FS-2016-22, June 2016
As a U.S. citizen or a resident alien of the United States, you are taxed on your worldwide income. However, if you live and work abroad, you may qualify to exclude foreign earned income and to exclude or deduct certain foreign housing amounts.
The foreign earned income exclusion is not available to nonresident aliens.
- The foreign earned income exclusion is available only for income earned for services performed in a foreign country, and is claimed on IRS Form 2555 or 2555-EZ.
- The maximum foreign earned income exclusion is indexed annually for inflation; for 2015, it was $100,800 per person.
Please note that you if you choose to exclude foreign earned income, you must exclude all of it up to that threshold amount – in other words, the lesser of the threshold amount or what you actually earned.
You may also be able to exclude or deduct foreign housing expenses in excess of a base amount and subject to a limit.
Foreign Earned Income Exclusion Requirements
To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income, your tax home must be in a foreign country, you must meet either the Bona Fide Residence or Physical Presence Test, and you must make a valid election.
- Foreign Earned Income is income that you receive for services you perform in a foreign country.
- Foreign earned income is earned in the year that you actually performed the services.
- Regardless of when you receive the income, it is applied to the year in which you actually earned it for purposes of figuring the excludable amount for that particular tax year.
It’s also important to note that you can receive the income anywhere, including the U.S., as long as you were in a foreign country when you performed the services that gave rise to the income. If you are an employee, examples of foreign earned income include wages and salaries, commissions, bonuses, tips, allowances or reimbursements for cost of living, overseas differentials, familial allowances, education allowances and other allowances or reimbursements.
It also may include severance pay, sick leave pay and vacation pay. Foreign earned income can also include noncash income such as the fair market value of lodging, a car, or employer provided meals.
If you are self-employed, foreign earned income includes professional fees for personal services you rendered in a foreign country. If you are engaged in a trade or business (other than a corporation), and capital is a material income producing factor of that trade or business, then a reasonable allowance as compensation for the personal services you actually rendered while in a foreign country is considered foreign earned income, but this amount cannot exceed 30% of the net profits of the business.
Foreign Tax Home?
To claim the foreign earned income exclusion, you must have a foreign tax home:
- Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home.
- Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. Having a "tax home" in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes.
- If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live.
- If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and your tax home is wherever you work. You are not considered to have a tax home in a foreign country for any period in which your abode is in the United States. However, your abode is not necessarily in the United States while you are temporarily in the United States or just because you maintain a dwelling in the U.S.
Bona Fide Residence Test
You meet the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for one year. If you go to a foreign country to work on a particular job for a specified period of time, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for one tax year or longer.
The length of your stay and the nature of your job are only two of the factors to consider in determining whether you meet the bona fide residence test. In addition to the time requirement, there a number of factors you need to consider when determining whether or not you qualify as a bona fide resident of a foreign country:
- What is your intent?
- Have you established a home in the foreign country?
- To what extent have you assimilated into the life and society of the foreign country?
- Are you physically present in the foreign country other than brief, temporary visits to the U.S. or elsewhere?
- What is the nature, extent and reasons for any temporary absences?
Physical Presence Test
You can also qualify by meeting the physical presence test.
You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. A full day is a period of 24 consecutive hours, beginning at midnight. This 12-month period may begin with any day. For example, if the 12 month period started on April 10, 2014, it would end on April 9, 2015. The 330 days do not have to be consecutive, as long as they fall within a period of 12 consecutive months.
The number of days that you can claim the foreign earned income exclusion is based on the total number of days during the year in question that fall within any chosen 12-month measurement period. You can count days you spent in a foreign country for any reason. You do not have to be in a foreign country only for employment purposes. You can count days you spent in a foreign country while on vacation (or for any other purpose) so long as on those days your tax home is still in a foreign country. Unlike the bona fide residence test, this test does not depend on the kind of residence you establish, your intentions about returning, or the nature and purpose of your stay abroad.
File a Return to Claim the Foreign Earned Income Exclusion
You must file a tax return to claim the foreign earned income exclusion. Even if your foreign earnings are below the foreign earned income exclusion threshold; you still must file a U.S. income tax return.
- You must attach either Form 2555 or Form 2555-EZ to your U.S. income tax return to claim the exclusion.
- The election to exclude foreign earned income and the election to exclude the cost of foreign housing are separate elections.
- You may make one or both elections by attaching Form 2555 or 2555-EZ to your tax return for the first year for which it is effective.
The maximum foreign earned income exclusion is adjusted annually for inflation. For 2015, the maximum exclusion has increased to $100,800. You cannot exclude more than the lesser of: $100,800, or your foreign earned income for 2015 minus your foreign housing exclusion. If your qualifying period is less than a year, the limitation amount has to be prorated.
Choosing to exclude foreign earned income affects credits and deductions for which you might otherwise be eligible. For example, you cannot take a foreign tax credit or deduction for taxes on income you can exclude. If you do take a credit or deduction for any of those taxes in a subsequent year, your election for the foreign earned income exclusion will be revoked beginning with that year. You are not eligible to claim the earned income credit. You must add back the excluded amount when computing modified adjusted gross income for purposes of the child tax credit and/or the additional child tax credit.
If both you and your spouse work abroad and each of you individually meet the requirements, you can each choose the foreign earned income exclusion, the foreign housing exclusion, and/or the foreign housing deduction. You and your spouse would then file separate Forms 2555 or 2555-EZ. Depending on the circumstances, a couple could end up filing one or two forms. There may be situations in which one spouse files a Form 2555 and the other files a 2555-EZ.
- Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad
- Form 2555
- Instructions for Form 2555
- Form 2555-EZ
- Instructions for Form 2555-EZ