you to not only ensure compliance with both U.S. and Spanish tax obligations – thereby avoiding the risk of penalties – but also to maximize your potential tax benefits.

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References

IRS.gov, filing requirements

IRS.gov, FATCA

IRS.gov, FBAR

IRS.gov, tax treaty U.S.-Spain

IRS.gov, form 2555

IRS.gov, FEIE

myexpattaxes.com, expat tax guide

greenbacktaxservices.com, expat tax guide

Santander, calculating Spanish tax