Foreign Earned Income Exclusion – Ultimate Guide to Minimize US Expat Tax Liability

By ZM Ishmurzina

Contemplating moving overseas for a job or a permanent home? There are several expat tax issues that Americans must consider. Foreign Earned Income Exclusion should be on the top of this list.

First and foremost, US citizens and resident aliens of the United States are taxed on their worldwide income. Living in a foreign country does not exempt American expats from filing US expatriate tax returns. Fortunately, per the Internal Revenue Code 911, Americans living abroad can utilize the foreign income exclusion and exclude from income up to $101,300 of foreign earnings in 2016 ($91,500 for 2010, $92,900 for 2011, $95,100 for 2012 and $97,600 for 2013, $99,200 for 2014 and $100,800 for 2015.).

Additionally, US expats can exclude some foreign housing expenses. However, Americans working overseas must meet several requirements to claim the foreign earned income exclusion and foreign housing exclusion. Earlier we reviewed the Foreign Housing Exclusion. This article covers the top expat tax rules about the foreign income exclusion.

Foreign Earned Income Exclusion – Top Expat Tax Rules for Americans Abroad

Expat Tax Tip 1: What is Foreign Earned Income Exclusion

By definition, foreign income exclusion is a tool used to minimize tax liabilities for American working overseas. If US expats meet the requirements, they exclude from foreign earned income up to $101,300 in a tax year 2016. This amount is adjusted for inflation every year. The exclusion amount was $91,500 in 2010, $92,900 in 2011, $95,600 in 2012, $97,600 in 2013, $99,200 in 2014 and $100,800 in 2015.

Expat Tax Tip 2: Foreign Income Exclusion for Married Filing Jointly

Each spouse can claim the foreign exclusion if s/he meets the requirements. The filing status, married filing jointly or separately, does not affect the amount of exclusion. However, each spouse must meet one of the tests to exclude the foreign income. Specifically, American expats must meet either the physical presence test or bona fide residence test to qualify.

Expat Tax Tip 3: Foreign Earned Income Exclusion and Self-Employment Tax

Self-employed expats can take the exclusion if they have foreign net earnings. Also, they have to meet the requirements of physical presence test or bona fide residence test.

Expat Tax Tip 4: Foreign Earned Income Exclusion Requirements

Individuals can claim the foreign income exclusion. However, living abroad is not sufficient to exclude the income. American expats must meet three tests to qualify for the exclusion:

  1. US citizens and green card holders must have a tax home outside of the United States.
  2. American expats must earn foreign income.
  3. Americans living abroad must meet either the bona fide test or physical presence test.

Expat Tax Tip 5: Foreign Earned Income Definition

Foreign earned income is the income earned for the services outside of the United States. Earned income is not limited to salaries and wages. Various benefits like cost of living differential, education and quarters allowance, home leave and quarters, will be considered the foreign earned income too. Please find below the detailed list of various types of earned income.

Foreign earned income is as follows:

  • Salaries and Wages
  • Commissions
  • Bonuses
  • Professional fees
  • Tips
  • Self-employment income

Various benefits included in the foreign earned income:

  • Fair market value of housing, meals and use of car provided by an employer
  • Cost-of-living allowance
  • Family allowance
  • Overseas differential
  • Education allowance for children
  • Home leave like a ticket to fly to the USA
  • Quarters allowance

Types of income that do not qualify as foreign earned income.

  • Income earned as an employee of US Government
  • Passive income such as interest, dividends, capital gains and annuities
  • Retirement income like pension and social security benefits
  • Other income like gambling winnings and alimony
  • Meals and accommodation provided for the convenience of the employer
  • Employer’s contributions to a nonqualified employee trust or to a nonexempt annuity

Several types of income that might be either earned or unearned.

Individual’s tax situation must be reviewed and through analysis must made by an expat tax CPA for the following types of income.

  • Rental income and royalties
  • Stock options
  • Some fringe benefits
  • Business profits from either a corporation, partnerships and proprietorships
  • Scholarships and Fellowships

Expat Tax Tip #6: Tax Home in Foreign Country

As we mentioned earlier, an American expat must have a tax home in a foreign country to claim the foreign earned income exclusion.

Tax home is usually the general place of employment, post of duty, or main place of business in case of self-employed Americans. Tax home might be different from your family home. In case of American retirees, the tax home can be a place where they live because they usually do not work.
Tax home must be in an overseas country throughout the period of the physical or bona fide residency. The foreign country territory includes not only the land but also the seabed, subsoil of submarine areas as well as territorial waters. Moreover, this territory must belong to a foreign country exclusively. Additionally, a foreign country is any country located outside of the United States and US possessions. US possessions include Guam, Puerto Rico, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa. The international waters do not belong to any country. Consequently, the international waters are not considered a foreign country. This fact is especially important for international pilots that make constant overseas flight. We wrote a separate article for International Crew Ship Members and Pilots about US expat taxes.

Expat Tax Tip 7: Foreign Earned Income Exclusion and Physical Presence Test

American expats must meet either the physical presence test or bona fide residence test to claim the foreign earned income exclusion. An individual meets the physical presence test if s/he is physically present in a foreign country or countries for 330 full (24-hour) days in a period of 12 consecutive months. To simplify the math, a US expat can spend only up to 35 days in the United States to qualify for the test.

Americans can be present in a foreign country for various reasons to qualify. For example, on January 1 Nick moved to Tuscany, Italy for 3 months to study the wine making process. Then he decided to take some culinary classes in Paris, France and learn flamenco in Spain. However, he took a trip back to the USA on June 1-20, 2014. He can claim the foreign earned income exclusion in 2014 because he has been overseas for 330 days within 12 consecutive months.

Expat Tax Tip #8: Foreign Income Exclusion and Bona Fide Residence Test

American expats must meet several requirements to qualify as a bona fide resident and to exclude the foreign earned income.

  • First, a taxpayer must a US citizen or resident (citizen of a foreign country that has a tax treaty with the USA with a non-discrimination cause).
  • Second, Americans must be present overseas for an uninterrupted period of one tax year.
  • Third, American expats must establish a tax home in a foreign country.

The IRS reviews the following factors to determine the eligibility as a bona fide resident:

  • Living Quarters (hotel (temporary), purchased residence, rented house or apartment, employer provided housing)
  • Close Family members living with a taxpayer
  • Income taxes paid to foreign government
  • Contractual terms and conditions of employment
  • Visa type and duration
  • Maintenance of U.S home
  • Finally, American expats cannot make a statement that they are not residents of a foreign country. Otherwise, they will not be eligible to meet the bona fide residence test.

Let’s review one example. Michael moved to Switzerland for work on November 1, 2013. His wife and children stayed in the USA originally but they joined him in Switzerland on February 1, 2014. The children attend a local school in Zurich. His wife became very active in youth programs in Zurich. In this scenario Michael will meet the bona fide residence test because he earned the foreign income, has a tax home in Switzerland and he meets the bona fide residence test.

Expat Tax Tip #9: US expat tax return must be filed to claim the exclusion

American expats must remember that they have to file US expatriate tax return to claim the foreign earned income exclusion. The IRS does not grant it automatically.

Expat Tax Tip #10: Form 2555 to claim Foreign Earned Income Exclusion

Americans living abroad must file Form 2555 to claim the foreign earned income exclusion and foreign housing exclusion.

Conclusion

Individual circumstances vary from one family to another. Consequently, the professional review of personal facts is required to determine whether a taxpayer can claim the foreign earned income exclusion. Expat tax CPAs at Artio Partners will ensure the maximum amount of eligible foreign earned income exclusion and detailed preparation of form 2555.