The US dollar circulates as legal tender in Panama right alongside the balboa, Panama taxes only Panama-source income under its territorial system, and the country's Pensionado program has turned it into one of the most established retirement havens for Americans in Latin America. None of that convenience carries over to the US side of the return, because citizenship-based taxation keeps every American filing a Form 1040 on worldwide income no matter how little the Direccion General de Ingresos ever touches. Panama and the United States have signed a tax information exchange agreement and a FATCA intergovernmental agreement, but neither one is a comprehensive income tax treaty, and no totalization agreement covers social security either. The result is a US filing obligation that runs entirely on its own rules, with double-tax relief built solely from the Foreign Tax Credit and Foreign Earned Income Exclusion under domestic US law.
Do US Citizens Living in Panama Have to File Both DGI and US Tax Returns?
Almost always on the US side, but not necessarily on the Panamanian side. The United States taxes its citizens and green card holders on worldwide income no matter where they live, a rule tied to citizenship and immigration status rather than residency, so a US Form 1040 is due every year regardless of what Panama requires. Panama, by contrast, runs a territorial system under the Direccion General de Ingresos and generally taxes only Panama-source income, so foreign-source income is generally exempt from Panamanian tax.
The practical result is that an American living in Panama on US Social Security, a US pension, or US-based investment income can have little to no Panamanian filing obligation at all, while the US return remains mandatory in every case. Someone earning Panama-source wages or running a business inside Panama will have a genuine DGI filing requirement layered on top of the US one. Either way, the Foreign Earned Income Exclusion and the Foreign Tax Credit do all of the double-tax planning work on the US side, because there is no treaty coordinating the two systems.
How Does Panama's Territorial Tax System Work for Foreign Income?
Panama taxes individuals on Panama-source income at progressive rates and, as a rule, exempts foreign-source income entirely, which is the opposite starting point from worldwide-tax countries like the United States. Employment income for work performed in Panama, income from a Panamanian business, and Panama-source investment income generally fall inside the DGI's net, while income sourced outside Panama generally does not.
That territorial design, combined with the country's use of the US dollar as legal tender alongside the balboa, is a large part of why Panama has become a major hub for American retirees, including through its Pensionado program for qualifying foreign retirees. None of that changes the US analysis, since the source rules that matter for a Panamanian filing are not the same as the rules that determine whether income counts as foreign earned income under IRC Section 911. Current-year Panamanian rates and sourcing rules should always be confirmed before finalizing a return, since a stale assumption about what counts as Panama-source can throw off both the DGI calculation and any US Foreign Tax Credit that depends on it.
Should You Claim the FEIE or the Foreign Tax Credit on Panama Income?
For most Americans in Panama, the Foreign Earned Income Exclusion tends to carry more weight than it does in higher-tax expat destinations, precisely because Panama's territorial system often leaves little or no Panamanian tax on the table to credit. When foreign earned income escapes Panamanian tax entirely under the territorial rules, the Foreign Tax Credit on Form 1116, computed by category under IRC Sections 901 and 904, has nothing to credit against US tax, which pushes the analysis toward the exclusion instead.
The Foreign Earned Income Exclusion on Form 2555 excludes foreign earned income up to an annually indexed maximum, for example $130,000 for 2025, under IRC Section 911, and does not depend on any Panamanian tax having been paid. It does nothing for self-employment tax, can disqualify the refundable Additional Child Tax Credit for a family with kids, and once revoked generally cannot be re-elected for five years without IRS consent. Income from US sources, such as a US employer, US clients, or US investment accounts, is not foreign earned income at all and stays fully taxable on the US return either way. Our FEIE versus Foreign Tax Credit comparison walks through the decision in more detail.
What Does the US-Panama Tax Information Exchange Agreement Do for Double Taxation?
Not much on the double-tax side, because it is not an income tax treaty. The United States and Panama have a tax information exchange agreement, which allows the two governments to share tax-relevant information on request, and a separate FATCA intergovernmental agreement, which governs how Panamanian financial institutions report US account holders. Neither agreement sets tie-breaker residency rules, reduces withholding rates, or supplies any mechanism for double-tax relief on its own.
With no income tax treaty in place, double-tax relief for a US person in Panama rests entirely on domestic law, the Foreign Tax Credit under IRC Sections 901 and 904 and the Foreign Earned Income Exclusion under IRC Section 911. Panama's territorial system already limits how much Panamanian tax there typically is to credit, so in practice the exclusion carries more of the load than the credit does for most Americans living there.
Does a US-Panama Totalization Agreement Cover Social Security?
No. The United States and Panama have never signed a totalization agreement, which means there is no certificate of coverage available to exempt a worker from paying into one country's social security system because they are already covered by the other's. That gap matters most for the self-employed, since a self-employed American doing business in Panama can face full US self-employment tax on net earnings with no Panamanian offset at all, in addition to any Panamanian social security contributions required on Panama-source activity.
An employee working for a Panamanian employer may see local social security withheld directly, but that withholding does nothing to reduce a US self-employment tax bill for someone working independently. Confirming coverage rules before setting up a Panama-based consulting or freelance arrangement is worth doing early, since there is no treaty-style exemption to fall back on later. See the Social Security Administration's totalization agreement overview for how the program works in countries where an agreement does exist.
How Are Panamanian Pensions and Retirement Accounts Taxed by the US?
Not automatically, and Panama's Pensionado program is exactly the kind of local perk that lulls people into assuming it carries over to the IRS. It does not: the discounts and benefits that come with qualifying Pensionado status are a Panamanian matter only, with zero effect on how a Panamanian pension or retirement account is treated on the US return.
IRC Sections 401(a) and 402(b) set the baseline: earnings building up inside a foreign retirement plan are generally taxable to a US person as they accrue, not when they are finally withdrawn, unless a treaty steps in to defer them. With no US-Panama income tax treaty on the books to supply that deferral, a Panamanian retirement account defaults to the general rule rather than getting the benefit of a treaty carve-out. Our foreign pension US tax treatment guide walks through the four questions that determine the answer for any foreign plan: whether growth is taxed as it accrues, whether a treaty defers it, what has to be reported, and how distributions are taxed.
Are Panamanian Investment Funds Taxed as PFICs?
Usually, yes, which catches many Americans off guard after they open an investment account with a Panamanian bank instead of keeping their portfolio at a US brokerage. A Panamanian mutual fund or other pooled investment vehicle typically meets the definition of a passive foreign investment company under IRC Section 1297, with Sections 1291 and 1298 governing the tax treatment, and Panama's territorial system has no bearing on that US classification since it applies whether or not any income tax treaty exists.
Once that PFIC label attaches, the default US outcome is harsh: without a timely election, gains and certain distributions get allocated across the entire holding period, taxed at the top rate for each of those years, and charged interest on top as though the tax had been owed all along. Each PFIC generally requires its own Form 8621 filing, even in a year where no tax is actually due, which is why Americans in Panama are usually steered toward US-domiciled brokerage accounts and US-based index funds rather than a local Panamanian fund.
What Else Do You Have to Report to the IRS?
The income tax return is not the only obligation on the table: Panamanian bank, brokerage, and investment accounts each trigger their own separate reporting requirements that exist independent of whether any US tax is actually owed and independent of the missing tax treaty or totalization agreement. Each filing is enforced under its own penalty structure, and those penalties routinely run far higher than whatever tax would have applied to the underlying account.
The Panama Reporting Stack
Reference- FBAR (FinCEN Form 114). Required when the combined balance of your Panamanian bank, brokerage, and pension-related accounts exceeds $10,000 at any point during the year. See our FBAR filing guide.
- Form 8938 (FATCA, IRC §6038D). A separate filing threshold, higher for Americans living abroad, that can require you to list the same Panamanian accounts directly on your federal tax return. See our Form 8938 guide.
- Form 8621 (PFIC). Generally required for each Panamanian mutual fund or other pooled fund that qualifies as a passive foreign investment company. See our PFIC and Form 8621 guide.
Citizenship already settles the filing question for most Americans in Panama, but not for someone whose status is murkier, for example a green card holder splitting time between Panama and the US, or a move to Panama that only became permanent partway through the year; that residency question gets answered separately by the substantial presence test.
Bottom Line
Between the territorial system, the dollarized economy, and the Pensionado program, Panama makes relocating easy in a way few countries can match, and that is exactly why Americans underestimate how separate the US filing obligation stays. With no income tax treaty and no totalization agreement linking the DGI to the IRS, the Foreign Tax Credit and the Foreign Earned Income Exclusion are left to handle double taxation entirely on their own, self-employment income carries the full US tax with no Panamanian offset, and retirement accounts and investment funds each need their own separate look. None of that is optional paperwork; the penalties on the reporting side alone routinely dwarf whatever tax was actually at stake.
Have questions about US expat taxes in Panama? Contact TS CPA for a free consultation. We respond within the same day.
Official IRS and Government Sources
- IRS, Foreign Earned Income Exclusion
- IRS, Foreign Tax Credit
- IRS, US Citizens and Resident Aliens Abroad
- IRS, United States Income Tax Treaties A to Z
- Social Security Administration, Totalization Agreements Overview
- FinCEN, Report of Foreign Bank and Financial Accounts (FBAR)
- IRS, About Form 8621
- IRC Section 911, Citizens or Residents Living Abroad