Facts About the Foreign Earned Income Exclusion

The worldwide income of a U.S. citizen or resident alien generally is subject to U.S. income tax regardless of where the taxpayer is living. However, taxpayers are allowed to exclude from their income a certain amount of foreign earned income and housing allowance if they meet certain requirements while living abroad. Here are some facts related to the income exclusion.

1.  The Foreign Earned Income Exclusion: United States citizens and resident aliens who live and work abroad may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs.

2.  The General Rules: To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country (otherwise known as foreign earned income). The employer can be a U.S. employer or a foreign one as long as the income is earned while working in a foreign country. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.

• Bona fide residence test – Generally, to meet the bona fide residence test, a U.S. citizen or 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 must be a resident of a foreign country for an uninterrupted period that includes an entire tax year. Thus, except in rare circumstances, the first tax year living and working in a foreign country will not meet the entire tax year requirement, and a taxpayer will need to qualify under the physical presence test to exclude income.

• Physical presence test – To qualify under the physical presence test, a U.S. citizen or a U.S. resident alien must be physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. The 12-month period will span two years, requiring a prorated exclusion for the first year living and working in a foreign country. Because the exclusion period must actually be met before a return can be filed taking the exclusion, a filing extension may be required.

3.  The Exclusion Amount: The foreign earned income exclusion is adjusted annually for inflation. For 2010, the maximum exclusion is up to $91,500 per qualifying person ($91,400 in 2009). Thus, a husband and wife both living and working out of the country can each qualify for the full exclusion amount.

4.  Housing Exclusion: In addition to the foreign earned income exclusion, there is also a foreign housing exclusion when the housing costs are in excess of a government set base amount. The base amount for 2010 is $14,640 (up slightly from $14,624 in 2009), and the maximum housing exclusion amount for 2010 is $12,810 (up slightly from $12,796 for 2009).

5.  Taking Other Credits or Deductions: Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income.

The foregoing is only a brief summary of the foreign earned income exclusion.  If you are currently living and working in foreign country, or have plans of doing so in the future, and would like to find out if this deduction will work for your particular circumstances, please call this office for additional details.

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