How much of my income can I exclude when claiming the foreign earned income exclusion?
As a U.S. citizen or a resident alien of the United States living abroad, you are taxed on your worldwide income. If you do not reside within the US or its territories or have any US income, you are still required to file an income tax return and pay taxes on your worldwide income, unless you do not meet the minimum filing requirements.
Fortunately, you can qualify to exclude from income up to an amount of your foreign earnings that is adjusted annually for inflation. Additionally, you may qualify to exclude or deduct certain foreign housing amounts. But you must file a tax return each year to claim the exclusion or deduction; otherwise you could risk having the IRS disqualify you from claiming the foreign earned income exclusion should you be audited later. What this means is you could potentially be taxed on those earnings both in your foreign country of residence and in the US. Ouch! And don’t forget about potential penalties and interest imposed by the IRS on those unfiled tax returns.
What are the requirements to claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction?
There are three tests that must be met, but you must first understand the definition of each test.
What are the requirements to meet the bona fide residence test?
To meet the bona fide resident test
What is a bona fide resident?
You are not automatically a bona fide resident by simply living in a foreign country or countries for a full tax year. To be a bona fide resident you must
Important!! The bona fide resident test is determined on a case by case basis based on questions you answer on the IRS Form 2555 or 2555-EZ. Factors taken into account as to whether you qualify as a bona fide resident are the nature and length and also your intention or purpose of your stay abroad. If you are overseas and work for an indefinite or long period of time and set up a permanent residence for you and your family you will likely qualify. However, if you go overseas for a defined period of time to work on a project, you will likely not qualify.
If you leave the country for short periods of time for business or pleasure, as long as you intend to return, you can still be considered a bona fide resident if you meet the test above.
What are the requirements to meet the physical presence test?
To meet the physical presence test, you must
How to count the days:
A full day is considered to be a full 24 hour period beginning at midnight.
What are the rules to determine the 12-month period?
The IRS provides four rules to determine a 12-month period
What if I don’t meet the 12-month period for a tax year?
In the year of a move to a foreign country, it is not always possible to meet the 12-month period in a calendar year. In this case, the IRS offers US citizen and resident alien taxpayers who expect to file the Form 2555 or Form 2555-EZ and need additional time to meet either the bona fide residence test or the physical presence test to claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction. This extension can go beyond the normal filing extension due date of October 15th to meet either of the two tests!! To request an extension under these conditions, yYou must complete the Form 2350, Application for Extension of Time To File U.S. Income Tax Return. To file the Form 2350, you must:
Earned income is defined as pay, either in cash or non-cash form for services provided. It includes:
· The following items could be considered either earned or unearned income. Please contact US Expat Tax help to determine how these items are classified in your specific case. Income from:
What is not considered foreign earned income?
Your tax home is defines as the general area of your main place of business, employment, or post of duty. You do not have to maintain your family home in the same area as your tax home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live.
One point that is important for expats to note is you are not considered to have a tax home in a foreign country for any period in which your “abode” is in the United States. "Abode" has been variously defined as one's home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. "Abode" has a domestic rather than a job related meaning and does not mean the same as "tax home." The location of your “abode” can differ from your tax home and often will depend on where you maintain your economic, family, and personal ties.
Data Source: www.irs.gov
Disclaimer of Liability: This publication is intended to provide general information to our clients, friends and readers. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.
IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.
By Stephen Stambaugh
Last updated: January 15, 2019