Foreign Earned Income Exclusion
A U.S. citizen or a resident alien of the U.S. living abroad is required to pay taxes in the U.S. on income earned both in the States and abroad. Even if you do not live in the U.S., or have any U.S. income, you still have to file an income tax return and pay taxes on your income earned elsewhere in the world. - with the exception being for those who do not meet the minimum filing requirements.
Luckily, the United States allows those living and working abroad to exclude up to a certain amount of their income each year from being taxed. Additionally, you may be eligible 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. There are also potential penalties and interest imposed by the IRS on unfiled tax returns, so it is a good idea to get your taxes taken care of before the IRS comes calling!
What are the requirements to claim the foreign earned income exclusion?
There are three requirements that must be met to claim the Foreign Earned Income Exclusion:
- You must have earned foreign earned,
- 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.
BONA FIDE RESIDENT TEST
What are the requirements to meet the bona fide residence test?
To meet the bona fide resident test
- You must be bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. This means for most taxpayers January 1 – December 31 and
- You must be either:
- A U.S. citizen, or
- 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.
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
- Establish a residence in a foreign country and
- Reside in a foreign country or countries for an uninterrupted period that includes an entire tax year and
- You cannot make a statement to the authorities of that foreign country that you are in that you are not a resident of that country and the authorities hold that you are not subject to their income tax laws as a resident
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.
PHYSICAL PRESENCE TEST
What are the requirements to meet the physical presence test?
To meet the physical presence test, you must
- You must be physically present in a foreign country or countries for at least 330 full calendar days during a period of 12 consecutive months
- Be a US citizen and resident alien
How to count the days:
- The 330 full days do not have to be consecutive
- You do not have to be in a foreign country just for job purposes, you can be on vacation
- The days must be within a foreign country or countries
- Days in in the US for illness, family problems, vacation, employer’s order donot count
What are the rules to determine the 12-month period?
The IRS provides four rules to determine a 12-month period
- Your 12-month period can begin with any day of the month. It ends the day before the same calendar day, 12 months later
- Your 12-month period must be made up of consecutive months. Any 12-month period can be used if the 330 days in a foreign country fall within that period
- You do not have to begin your 12-month period with your first full day in a foreign country or to end it with the day you leave. You can choose the 12-month period that gives you the greatest exclusion
- In determining whether the 12-month period falls within a longer stay in the foreign country, 12-month periods can overlap one another
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-EZand 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, you must complete the Form 2350, Application for Extension of Time To File U.S. Income Tax Return. To file the Form 2350, you must:
- Be a US citizen or resident alien
- Expect to qualify after the due date of your return (normally April 15) for the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction
- Your tax home must be in foreign country or countries throughout the time period for your bona fide or physical presence
- Pay any taxes due by April 15
- File the form on or before due date of your return - April 15th or if you are “out of country” on April 15th the on or before June 15th , but do it early enough to finish your return on time because the extension could potentially not be approved
- If the extension is approved, the extension will be valid until 30 days the date you expect to meet either the bona fide residence test or the physical presence test or if you allocate moving expenses you could be given an extension to 90 days after the end of the year following the year you move
What is a tax home in a foreign country?
Your tax home is defined as 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.
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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.