Tax guide for Americans in Japan

Resident vs. non-resident of Japan

When an American expatriate moves to Japan, one of the first and most crucial steps in understanding their tax obligations is determining their residency status. Japan’s tax system classifies individuals into two main categories: residents and non-residents, each with different tax implications.

Resident status

Residents in Japan are further divided into "permanent residents" and "non-permanent residents."

• Permanent residents: These are individuals who have lived in Japan for more than five years within the past ten years. Permanent residents are subject to tax on their worldwide income, regardless of where it is earned or paid.
• Non-permanent residents: These individuals have lived in Japan for five years or less within the past ten years. Non-permanent residents are taxed on all income earned in Japan and any income from abroad that is remitted to Japan.

Regardless of their permanent or non-permanent status, residents are required to pay tax on their global income if Japan is their domicile. They are also eligible for various tax deductions and credits, which can significantly reduce their taxable income.

Non-resident status

Non-residents are individuals who have lived in Japan for less than one year and do not have a permanent home in the country. They are only taxed on their Japan-sourced income, and any foreign income is generally not subject to Japanese tax. However, non-residents are not eligible for the same range of tax deductions and credits as residents.

Types of taxation in Japan

Japan has a comprehensive tax system that affects both residents and non-residents. Here are the key types of taxes you should be aware of.

Personal income tax rates

Japan's personal income tax is progressive, meaning the rate increases as your income increases. The rates range from 5% to 45%.

The current national rate is:

* Japanese yen

Surtax

In Japan, a surtax is applied to the personal income tax, serving as an additional financial obligation for taxpayers. The surtax is calculated at a rate of 2.1% of the total amount of income tax owed.

This means that once you have calculated your personal income tax based on the progressive rates, you will need to add an additional 2.1% of that amount as a surtax.

For example, if your calculated income tax is 1,000,000 JPY, the surtax would be 21,000 JPY, bringing your total tax liability to 1,021,000 JPY.

Local income tax

Local income tax in Japan, also known as inhabitant tax, is levied by the local prefectural and municipal governments.

This tax is calculated based on the taxpayer's income from the previous year and is typically around 10% of the taxable income.

The local income tax is divided into two parts: prefectural tax and municipal tax, each constituting about 5% of the taxable income.

Consumption tax

Consumption tax in Japan is a national tax levied on the sale of goods and services, similar to value-added tax (VAT) or goods and services tax (GST) in other countries.

This tax is usually included in the displayed price of goods and services, so consumers are not always explicitly aware of the tax. However, it is an important source of revenue for the government.

Certain goods and services, such as food, newspapers, and public transport, are subject to a reduced rate of tax to reduce the financial burden on consumers.

Inheritance tax rates

Inheritance tax in Japan is levied on the assets inherited from a deceased person. The tax rates are progressive and depend on the value of the inherited assets and the relationship between the deceased and the heir. The rates range from 10% to 55%, with higher value inheritances being subject to higher tax rates.

There are also specific deductions available based on the family relationship, which can significantly reduce the inheritance tax liability.

Types of income in Japan

Japan's tax system categorizes income into various types, each with its own set of rules and regulations.

Employment income

Employment income in Japan includes all compensation received as a result of employment services. This encompasses salaries, wages, bonuses, allowances, and any other monetary benefits provided by the employer.

• Salaries and wages: Regular payments made by the employer to the employee for services rendered.
• Bonuses: Additional compensation that may be paid periodically based on performance or company profitability.
• Allowances: Payments for specific purposes such as housing, transportation, or family support.

Equity compensation

Equity compensation refers to non-cash compensation provided to employees in the form of company shares or options to purchase shares. This type of compensation is often used to align the interests of employees with those of the company and to incentivize long-term performance.

• Stock options: The right to purchase company shares at a predetermined price. Taxation occurs when the option is exercised, and the income is calculated as the difference between the market value of the shares and the exercise price.
• Restricted stock: Shares granted to an employee with certain restrictions, usually related to the vesting period. Taxation occurs when the restrictions are lifted, and the income is calculated based on the market value of the shares at that time.
• Stock Appreciation Rights (SARs): A right to receive a cash payment or shares equivalent to the appreciation of the company’s stock over a certain period. Taxation occurs when the SAR is exercised.

Equity compensation can be complex, and the tax implications depend on the specific terms and conditions of the compensation plan.

Business income

Business income in Japan refers to the income earned by individuals from conducting a trade, business, profession, or any other form of self-employment. This includes income from services provided, sales of goods, and any other business activities.

• Calculating business income: Business income is calculated as the total revenue generated from business activities minus the necessary and appropriate expenses incurred in generating that income.
• Expenses: Allowable expenses include costs such as rent, utilities, salaries of employees, cost of goods sold, and other operational costs.
• Taxation: Business income is subject to income tax, and individuals engaged in business activities are required to file a tax return and pay tax on their business income. The tax rate depends on the amount of income and can range from 5% to 45%.

Capital gains

Capital gains in Japan refer to the profit made from the sale of assets such as real estate, stocks, and other investments.

• Real estate: Capital gains from the sale of real estate are classified as either short-term or long-term, depending on the holding period. Short-term capital gains are taxed at a higher rate compared to long-term capital gains.
• Stocks and securities: Capital gains from the sale of stocks and securities are subject to separate taxation, and the tax rate is generally 20.315% (including national and local taxes).
• Tax reporting: Individuals are required to report their capital gains and pay the appropriate tax. There are certain exemptions and deductions available, which can reduce the taxable amount.

Dividend income

Dividend income in Japan refers to the income received by shareholders from their investments in company stocks.

• Taxation: Dividend income is subject to income tax, and the tax rate is generally 20.315% (including national and local taxes).
• Withholding tax: In most cases, the company paying the dividends will withhold the tax at source, and the shareholder receives the net amount after tax.
• Foreign dividends: For Japanese residents, dividend income from foreign sources is also subject to tax in Japan. However, tax treaties and foreign tax credits may apply to prevent double taxation.

Non-resident’s income

Non-residents in Japan are individuals who have lived in Japan for less than one year and do not have a permanent home in the country. Non-residents are taxed only on their Japan-sourced income.

• Japan-sourced income: This includes income earned within Japan, such as salaries for services rendered in Japan, rental income from property located in Japan, profit made from selling property in Japan, and income from business conducted in Japan.
• Taxation: Non-residents are subject to income tax on their Japan-sourced income. The tax rate depends on the type and amount of income.
• Withholding tax: Employers are required to withhold income tax from salaries paid to non-residents. For other types of income, the payer may be required to withhold tax at source.

Social security in Japan

Japan has a full social security system that provides various benefits to residents, including health insurance, pensions, unemployment insurance and workers' compensation.

Participation in these programs is mandatory for all residents, including expatriates, depending on their employment status and length of stay in Japan.

1. Health insurance: There are two main types of health insurance in Japan: Employees' Health Insurance (健康保険, Kenkō Hoken) and National Health Insurance (国民健康保険, Kokumin Kenkō Hoken). Employees of companies are typically enrolled in the Employees' Health Insurance, while self-employed individuals, students, and part-time workers may join the National Health Insurance. Both insurances cover a portion of medical expenses, with the insured person usually paying 30% of the medical costs.
2. Pension: The Japanese pension system consists of two tiers: the National Pension (国民年金, Kokumin Nenkin) and the Employees' Pension Insurance (厚生年金保険, Kōsei Nenkin Hoken). All residents aged 20 to 59 are required to enroll in the National Pension, while employees of companies are also covered by the Employees' Pension Insurance. The pension provides income for the elderly, disabled, and surviving family members of deceased insured persons.
3. Unemployment insurance: The Employment Insurance (雇用保険, Koyō Hoken) provides financial support to individuals who have lost their jobs. Employees of companies are automatically enrolled in this insurance, and it offers benefits such as job-seeking support and training programs.
4. Workers' compensation: The Workers' Accident Compensation Insurance (労働者災害補償保険, Rōdōsha Saigai Hoshō Hoken) provides compensation for work-related injuries, illnesses, and death. All employees, regardless of their employment type, are covered by this insurance.

Deductions for expats in Japan

Expatriates living and working in Japan have access to various tax deductions and credits that can help reduce their taxable income and overall tax liability.

Employment expenses

Expatriates who earn income through employment in Japan can claim deductions for certain employment-related expenses.

• Commuting expenses: Costs incurred while commuting to and from work can be deducted. The amount of the deduction depends on the distance and the mode of transportation used.
• Business expenses: Necessary and actual expenses incurred in the performance of employment duties, such as travel, entertainment, and supplies, can be deductible.
• Work-related deductions: Specific deductions are available for certain professions, such as seafarers and researchers, based on the nature of their work.

To claim these deductions, expatriates must maintain proper documentation and receipts of their expenses. The deductions should be claimed in the annual tax return.

Personal deductions

In general, expatriates can benefit from a number of personal deductions in addition to work-related expenses.

1. Basic deduction: All taxpayers are entitled to a basic deduction, which reduces the amount of income subject to tax.
2. Spouse deduction: If an expatriate’s spouse has low or no income, a spouse deduction may be claimed, reducing the taxable income.
3. Dependent deduction: Additional deductions are available for supporting dependents, such as children or elderly parents.
4. Social insurance premiums: Premiums paid for public pension, health insurance, and long-term care insurance are deductible.
5. Life insurance premiums: Premiums paid for certain life insurance policies and annuities can be deductible, subject to limits.
6. Medical expenses: Medical expenses not covered by insurance that exceed a certain threshold can be deductible.
7. Disaster losses: Losses incurred due to natural disasters may be deductible, subject to certain conditions.

Business deductions

Expatriates in Japan who operate a business or are self-employed have access to various business deductions that can help reduce their taxable income.

1. Operating expenses: Costs incurred in the day-to-day operation of a business, such as rent, utilities, and office supplies, are deductible.
2. Travel and entertainment: Expenses related to business travel, client entertainment, and meals can be deducted, provided they are necessary and directly related to the business.
3. Depreciation: The cost of tangible assets used in the business, such as machinery, equipment, and vehicles, can be depreciated over their useful life, providing an annual deduction.
4. Professional fees: Fees paid for professional services, such as legal, accounting, and consulting, are deductible.
5. Advertising and promotion: Costs associated with advertising and promoting the business can be deducted.
6. Employee salaries and benefits: Salaries, wages, and benefits paid to employees are deductible business expenses.

Losses

Business losses can also impact an expatriate’s tax situation in Japan.

• Operating losses: If a business’s expenses exceed its income, the resulting operating loss can be used to offset income in other categories, reducing the overall taxable income.
• Carryover of losses: In some cases, business losses can be carried over to future tax years to offset income in those years, providing tax relief over time.
• Capital losses: Losses from the sale of capital assets, such as property or investments, can be deducted, subject to certain conditions and limits.
• Disaster losses: Losses incurred due to natural disasters or other unforeseen events may be deductible, providing additional relief.

The tax treaty between the US and Japan

The United States and Japan have a tax treaty in place to prevent double taxation of income and provide clarity on the tax treatment of various types of income.

• Avoidance of double taxation: The treaty outlines which country has the right to tax specific types of income, ensuring that individuals are not taxed on the same income by both countries.
• Reduced withholding taxes: The treaty may reduce the withholding tax rate on certain types of income, such as dividends, interest, and royalties, paid from one country to a resident of another country.
• Tax credits: Individuals who pay tax to one country on income that is also taxed by the other country may be eligible for a foreign tax credit, reducing their tax liability.
• Pensions and social security: The treaty includes provisions regarding the taxation of pensions and social security benefits, providing clarity for retirees and beneficiaries.
• Assistance in tax matters: The treaty facilitates cooperation between the tax authorities of the two countries, including the exchange of tax information and assistance in collecting tax debts.

Most popular tax forms for US expats

US expatriates living in Japan are required to file US tax returns, and there are several forms that are commonly used:

1. Form 1040: The standard US individual income tax return, which all US citizens and resident aliens must file if their income is above a certain threshold.
2. Form 2555: Used to claim the Foreign Earned Income Exclusion, which allows qualifying expats to exclude a certain amount of their foreign earned income from US taxation.
3. Form 1116: Used to claim the Foreign Tax Credit, which provides a credit for income taxes paid to a foreign country.
4. Form 8938: Required for taxpayers with specified foreign financial assets that exceed certain thresholds.
5. FBAR (FinCEN Form 114): Required if a taxpayer has a financial interest in or signature authority over foreign financial accounts and the total value of the accounts exceeds $10,000 at any time during the calendar year.

When are Japanese taxes due?

In Japan, the fiscal year runs from January 1 to December 31, and the deadline for filing income tax returns is March 15 of the following year. If additional tax is owed, it must be paid by this date to avoid penalties and interest.

If a taxpayer is unable to file by the deadline, they may apply for an extension, but any tax owed must still be paid by March 15.

Japan tax forms for US expats

US expatriates living in Japan will primarily deal with the following Japanese tax forms:

1. Form B: used by residents to report their income and claim deductions. It includes various schedules for different types of income and deductions.
2. Form 16: used to report employment income and any tax withheld at source.
3. Form 17: used by self-employed individuals to report their business income and expenses.
4. Form 22: used to report capital gains from the sale of property or securities.
5. Form 23: used to report rental income.