U.S. citizens working abroad: Tax treatment of foreign earned income

06 Dec, 2015 TAX LAW 0

Chapter 41
U.S. citizens working abroad: Tax treatment of foreign earned income

How to Qualify for the Foreign Earned Income Exclusion

You qualify for the foreign earned income exclusion if you are a U.S. citizen, you have a tax home in a foreign country, and you meet either the foreign residence test or the physical presence test, described below.

Generally, if you are a resident alien of the United States, you may qualify for the foreign earned income exclusion if you satisfy the physical presence test. This assumes that you continue your resident alien status while living outside the United States.

Tax home. Your tax home generally is the location of your principal place of employment, which may or may not coincide with the location of your family’s residence. Among the factors that are important in determining whether or not your tax home is outside the United States are the anticipated duration of your overseas assignment and whether or not you will return to the same employment location in the United States. Under IRS guidelines, an anticipated short-term (1 year or less) assignment overseas, followed by a return to the same place of employment in the United States, would indicate that you do not have a tax home outside the United States.

If you meet either the foreign residence test or the physical presence test (discussed below) and have a tax home outside the United States, you are eligible for two exclusions—the foreign earned income exclusion and the foreign housing exclusion. Self-employed individuals are eligible for a housing deduction rather than the housing exclusion (see the discussion later in this chapter).

Foreign residence test. The foreign residence test requires that you be a “bona fide resident” of a foreign country (or more than one foreign country) for an uninterrupted period that includes an entire tax year. Whether or not you are a bona fide resident is a subjective question. The answer is determined by the facts and circumstances of your particular situation, including the purpose of your trip and the nature and length of your stay abroad, and your intent.

The following factors are considered by the IRS in determining your intent to be a “bona fide” resident in a specific place.

The type of quarters you occupy (hotel or rooming house, rented quarters, purchased quarters, or quarters furnished by your employer)
How long your family resided with you during the tax year
The length of the uninterrupted period of time during which you have been living outside the United States
The nature of any conditions or limitations concerning your employment agreement and the type and term of your visa to live/work in the foreign country
Whether you maintain a home in the United States and, if so, its rental status and the relationship of any tenants to you

If you make a statement to the authorities of a foreign country that you are not a resident of that country, and if you are not subject to tax by that country, you do not qualify as a bona fide resident of that country.

However, once you have met the foreign residence test for an entire tax year, your qualification is retroactive to the first day you established your bona fide residence. Occasional trips to the United States for business or vacation do not affect your qualification.

Example 1. You moved from the United States to a foreign country, arriving on September 15, 2014. You entered the country under a resident visa with your family for a 3-year assignment. You did not declare to the foreign authorities that you were not a resident of that country. You qualify as a bona fide resident of the foreign country if these facts remain the same through December 31, 2015. You may file your 2014 U.S. income tax return (or amend your original 2014 tax return) to claim the benefits of being a bona fide resident of a foreign country for the period September 15, 2014, through December 31, 2014.

Example 2. George has been a resident of the United Kingdom for 5 consecutive years. If he moves to France this year, he continues to be a bona fide resident of a foreign country. An uninterrupted period of bona fide residence may include residence in more than one foreign country in a given year.

Example 3. Amy moved to France with her family on June 15, 2013, for a job assignment of indefinite length. On December 3, 2014, she was transferred back to the United States. She did not satisfy the bona fide residence test in either year, since she did not maintain a bona fide residence in a foreign country for a period that includes a complete tax year. However, she may qualify for the foreign exclusions under the physical presence test (discussed below).

Physical presence test. This test simply requires that you be physically present in a foreign country (or countries) for 330 full days during any consecutive 12-month period. This is a purely objective test. There is no reference to your intentions or to any other factors that determine bona fide residence abroad.

Two important rules to keep in mind regarding this test are as follows:

A full day is a 24-hour period commencing at midnight. Thus, a day in which you travel to or from the United States is not a full day in a foreign country.
When you travel between foreign countries, the travel days will qualify as full days in a foreign country, provided that the time spent outside of either foreign country during the journey (i.e., time spent over international waters and/or time spent in the United States) is less than 24 hours.

The Foreign Earned Income Exclusion

If you qualify, you may elect to exclude a maximum of $99,200 in foreign earned income from your U.S. taxable income in 2014. The amount of the exclusion is indexed annually for inflation.

The amount of earned income you may exclude depends on either (1) the number of days during the year in which you were a bona fide resident of a foreign country or (2) the number of days you were physically present in a foreign country during a 12-month period. These are known as your “qualifying days.” If you are out of the United States for the entire year, you may exclude all of your earned income up to the $99,200 limit. However, if you are out of the United States for only part of the year, you generally must prorate the exclusion based on your number of qualifying days during the taxable year.

Example. You were a bona fide resident of a foreign country for 300 days during 2014. The maximum amount of income you may exclude from U.S. taxes is 300/365 × $99,200, or $81,534. Your exclusion is, of course, limited by the amount of foreign income you earn. If you earn less than the maximum allowed, you may exclude only that lower amount.

Only foreign earned income is eligible for the exclusion. Earned income is income you receive for the performance of personal services. It does not include dividends, interest, capital gains, rental property income, and other kinds of unearned income. For example, interest paid on a bank account in the United Kingdom to a U.S. expatriate on assignment in London is not eligible for the exclusion, since it is not foreign earned income.

Earned income may be received in cash or as benefits-in-kind and includes the following:

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U.S. citizens working abroad: Tax treatment of foreign earned income