Foreign Earned Income Exclusion

Foreign Earned Income Exclusion

Income can be excluded from taxes 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.

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.

You must have foreign earned income and

You tax home must be in a foreign country and

You must be one of the following:

A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,

A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or

A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

Foreign Earned Income Exclusion - Requirements

To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income, your tax home must be in a foreign country, and you must be one of the following:

A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,

A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or

A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

Changes in the Foreign Earned Income Exclusion

The maximum amount of the Foreign Earned Income Exclusion under Internal Revenue Code (IRC) section 911 is indexed to inflation ($100,800 for 2015, $101,300 in 2016, $102,100 in 2017) and 2018 is $104,100.

The amount of foreign earned income (and foreign housing costs) excluded from an individual's gross income will be used for purposes of determining the rate of income tax and alternative minimum tax (AMT) that applies to his or her non-excluded income. An individual’s tax on any foreign earned income above the exclusion amount and on any unearned income is computed as if the foreign earned income exclusion was not claimed. The individual's tax will be the excess of the tax that would be imposed if his or her taxable income were increased by the amount(s) excluded, and the tax that would be imposed if his or her taxable income were equal to the excluded amount(s). For this purpose, the excluded amount(s) will be reduced by the aggregate amount of any deductions or other exclusions otherwise disallowed.  In many cases this will have the effect of increasing an individual’s U.S. federal income tax to an amount greater than it would have been under prior law.

What types of income are considered foreign earned income?

Earned income is defined as pay, either in cash or non-cash form for services provided. It includes:

  • Salaries and wages
  • Commissions
  • Bonuses
  • Professional fees
  • Tips
  • The fair market value of property or facilities provided to you by your employer in the form of lodging, meals, or use of a car
  • Any reimbursements or allowances for the following items:
  • Cost of living
  • Overseas differential
  • Family
  • Education
  • Home leave
  • Quarters
  • Moving  (to a foreign country)

·         The following items could be considered either earned or unearned income.

Income from:

  • Business profits from sole proprietorships, partnerships, and corporations
  • Stock options
  • Royalties
  • Rents
  • Certain Fringe benefits
  • Scholarships and Fellowships

What is not considered foreign earned income?

  • US Government employee income
  • Dividends
  • Interest
  • Capital gains
  • Gambling winnings
  • Pensions
  • Annuities
  • Social security benefits
  • Alimony
  • Meals and lodging that were furnished for the convenience of your employer that you exclude from your income
  • Amounts you include in your income because of your employer's contributions to a nonexempt employee trust or to a nonqualified annuity contract
  • Payments you receive after the end of the tax year following the tax year in which you performed the services that earned the income
  • Any unallowable moving expense deduction that you choose to recapture

Late Elections to Claim the Exclusion

Usually, you must claim the exclusion either:

  • Within one year of the due date of your return
  • By amending a timely filed return

However, you can still claim the exclusion after these dates if either:

  • The IRS hasn't discovered your failure to file.
  • You owe no tax after taking the exclusion into account.

If you haven't filed returns in prior years, you might be able to exclude your foreign earned income from U.S. tax. This could have the effect of eliminating your tax liability and any penalties and interest that would be assessed.



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