Figuring the Foreign Earned Income Exclusion
A common misconception about the foreign earned income exclusion is that it is exempt income not reportable on a U.S. tax return. In fact, only a qualifying individual with qualifying income may elect to exclude foreign earned income, and the qualifying exclusion applies only if the qualifying individual files a tax return and reports the income.
Limit on Excludable Amount
The foreign earned income exclusion amount is adjusted annually for inflation. For tax year 2014, the maximum foreign earned income exclusion is up to $99,200 per qualifying person. If the individuals are married and both work abroad and meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $198,400 for the 2014 tax year.
In addition, the amount of qualified housing expenses eligible for the housing exclusion and housing deduction is also limited. The limitation on housing expenses is generally 30% of the maximum foreign earned income exclusion. For the 2014 tax year, the housing amount limitation is $29,760. However, the limit will vary depending upon the location of the qualifying individual’s foreign tax home and the number of qualifying days in the tax year.
The foreign earned income exclusion is limited to the actual foreign earned income minus the foreign housing exclusion. Therefore, to exclude a foreign housing amount, the qualifying individual must first figure the foreign housing exclusion before determining the amount for the foreign earned income exclusion.
Amounts Paid in Year Following Work
Generally, you are considered to have earned income in the year in which you do the work for which you receive the income, even if you work in one year but are not paid until the following year. If you report your income on a cash basis, you report the income on your return for the year you receive it. If you work one year, but are not paid for that work until the next year, the amount you can exclude in the year you are paid is the amount you could have excluded in the year you did the work if you had been paid in that year.
Year-End Payroll Period
There is an exception to the general rule that income is considered earned in the year you do the work for which you receive the income. If you are a cash-basis taxpayer, any salary or wage payment you receive after the end of the year in which you do the work for which you receive the pay is considered earned entirely in the year you receive it if all four of the following apply.
The period for which the payment is made is a normal payroll period of your employer that regularly applies to you.
The payroll period includes the last day of your tax year (December 31 if you figure your taxes on a calendar-year basis).
The payroll period is not longer than 16 days.
The payday comes at the same time in relation to the payroll period that it would normally come and it comes before the end of the next payroll period.
You are paid twice a month. For the normal payroll period which begins on the first of the month and ends on the fifteenth of the month, you are paid on the sixteenth day of the month. For the normal payroll period that begins on the sixteenth of the month and ends on the last day of the month, you are paid on the first day of the following month. Because all of the above conditions are met, the pay you received on January 1, 2014, is considered earned in 2014.
Amounts Earned Over More Than 1 Year
Regardless of when you actually receive income, you must apply it to the year in which you earned it in figuring your excludable amount for that year. For example, a bonus may be based on work you did over several years. You determine the amount of the bonus that is considered earned in a particular year in two steps.
- Divide the bonus by the number of calendar months in the period when you did the work that resulted in the bonus.
- Multiply the result of (1) by the number of months you did the work during the year. This is the amount that is subject to the exclusion limit for that tax year.
You were a bona fide resident of Brazil for all of 2011and 2012. You report your income on the cash basis. In 2011, you were paid $79,800 for work you did in Brazil during that year. You excluded all of the $79,800 from your income in 2011. In 2012, you received $18,800 for work you did in 2011. You can exclude $13,100 of the $18,800 from your income in 2012. This is the $92,900 maximum foreign earned income exclusion in 2011 minus the $79,800 actually excluded in that year. You must include the remaining $5,700 in income in 2012 ($18,800 - $13,100) because you could not have excluded that income in 2011 if you had received it that year.
Amounts Received More Than 1 Year After It Was Earned
You cannot exclude income you receive after the end of the year following the year you do the work to earn it.
You qualify as a bona fide resident of Sweden for 2009, 2010, and 2011. You report your income on the cash basis. In 2009, you were paid $67,000 for work you did in Sweden that year and in 2010 you were paid $72,000 for that year's work in Sweden. You excluded all the income on your 2009 and 2010 returns.
In 2011, you were paid $90,000; $80,000 for your work in Sweden during 2011, and $10,000 for work you did in Sweden in 2009. You cannot exclude any of the $10,000 for work done in 2009 because you received it after the end of the year following the year in which you earned it. You must include the $10,000 in income. You can exclude all of the $80,000 received for work you did in 2011.
Part Year Exclusion
If you qualify under either the bona fide residence test or the physical presence test for only part of the year, you must adjust the maximum limit based on the number of qualifying days in the year. The number of qualifying days is the number of days in the year within the period on which you both:
- Have your tax home in a foreign country, and
- Meet either the bona fide residence test or the physical presence test.
For this purpose, you can count as qualifying days all days within a period of 12 consecutive months once you are physically present and have your tax home in a foreign country for 330 full days. To figure your maximum exclusion, multiply the maximum excludable amount for the year by the number of your qualifying days in the year, and then divide the result by the number of days in the year.
Physical Presence Test
Under the physical presence test, a 12-month period can be any period of 12 consecutive months that includes 330 full days. If you qualify under the physical presence test for part of a year, it is important to carefully choose the 12-month period that will allow the maximum exclusion for that year.
Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.