 Return to Tax Guides
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III.
Foreign Earned Income Exclusion The limitation on the foreign earned income exclusion is as follows:
For tax years beginning after 2007, the $80,000 amount will be increased by a cost-of-living adjustment. A qualified individual can elect to exclude from 2002 income the first $80,000 of foreign earned income. In addition, the taxpayer can elect to take a housing exclusion (the "housing cost amount," discussed below). A husband and wife who each qualify for the foreign earned income exclusion can claim it separately. The combined benefit of the foreign earned income and foreign housing costs may not exceed the taxpayer's foreign earned income for the year. For purposes of applying the exclusion, foreign earned income is considered received in the year the taxpayer performs the services, even if it was actually received in an earlier year. (If payment is received in a year after the performance of the services, it can't be excluded, except that a bonus, subject to forfeiture, and paid after several prior years of foreign services, can be allocated proportionately to those prior years.) Earned income is wages, salaries, professional fees, and other compensation for services rendered except when earned in countries where travel by U.S. citizens is restricted by U.S. law or regulations. In the case of a trade or business in which capital is a material income-producing factor, earned income is a reasonable allowance for services, but not in excess of 30 % of the taxpayer's share of the business net profit. To qualify, the taxpayer must have the TAX HOME in a foreign country AND meet either the BONA FIDE RESIDENCE TEST OR PHYSICAL PRESENCE TEST AND .... FILE A TAX RETURN. Needless to say, failing to file a tax return claiming the earned income exclusion can be a costly affair! In line with the general need of the US government to collect more revenue, the foreign earned income exclusion rules and enforcement are being strengthened. However, regulations now permit taxpayers living abroad, who failed to file a timely return in a prior year, to have the exclusion restored without a private letter ruling, if the return is filed with proper disclosures and the exclusion claimed before the IRS discovers the failure to file and/or claim the exclusion. In addition to the foreign earned income exclusion, above, an individual can elect to exclude a portion of income equal to the excess of the taxpayer's "housing expenses" over a base housing amount. The term "housing expenses" means the reasonable expenses paid or incurred during the taxable year by, or on behalf of, the individual for housing for the individual (and for the spouse and dependents, if they resided with the taxpayer in a foreign country). The term includes expenses attributable to the housing, such as utilities and insurance, but does not include interest and taxes, which are separately deductible. If the taxpayer maintains a second household outside the U.S. for the spouse and dependents, who do not reside with the taxpayer because of adverse living conditions, then the housing expenses of the second household also are eligible for the exclusion. Housing expenses are not treated as reasonable to the extent that they are lavish or extravagant under the circumstances. The base housing amount is 16 percent of the salary of an employee of the United States whose salary grade is step 1 of grade GS-14. (In 2002, the base housing amount is $10,842 or $29.70 per day.) There is also an exclusion of meals and lodging provided to employees who reside in certain camps in foreign remote areas where satisfactory housing isn't available to the employee in the open market. Deductions and credits attributable to excluded income are not allowed. For example, foreign taxes paid on excluded income may not be credited against U.S. taxes. Pensions and annuities and income from certain trusts are not excludable. As a general rule, employees of the federal government or any of its agencies are not eligible for the exclusion. But independent contractors who do work for the government are eligible. The initial election to exclude foreign earned income or employer-provided housing costs may be made either on a timely filed return, on an amended return, or on a late-filed return that is filed within one year after the due date. The election can be made after the prior periods described, provided you have no federal tax liability after taking into account the exclusion. If you do have a federal tax liability and file after the periods described above, you can again claim the exclusion, provided you file before the IRS discovers that you failed to choose the exclusion. The election must be attached to the income tax return for the first year for which the election is effective. An election is effective until revoked. A taxpayer can revoke an election for any tax year after the year for which the election was made. Once revoked, a new election cannot be made until the sixth year following the year of revocation (unless the IRS consents to an earlier election) Moving expense reimbursement for a move to a foreign country is, in the absence of evidence to the contrary, attributable to services performed in the foreign country and vice versa. All the housing costs of a married couple may be allocated to one of them if they reside together, even if they file separate returns. However, if the couple resides apart, they must compute their housing cost amounts separately and must use a separate base housing amount for each spouse who deducts or excludes a housing cost amount. TAX HOME This is the regular or principal place of business. The regular place of abode will be the tax home if there is no regular or principal place of business. If you are an itinerant and have neither a regular place of business nor a place where you regularly live, then your tax home is where you work. One cannot have a tax home abroad, when one's abode is in the USA. A temporary foreign assignment does not qualify for a foreign tax home. It will be treated as temporary if: The foreign assignment is expected and does last one year or less. One intends to return to the US after the assignment. Whether the US home is really the regular abode will be confirmed if at least two of the following are answered in the affirmative: •Was the US home used as a residence prior to going abroad for the new job? Were work
contacts maintained at the US home while abroad? If two of the above are answered in the negative, the assignment is indefinite. Thus one might be able to claim the foreign earned income exclusion, but not travel expenses away from the US tax home. If one can answer in the affirmative to all 3 questions, the job is realistically expected to last less (and does last less than 1 year) and one returns to the US home, it is a temporary assignment. Thus one may be able to qualify for expenses away from the US tax home, but not the foreign earned income exclusion. If one can answer in the affirmative 2 of the questions, the assignment is expected to last 1 year or less, and it does and one would return to the US tax home, then the location of the tax home depends on facts and circumstances. In determining the abode there is no concrete answer, but the following are considered:
BONA FIDE RESIDENCE The taxpayer must be a foreign resident for an uninterrupted period that includes an entire tax year. (For calendar year taxpayers, this means a period from Jan. 1 to Dec. 31). The law and regulations focus on intention, they are therefore somewhat vague, but include the following: • intention on becoming a resident of the foreign country While much of the test is based on intention, other parts are clear. Generally, the individual must be present in the foreign country and not be a mere transient or sojourner. A transient is determined by intention. If it is for a specific purpose which can be accomplished promptly, then this may be deemed to be a transient. A taxpayer whose stay in the foreign country is very limited by immigration laws is not a resident of the foreign country. If there is earned income from the country claimed as the tax home, and it is represented to the tax authorities of that country that the taxpayer is not a resident for tax purposes and is held not to be subject to its income tax, THEN THE TAXPAYER IS NOT A BONA FIDE RESIDENT OF THE FOREIGN COUNTRY. A taxpayer who can prove that he would have met the bona fide residence test except that he had to leave early because of civil unrest, etc., can get a pro rata exemption for the time he was in the foreign country. This test is only available to US citizens. PHYSICAL PRESENCE The taxpayer must be physically present in one or more foreign countries 330 full days during a period of 12 consecutive months. A day is a consecutive period of 24 hours commencing at midnight. Time spent in international "waters" does not count towards the time spent in foreign countries. This test is only concerned with length of stay, not type of residence established, intentions, or nature of stay like the Bona Fide Residence test, but keep in mind that one must meet the Tax Home requirement. The physical presence test is concrete, and therefore, easier to prove than the bona fide residence test, however, many spend too much time in the USA to qualify for the physical residence test. This test is available to US citizens as well as Resident Aliens. |