If you live or work outside the United States did you know you can actually exclude almost $100,000 of your income tax free.
The Foreign Earned Income Exclusion is a one of the largest tax benefits available to you as US resident living or working abroad. This is something an expat would love almost as much as traveling abroad.
Expat is a short way of saying expatriate. An expatriate is defined as a person residing in a country other than their native country.
If you take this exclusion your first $97,600 earned overseas is going to be exempt from income tax.
Before you pack up the family and hop on a plane thinking you are about to just live tax free overseas. Not everyone can actually qualify for this exclusion.
In order to qualify for the Foreign Earned Income Exclusion, you must meet one of two test.
- 1) The Bona Fide Residence Test.
- 2) The Physical Presence Test.
Bona Fide Residence Test
You meet the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. You can use the bona fide residence test to qualify for the exclusions and the deduction only if you are 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.
You do not automatically acquire bona fide resident status just by living in a foreign country or countries for 1 year. If you go to a foreign country to do work for a particular job for a specified period of time, you will normally not be considered a bona fide resident of that country even though you have worked there for 1 tax year or longer. The length of your stay and the nature of your job are only some of the factors that goes into determining whether you can meet the bona fide residence test.
Bona fide residence. To meet the bona fide residence test, you must have established a bona fide residence in a foreign country.
Your bona fide residence is not necessarily the same as your domicile. Your domicile is your permanent home, the place to which you always return or you intend to return.
You could have your domicile in Nashville, Tennessee and a bona fide residence in Sydney, Australia. Nashville will be a bona fide residence, if you intend to return eventually to Tennessee.
The fact that you visit Australia does not automatically make Australia your bona fide residence. If you go there as a tourist, or on a short business trip, and return to the United States, you have not established a bona fide residence in Australia. If you go to Australia to work for an indefinite or extended period and you set up permanent quarters there for yourself and your family, there is a good chance you can claim you have established a bona fide residence in a foreign country, even if you intend to return to the United States someday in the future.
Now in real life it can be more difficult to decide whether you have actually established a bona fide residence. If you have any doubt or concerns feel free to reach out to IATC Inc for help.
Your bona fide residence will be determined according to each individual case, taking into account three main factors such as your
- Intention,
- Why you are visiting and
- The nature and length of your stay abroad.
A treaty that prevents you from becoming a bona fide resident of a foreign country is determined based on each individual treaty. All provisions of a treaty you could be subject including specific provisions relating to residence or privileges and immunities should be reviewed as well.
To meet the bona fide residence test, you must reside in a foreign country or countries uninterrupted for an entire tax year. An entire tax year is from January 1 through December 31 for taxpayers on a calendar year basis.
An entire year without seeing family or friends might be too difficult a task for some. You are allowed to leave the country for a brief or temporary trip back to the United States or somewhere else for vacation or business. And still be a bona fide residence in a foreign country, To keep your status as a bona fide resident of a foreign country, you must have a clear intention of returning from the trips, without unreasonable delay, to your foreign residence or to a new bona fide residence in another foreign country.
Once you have established bona fide residency in a foreign country for an uninterrupted period that includes an entire tax year, you are a bona fide resident of that country for the period starting with the date you actually began the residence and ending with the date you abandon the foreign residence. Your period of bona fide residence can include an entire tax year plus parts of 2 other tax years.
If you are assigned from one foreign location to another, you may or may not have a break in foreign residence between your assignments, depending on the circumstances.
The second physical presence test can be more confusing when applying to a person tax return. To be qualified for the exclusion based on your physical presence means you can leave the United States for business and can not return for more than 35 days throughout the past twelve months. This test is also not based on a calendar year. You can qualify by using any twelve month period of time.
One thing to keep in mind is with the 35 day limit. The days do not have to run straight in a row. You can become ineligible to take the exclusion if you have taken multiple trips back to the US that exceeds 35 days in the US during a 12 month period.
The Deductions
If a person meets the foreign income exclusion they are allowed to deduct up to $97,600 of their foreign earned income from their US taxes. If you are married filing jointly, you would be able to deduct up to double that from your US taxes. This amount is also indexed for inflation and increases each year.
The Foreign Earned Income Exclusion relies solely on foreign income for calculation purposes and the income must be earned. Foreign income from passive sources such as dividends, interest, retirement income, and rental income are not included since those income sources are not considered “earned” income.
Additional Complexities
There are some additional complexities to the Foreign Earned Income Exclusion, so it is almost always advisable to consult with a tax expert about your specific situation at www.iatcpro.com
Self employed individuals having to still pay their Self-Employment tax to the US. After paying your self employment taxes you can exclude your earnings.
Not all US expats are able to take advantage of the foreign earned income exclusion. If you are a US Government Employee and are paid by the US government then you will not be able to use the Foreign Earned Income Exclusion to minimize your US expat taxes. This includes individuals in the Armed Forces Exchange, Commissioned and non-commissioned Officers’ messes, Armed Forces motion pictures services and employees of kindergartens on Armed Forces installations.
Tax credits.
if you claim either of the foreign income exclusion, You can’t take the additional child tax credit or earned income credit.
Additional Income: If you decided to rent your property while you were living abroad. Your rental income is still going to be reported, along with your usual expenses.
Need to File State Returns: Living or working abroad does not eliminate your need to file a state tax return with some states. Certain taxpayers must maintain a state of domicile in the United States, and there will be tax obligations to that state.
Retirement: If you are still making contributions to your retirement accounts, even if it’s your SEP, IRA or ROTH IRA they are all subject to certain limits based on your gross income. If you plan to claim your IRA deduction, special rules apply.
Foreign Housing Exclusion or Deduction: In addition to the foreign earned income exclusion, you can also claim an exclusion or a deduction from gross income for your housing amount if your tax home is in a foreign country, you have self employment income, and you qualify under either the bona fide residence test or the physical presence test.
Even though you are ineligible your spouse can claim this exclusion be if they are not government and work overseas. If you are having a hard time determining your eligibility for the foreign earned income exclusion schedule an appointment at www.iatcpro.com.
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