Tax Season in Portugal

It’s not actually tax season in Portugal yet, but…it’s complicated.

I’m from the USA – one of the only countries on earth that taxes citizens for being citizens, regardless of where they are in the world. (In most places, you pay local taxes – to support the cost of the services you’re using – with much-reduced taxation in your country of origin. The US taxes you exactly the same no matter where you are in the world.)

In general, US vendors and employers are required to send tax forms showing money earned the prior calendar year by January 31, so “tax season” begins on the first of February. Federal taxes must be submitted by April 15. If you’re owed a refund, it will appear within a month or so.

In Portugal, the tax season begins on April 1, when the tax reporting system opens for the year. There are no documents to wait for – employers enter the data in the tax system, and it’s there waiting for you.

But there’s a third tax season in our calendar now – the place where these two systems meet.

Tax Treaties: a unique set of rules

Our status is unique to us, and everyone’s story will vary based on their income sources and the countries and tax treaties involved. Obviously, I’m not going to give a bunch of specifics about our income and taxes!  But I’ll share enough to help you start asking the right questions.

Paying Taxes

In the U. S. system, taxes are withheld throughout the year, and at the end of the year, it’s possible to either owe or receive money. Depending on your deductions and specific circumstances, you can find that you owe money (in which case, a payment is submitted with your tax filing) or that you have overpaid (and a refund will be issued within about 30 days of your tax filing). If you owe money and don’t send payment by April 15, you can be assessed usurious interest on the debt.

In the Portuguese system, you can “file” (enter your information into the central system) in April. Your data will be reviewed and assessment, if any, will be conveyed by late summer. If you owe a payment, you can use Portugal’s excellent “Multibanco” payment system.

For government payments, transaction limits are exempted so while I couldn’t pay for a new car as a commercial transaction (for that I’d need to do a traditional bank transfer), when we purchased our home, the sales tax payment was made via MB. The tax authority’s government vendor ID permitted the over-limit amount to go through. You can use the same method to pay for groceries – the terminal displays a QR code containing the data that you can scan with your bank app.

Double Taxation

Because our country has a tax treaty with Portugal, we are protected from being taxed twice on the same income – but to use that protection, there are a few hoops to jump through.

Our treaty says that the U.S. will allow us to offset any taxes already paid to Portugal. So if we pay $800 in income tax to Portugal, and our US tax filing shows we owe $1,000 – we will pay $200 to the US, having already paid the rest to Portugal.

Philosophically, the way that works is “since you don’t actually live in the US, and have to pay taxes in Portugal, we won’t make you pay the same tax again – you only pay the difference.”

Operationally, it’s a slightly different story.

You can’t even start entering Portuguese taxes until April 1, remember? And you don’t know what you’ll owe until August. But your American taxes have to be filed and paid by April 15.

Oops.

Fortunately, the IRS has thought about this, and grants an automatic extension to citizens who live abroad. Which not only doesn’t help at all, but creates its own confusion.

• The automatic extension is two months – until June 15. Which means Americans in Portugal still have to file for an extension. The 6-month expat extension gives you until October 15.
  • The automatic extension is only automatic if you attach a statement to your return explaining how you qualify for it.
  • It’s possible to apply for an additional 2-month extension, which would give you until December 15.
  • Different forms apply depending on your circumstances. Form 4868, for example, requests that October extension. But Form 2350 is used for Foreign Earned income Exclusion extensions.
• If you receive an extension, it applies only to the tax filing. If you owe money, it’s still due by April 15.
  • Interest begins to accrue at that time.
  • In mid-June, late payment penalties begin to accrue

Which basically means you need to ensure that you have an idea of what you’ll need to pay, and ensure the IRS has more than that from you prior to April 15, then wait and get the difference back in the fall as a refund when you file your taxes.

• If you have more than a threshold amount in a foreign bank account, you’re also required to file an “FBAR” (FinCen114) with the Treasury Department by April 15.

Categories and Complications

We’ve found some things to be very similar, and others to be very different from our country of origin. For example, we sold our house in the US, and bought a home in Portugal. Because we sold a primary residence and then immediately bought a new primary residence – the capital gains rules worked very similarly. Other things are totally different – sometimes because the Portuguese system categorizes the income differently, and sometimes because the tax treaty has rules that affect a specific type of income.

For example, as “employees of organizations that were part of the government”, our pensions are “government pensions”.  This is a different thing than the national pension of, for example, the UK, which is more analogous (in this case) the what the US calls “Social security”. In Portugal, our social security will be taxable income. Our government pensions are not, as the tax treaty gives the US the first rights of taxation. So we’d owe no tax on that income here, and it’s taxed normally in the U. S.

If we apply for citizenship in Portugal, as Portuguese citizens, that income would be taxable – but still being US citizens, we’d look to the US to offset the double taxation. If we don’t apply for citizenship, then when we’re old enough for social security, that portion of our income will be taxable, while the pensions still would not – but the tax rate would be determined based on both.

Our current status does offer one advantage: until we are old enough for social security or apply for citizenship, our state pension income is basically exempt in Portugal. If we can be confident we won’t owe money here – we can file our US taxes on time without dealing with the foreign tax credit and the timelines it imposes.

One-time considerations

Since this is our first year, we also have the challenge that our status changed partway through the year. Like so many things involving taxes, the rule about when you become tax resident is “it depends.” While there are lots of variables, at a simple level, tax residency in Portugal is determined by one of two things:

• The date you arrived in country with the intend to reside
• The date you updated your address on your taxID

Portugal has multiple “user IDs” – a taxpayer ID, a resident/citizen card number, a worker/income ID, a health system ID – unlike the US, there’s not just one central identifier to make it easy for the identity thieves.  In order to do any business – open a bank account, for example – you have to have a tax contributor ID.

Obtaining a contribuinte or NIF is one of the first tasks in getting your visa application together. In the past, if you weren’t in the country, you had to have a legal agent on the ground. With electronic communications available, Portugal no longer universally requires that – but your address has to be the place you actually live. Once we arrived, one of our tasks was to remove our agent and then update to our new local address. That took a couple of steps and a little bit of time

So for us, the possibilities for determining “when we became tax resident in Portugal” were:

• April 12 (arrival date)
  • Or any date from April 12 to June 12 (arrival +60 days)
• July 17 (the date that our updated NIF document was issued)

In our circumstance, our official tax residency began with the change to our NIFs. Why does it matter? There are a few significant impacts. For example:

• We sold our house in the US in May.  In our case, it’s unlikely we would have had a tax burden in Portugal anyway – but finalizing all of our business in the US prior to our change in tax residency means that this doesn’t even need to be included – and the complexity of trying to address it with unfamiliar US sale and tax documents isn’t something we’ll need to navigate.
• Our taxable income for this first year is half what it is in the US, because only the second half of the year counts.

This also means that “all the things we have to do and consider” in year one are just a little different than they will be in subsequent years. And two other people, whose situation is 90 or 95 percent similar to ours – might have different answers. Tax law is like that everywhere, apparently.

Which mostly goes to show why it is worth the cost to hire tax accountants to help you navigate and ensure you’re doing the right things.

About tax rates

Portuguese tax rates are progressive, so not only does the tax rate depend on your income, it applies only to that tier of income. The US system is similar, but the brackets and percentages are lower. The numbers below are an example – “not tax advice” and all that. In a highly simplified and not-in-any-way-accurate-to-your-accountant way, they do give an insight into how the taxes paid differ. They show the current tax brackets for both countries, and how that would lay out for someone earning 100k/yr.

(PT) Earnings	Tax Rate	Amount of income taxed at this rate	Tax
Up to €8,059	13.0%	€                           8,059	€      1,047.67
Over €8,059 up to €12,160	16.5%	€                           4,101	€          676.67
Over €12,160 up to €17,233	22.0%	€                           5,073	€      1,116.06
Over €17,233 up to €22,306	25.0%	€                           5,073	€      1,268.25
Over €22,306 up to €28,400	32.0%	€                           6,094	€      1,950.08
Over €28,400 up to €41,629	35.5%	€                        13,229	€      4,696.30
Over €41,629 up to €44,987	43.5%	€                           3,358	€      1,460.73
Over €44,987 up to €83,696	45.0%	€                        38,709	€   17,419.05
Over €83,696	48.0%	€                        16,304	€      7,825.92
			€   37,460.72

(US) Earnings	Tax Rate	Amount of income taxed at this rate	Tax
$0 to $11,600	10%	$                        11,600	$             1,160
$11,601 to $47,150	12%	$                        35,549	$             4,266
$47,151 to $100,525	22%	$                        53,374	$          11,742
			$          17,168

About the difference in taxes

The difference in those two totals can certainly give folks sticker shock. In expat groups, most of the comments we see on the topic are from people who are looking for ways to get out of paying so much, or complaining about it. When Portugal revamped their “non-habitual tax regime” and ended the program that allowed expats to pay a flat 10% on a lot of their income for 10 years, we saw lots of people up in arms and commenting that “this just rules Portugal out for me.”

I find these statements flat-out offensive, entitled – and tunnel visioned.

Tunnel visioned

It seems shortsighted to me to look at only one bugaboo and use it as the basis for financial decisions. By all means, make decisions that are sound based on your situation – but your financial situation encompasses so much more than taxes. For example:

• Add up your expenses and co-pays for the last year and compare them to what you’ll pay in your destination country. (The private medical insurance we keep in addition to our access to the public system costs us both less for a year than the monthly cost quoted to my husband’s father more than a decade ago.)
• We bought a home of similar size and value to our former US home. Our US property taxes were more than ten times our Portuguese ones.
  • And the annual insurance that cost us over $2k in the US is ¼ that amount here – even with zero deductible and earthquake coverage included.

We feel like it will be a year or two before we can say for sure whether we are even paying “more”, but for the moment what we know is that we are paying “differently.” And the logic behind that difference is this:

• Everyone contributes. For example, we all pay property tax and that helps cover the costs of some of our local services.
• Those who are benefitting most, contribute proportionally. Their prosperity is supported by shared resources (for example, their production facilities use electricity from the public grid, and goods travel on public roads), and the impact to them is less (in our 100k example, the 8k paid on income above 83k didn’t cause any hardship. “Splitting the bill equally” so that they only paid 4k and someone making 12k/yr paid the other 4k on the other hand…).

We have a friend in the US who survives on disability. We came to Portugal, in part, because we prefer a system that assumes people like her have a right to thrive. A few extra bucks paid in taxes, one less trip to some other European country each year – seems like a reasonable tradeoff. Not everyone has to agree, of course – but if you’re going to ask a country to allow you to come and live there, allow you the benefit of everything they have built – maybe don’t be offended by being asked to give just a little bit in return.