Foreign Earned Income Exclusion

Ok, so I wrote a post about my friend and the International tax exemption here [link], but I totally forgot about the Foreign Earned Income Exclusion which may be the best option.  This exclusion will allow you to exclude a certain amount of your foreign earned income to not be taxed in the US.  This is of course only for U.S. citizens or resident aliens living abroad.  Currently the limit is $95,100. You must pass several requirements to qualify:

  1.  You must be earning income in a foreign country (pretty obvious) but the catch here is that your “Tax Home” must be in a foreign country.  This means that your primary physical work location must be in the foreign country.
  2. You must be a U.S. Citizen or Permanent Resident

In addition, you must meet just one of the following:

  1.  A U.S. Citizen that is a ‘bona fide’ resident of a foreign country for an entire tax year.  This must be an uninterrupted full year.  Normally this would be Jan 1 to Dec 31 but if you have a different tax year then you would use those dates.
  2. A U.S. resident alien that is also a citizen of a country that the United States has a special agreement with. This agreement is called a tax treaty.  Also you must be a resident for a tax year.
  3. A U.S. citizen who is physically in a foreign country for 330 full days during 12 straight months. This is pretty self-explanatory.  You just check your plane ticket arrival to the country and add 330 days to pass this test.

Once you have decided on which test you may pass then be sure to have proof such as copies of boarding passes, visa stamps, or plain tickets.

Bona Fide Residence Test

It is important to note that you do not automatically qualify as a resident just by going to the foreign country and staying for one year.  A resident of a foreign country is generally defined as a person who intends on living and working in the foreign country for an indefinite amount of time.  So if you go and work on a contract for 1 year and intend on returning back to the United States at the end of that period then it would be difficult to claim that you are a bona fide resident of that country.

Here the intention is what is important.  Obviously this is up to some debate.  But if you would like to claim this benefit then be sure to have proof of your intent.  This could come in form of closing bank accounts in the United States or selling assets.  I am not sure how strict the IRS would be on this test but be prepared.

The Physical Presence Test

This one is a little bit easier to measure.  Just stay in the foreign country for at least one year and you got it.  The good thing to remember with this test is the timing.  If you live in a foreign country you will automatically get an extra month to do your taxes.  So normally taxes are due on April 15 but if you live in a foreign country you will have until May 15.  So, if you need extra time to pass this test than you have the one month.  Or you can easily extend the return to get more time.

The Benefits

The good thing about this exclusion is that it does not depend on the amount of taxes paid to the foreign country.  So if you pay a very small amount of income taxes in the foreign country then you should be able to exclude those amounts and only pay taxes on the income that you earned in the United States. This would be best if your annual income was less than the $91,500 limit.