The United States may be one of a handful of countries in the world that requires its citizens living abroad to file their taxes, but the federal tax code allows some relief for Americans living and working abroad. Depending on your income and the way that income was earned, you may qualify for the Foreign Earned Income Exclusion, which is worth up to $100,800 for a single filer ($201,600 for married, filing jointly). The tax savings may be potentially very beneficial if you qualify to be able to exclude a portion of your income from federal income tax.
How to qualify
There are 3 general requirements to qualifying for the Foreign Earned Income Exclusion:
1. Your tax home must be in a foreign country (or within its territorial waters).
2. You must have foreign earned income.
3. You must be a bona fide or physically present resident of a foreign country.
A ‘tax home’ generally implies the main place you will conduct your work. It does not necessarily mean where you reside.
‘Foreign Earned Income’ is specific in that it means your income from abroad must be earned (e.g. wages, tips, professional fees), and not passive income (e.g. rental income, interest income).
“Bona fide” and “physically present” resident status are very specific requirements the IRS defines based on the amount of time you stay in a foreign country. While the IRS ultimately decides the status based on the information provided in the required Form 2555, “bona fide” resident status generally means an uninterrupted residence in a foreign country for at least an entire tax year.
The “Physically Present” test is based on how long you stay in a foreign country, and does not consider the nature of your stay or if you have residence there. The requirement to meet it is be physically present in a country for at least 330 days during a 12 month period. Let’s look at a two examples:
Jeff works for a Torrance-based oilfield services company on an oil rig off the shores of California in waters considered part of Mexican territory. His work schedule is a 14-days working/14-days off shift, as is typical for those in that industry. However, he does not qualify for the foreign income exclusion because he is not a ‘bona fide’ foreign resident, he still regularly goes home on his off time to his home in Long Beach. He also does not meet the “physically present” test.
Terry works for a multinational accounting firm based in El Segundo, CA. His firm appoints him to develop a business unit for
the European market. He moves himself and his family to London, United Kingdom, starting May 2015. While residing there, Terry rents out an extra room in his townhouse to a student. In December, his managers feel it would be better to develop the European division from a more centralized location in Frankfurt, Germany.
Terry and his family move there next. By June of 2016, Terry’s managers determine he has adequately developed their European division and his work abroad is done for now, so he moves himself and his family back to El Segundo. Terry and his family qualify as ‘bona fide’ residents of a foreign country because of his uninterrupted stay abroad. However, the income he earned from his
rented room in London will not qualify for the Foreign Income Exclusion because it was passive income.
Foreign Housing Exclusion and Deduction
In addition to the foreign income exclusion, expats have the option of claiming an exclusion or a deduction from gross income for your housing costs if your tax home is in a foreign country. The amount you can claim is determined by the
total of your housing expenses minus the base housing amount, which is calculated as 16% of the exclusion amount on a per day basis on the number of qualified days living abroad. However, you can only claim either the housing deduction or the exclusion. You cannot claim both for your filing.
Claiming the Foreign Income Exclusion
Complete Form 2555 (or Form 2555-EZ) and submit with your Individual income tax form 1040. Form 2555-EZ is a more simplified form whose main differences from Form 2555 are:
–No self-employment income for the year.
–No business or moving expenses for the year.
–Not claiming the foreign housing exclusion or deduction.
Hopefully this primer on the Foreign Income Exclusion wasn’t too overwhelming! There are a multitude of other individual factors to consider as an expat who is filing. However, we at MiklosCPA, a Los Angeles-area CPA firm, have knowledge and experience in helping expats properly prepare their taxes. If you are interested in learning more in how we can help, do not hesitate to get in touch with us via email.