Your Expat Taxes: Understanding US vs. Foreign Sourced Income

You often hear the term ‘foreign earned income’ tossed around when it comes to your US expat taxes. It’s important to distinguish between income earned in the US and abroad, since money earned in foreign countries can be excluded from US expatriate tax up to a certain threshold. Here’s what to know about the differences between US and foreign-sourced income.

What is Earned Income?

It’s important to understand what ‘earned income’ means – in general, the IRS classifies income by where it is earned for your expat taxes. Therefore, if you’re working abroad, your income is considered foreign earned. On the contrary, if you’re working in the US, it will be considered US earned income. This holds true, whether a US or a foreign company is paying you.

Own your own business? The same rules will apply to your income.

  • If your primary income comes from personal service, such as a lawyer or doctor, the source of your income will be where the services are performed.
  • If your primary income comes from selling products, the source of the income will be where the products are sold (if your company purchases the items it sells).
    • If the company produces the items it sells, the source of income will be where the items are produced.

What is Passive Income?

This is any income that you aren’t working to earn, and includes interest, dividends, capital gains, rental property income, retirement income and more. It’s a bit more complicated to determine whether it’s US or foreign source income – so we’ve broken it down here:

Type of IncomeSource of Income
Interest

 

Residence of the payer – If outside the US, then the income is considered to be foreign. If from the US, then the income is US earned.
Dividends

 

Location of the corporation – Foreign corporations produce foreign earned dividends. US corporations produce US earned income. Where the company is incorporated determines if it is foreign or US (note: some foreign earned dividends may be considered US earned if the corporation is partially owned by US shareholders).
Rents

 

Location of the property – If the property is located outside the US, then the income is foreign earned. If the property is within the US, it is considered US earned income.
Royalties – Natural resources (Oil, Gas, etc.)

 

Location of the corporation – Foreign corporations produce foreign earned dividends. US corporations produce US earned income.
Royalties – Patents, Copyrights, etc.(Intellectual Property)

 

Where the property is used – If the patents or copyrights are used outside the US, it is foreign earned income. If the royalties are from intellectual property used inside the US, then it is US earned income.
Sale of Property – Real Estate (Land and buildings)

 

Location of the property – If the property is located outside the US, then the income is foreign earned. If the property is within the US, it is considered US earned income.
Sale of Property – Personal  (Any property that is not land or building)

 

Location of the seller’s tax home – A tax home is where the taxpayer primarily lives and works.
Pensions and retirement income (Not including Social Security)

 

Location of where the services were performed to earn the pension/retirement income
Scholarships/Fellowships

 

Generally, the residence of the taxpayer determines whether scholarships are considered to be foreign or US earned. Residences outside the US are considered to be foreign earned, and residences within the US are considered to be US earned.

Why the Differences Are Important

All of your worldwide earned income must be reported on your US Tax Return – foreign and US earned. That doesn’t mean you’ll necessarily pay tax on this income, though, as there are several tax treatments that can be applied. These include the Foreign Earned Income Exclusion, which allows you to exclude up to $101,300 of foreign earned income from your 2016 US taxes ($102,100 in 2017) and the Foreign Tax Credit, which prevents you from being double-taxed on your foreign earned income.

Have More Questions About How Income Source Affects Expat Taxes?

One of our expert accountants will be happy to assist you with all of your needs related to expat taxes – contact us today for the answers you need.

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