If you conduct business in a country other than the United States, it’s likely you’ve heard of the Foreign Earned Income Exclusion. U.S. citizens who live and work abroad at least part of the year may be eligible for the income tax exclusion, but only if they meet specific criteria.
According to the Internal Revenue Service, you must first determine if your “tax home” is outside the United States. The IRS defines a “tax home” as “the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual.” These rules do not apply to territories of the United States, like Guam or Puerto Rico.
It is not required that your family home be located in the same country as your tax home, but you must qualify under either the Bona Fide Resident Test or the Physical Presence Test.
Bona Fide Residence Test
According to the IRS, to be considered a “bona fide resident” of another country, you must pass the Bona Fide Residence Test:
- You must be a U.S. citizen or resident alien who is a citizen or national of a country which with the U.S. has an income tax treaty in effect.
- You must prove to the IRS that you have been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year.
Questions about bona fide resident status are handled on a case-by-case basis, so you may have to prove your status in the event of an audit.
Physical Presence Test
The Physical Presence Test is based on how long you stay in a foreign country. To pass the test you must:
- Be a U.S. citizen or resident alien who is a citizen or national of a country which with the U.S. has an income tax treaty in effect.
- Be physically present in a foreign country for 330 full days during a period of 12 consecutive months. (The days do not have to be consecutive.)
- Live in the foreign country or countries during the period of physical presence.
The IRS has put a limit on excludable income. Even if you meet all the requirements for the Foreign Earned Income Exclusion, the maximum exclusion amount for 2013 is $97,600. If you and your spouse both work abroad, you may claim as much as $195,200 in excludable income. This exclusion is actually limited to the “actual foreign earned income minus the foreign housing exclusion.” There is a limitation of approximately 30% of the maximum foreign earned income exclusion on housing expenses. For the 2013 tax year it is $29,280. This may vary depending on a variety of factors.
As indicated by its name, this exclusion only applies to earned income such as salaries, tips and other taxable employee pay, net earnings from self-employment and gross income received as a statuary employee. Unearned income such as gambling winnings, social security benefits and capital gains are not excluded. There are, however, other allowances and income that may be considered earned; it would be wise to contact an accountant to help you determine exactly what can be excluded.
Calculating the foreign earned income exception is extremely tricky, and is best left up to an expert who is intimately familiar with the tax code. Contact the professionals at GPP for help at 972-818-5300.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.