US citizens in Spain and how US and Spanish tax fit together

Key rules

• Two returns: As a US citizen resident in Spain, you file in both countries every year, even if you owe no US tax.
• Double tax relief: Credits for tax paid in the other country relieve double taxation, but the treaty does not stop the US taxing you.
• Credit or exclusion: You cannot claim both on the same income, and the exclusion does not cover dividends, interest or capital gains.
• Interest: Interest on unpaid US tax runs from 15 April even if you extend your filing.

You file in both countries

Moving to Spain does not end your US tax duties. The US taxes its citizens on worldwide income wherever they live. Spain taxes you on worldwide income once you are a Spanish tax resident. So you file a US return and a Spanish return every year.

The tax treaty between the two countries has a "saving clause". It lets the US tax its own citizens as if the treaty did not exist. This means you cannot use treaty reductions against your US tax. A few treaty parts still work for you, mainly the relief from double taxation, non-discrimination and the procedure for settling disputes between the two tax offices. Some rules on pensions, government pay and students or teachers also still apply.

How you avoid paying twice

You are not meant to pay full tax twice on the same income. Two tools exist, and you cannot use both on the same income:

• Foreign tax credit. The Spanish income tax you paid is credited against US tax on the same income. Unused credit can be carried back one year and forward ten years.
• Foreign earned income exclusion. Part of your earned income, up to a yearly limit, is left out of US tax. You must pass the bona fide residence or physical presence test. It does not cover dividends, interest or capital gains. Cancelling the exclusion later locks you out of it for five years, so think before choosing it.

Spanish income tax is higher than US tax for most residents, so for most US citizens resident in Spain the foreign tax credit removes most or all of the US tax on income Spain taxes, and the foreign earned income exclusion is rarely the better choice.

Spain also gives credit for US tax on US-source income, as the treaty allows. Spanish wealth tax and social security are not covered by the income tax credit. A separate agreement between the two countries coordinates social security.

What the US asks of you each year

• Form 1040 reports your worldwide income if it is above the filing threshold. It is due 15 April, but people living abroad get an automatic extension to 15 June. Form 4868 extends it to 15 October. Interest runs on any tax due from 15 April.
• FBAR is required if your combined foreign account balances go above 10,000 USD at any point in the year. It has the same 15 April date, with an automatic extension to 15 October.
• Form 8938 goes with your 1040 if your foreign financial assets pass higher limits for people abroad. For a single filer, that is 200,000 USD at year end or 300,000 USD at any time.
• Modelo 720 is the Spanish report of assets held abroad, which includes US bank accounts, brokerage accounts and shares. You file it with the Spanish tax agency if the assets in any one category (accounts, securities, property) exceed 50,000 euros, between 1 January and 31 March for the previous year.
• Other forms may apply: 5471 for foreign companies, 8621 for PFICs (which include many Spanish investment funds) and 3520 for foreign trusts and gifts.

Spanish investment funds are a common trap for US citizens, because they count as PFICs and carry heavy US reporting. As a US person, avoid buying Spanish or other EU investment funds, or get advice before you do. If you already hold some, report them on Form 8621 every year.