Expatriates or Expat Tax Deferral Planning

By Jason Watson, CPA
Posted Monday, December 30, 2024

For our small business owners or contractors working overseas, there is a consideration when it comes to tax deferred retirement planning. Currently the amount of foreign earned income that can be excluded from ordinary income tax is $130,000 (for the 2025 tax year). Therefore, if you qualify as an expat and your income is less than $130,000 all your income is excluded.

Fast forward, if you elect to defer some of your earnings into a tax deferred retirement account you might be creating a tax liability unnecessarily. In other words, if your income was already being excluded from income tax, why put money into a tax deferred retirement account just to pay tax on the money later when that money was never supposed to be taxed in the first place. Huh? Stay with us.

You make $130,000. You pay $0 in taxes. You put $7,000 in a normal trading account. This $7,000 was never taxed and never will be. You make $10,000 on it because you’re smart. You sell the investments and recognize a $10,000 taxable gain all at capital gains rates.

Same situation, but with an IRA-

You make $130,000. You pay $0 in taxes. You put $7,000 (for the 2025 tax year) in an IRA. This $7,000 is not taxed. You make $10,000 on it because you’re smart. You sell the investments, withdraw the money and recognized a $17,000 taxable gain, all at ordinary income tax rates.

There are more devils in the details of course, but you get the general idea. To put money away in a tax deferred retirement account when that income was already going to be excluded generally does not make sense. A Roth IRA in this situation would be more ideal.

Implementing a 401k plan doesn’t solve any problems either. According to the IRS and specifically IRC Sections 1402(a)(11), 3401(a)(8) and 911, and Revenue Ruling 70-491, if all your income is excluded using the foreign earned income exclusion, then you cannot contribute to a 401k plan.

Revenue Ruling 70-491 sums it up from 1970 (when the foreign earned income exclusion was $25,000). An attorney established a profit-sharing plan and earned $40,000. The ruling stated only $15,000 was considered earned income for the purposes of Section 401 (which is where we get 401k plan stuff).