Ever heard of the foreign earned income exclusion? If you work abroad, or are planning to make that move to live in a foreign country, this article might be of interest to you. Here we will talk about how you might qualify for an exclusion that can decrease your U.S. federal taxes.
Do you work abroad? You might qualify for the foreign earned income exclusion. This exclusion is an election to exclude a designated amount of foreign earned income from U.S. federal tax. The exclusion is $102,100 in 2017 and is adjusted annually for inflation. However, the maximum amount you can exclude or deduct is your foreign earned income for the year.
Foreign earned income includes wages, salaries, professional fees and other compensation received for personal services performed in a foreign country. Non-cash income such as a car, allowances and reimbursements received for services performed in a foreign country also are considered foreign earned income.
To qualify for the exclusion, the taxpayer must meet the tax home test, and either the bona fide residence test or the physical presence test.
- To meet the tax home test, your tax home (which is your regular place of business or employment) must be in a foreign country.
- To meet the bona fide residence test, you must reside in a foreign country for an uninterrupted period that includes a full tax year. For U.S. taxpayers, this would be a calendar year, beginning January 1 and ending December 31.
- To meet the physical presence test, 330 full days out of any 12-consecutive month period must be spent in a foreign country or countries. For example, the period can begin on June 6, 2016 and end on June 5, 2017, and the 330 days within this period need not be consecutive and need only to add up to 330 days.
You might also have housing costs while living and working abroad. U.S. citizens can make a separate election to exclude or deduct excess housing costs from foreign earned income. The deduction is claimed when you pay for your housing expenses while the exclusion is claimed when housing is provided for you by your employer.
Once you choose to claim both or either exclusion, your choice remains in effect for that year and all future years unless it is revoked. Revocation is made by filing a statement with an original, amended, or late-filed return. The revocation is then effective for that return’s tax year and the years after that. A taxpayer can also revoke an election if he or she takes an action that is inconsistent with the election. If you choose to revoke the election in favor of taking foreign tax credits, you may not elect to exclude your foreign earned income or your housing costs for five years without permission from the IRS.
Although these exclusions bring down the amount of income that is taxed, they do not reduce the tax rates for the non-excluded income. You must use the tax rates that would have applied had you not claimed the exclusions. The excluded foreign income is added back to gross income to figure the tax rate. This tax rate is then used on the non-excluded income to calculate federal tax.
Considering the complexity of issues regarding foreign earned income, it is important that your eligibility for the foreign earned income and housing exclusions is reviewed by a tax professional. If you have any questions regarding this or any other tax matters, please do not hesitate to contact your L&B professional at (858) 558-9200.