You may already be aware that Americans are taxed on worldwide income. However, if you are an American residing outside the US, you may be able to exclude all or part of your foreign source wages and self-employment income from your US expat income tax return. This exciting opportunity comes courtesy of the FEIE, which stands for Foreign Earned Income Exclusion, but it may as well stand for extra cash in your pocket because that’s exactly what it means for many expats.
Qualifying for the FEIE is slightly more complicated than simply attaching IRS Form 2555 to your US expat income tax return. First, you must work and reside outside the US and meet either the bona fide or physical presence test. Also, the exclusion amount changes annually since it is adjusted for inflation; for 2018, you can exclude up to $103,900. Please note: the exclusion only applies to income earned from performing services as an employee or independent contractor such as wages, salaries, professional fees, or compensation for personal services. The reduction does not reduce any self-employment taxes assessed.
The Bona Fide Residence Test
How can you qualify for the bona fide residence test? You are considered a bona fide resident of a foreign country if you reside in that country for an uninterrupted period that includes the entire year. It must include a full calendar year: January to December. The intent of the test is to clearly establish intent to return to the foreign country where you were living and have your home in that country. Moreover, the bona fide test applies to US citizens and to any US resident alien who is a citizen or national of a country with which the US has an income tax treaty.
Also, per the IRS rules, you are not considered a bona fide resident of a foreign country if you make a statement to the authorities of that country that you are not a resident of that country and the authorities hold that you are not subject to their income tax laws as a resident. If you have made such a statement and the authorities have not made a final decision on your status, you are not considered to be a bona fide resident of that foreign country.
The Physical Presence Test
The physical presence test’s requirements are slightly different. You are considered physically present in a foreign country when you meet the 330-day test in any consecutive 12-month period. You can also live and work in different countries but must be physically present outside the US for 330 days. The rule for the physical presence test is a bit more flexible with the 330 days since you can cross years to meet the test. You can choose which 12-month period to use, and that gives you the freedom to select the period providing the greatest exclusion!
There’s an Exception to Every Rule
Some exceptions are important to understand so as not to jeopardize your election and exclusion, such as the waiver of time requirements and US travel restrictions. The waiver of time requirements states that both tests contain minimum time requirements. However, the minimum time requirement can be waived if you must leave the foreign country because of war, civil unrest, or similarly adverse conditions. You must be able to show that you reasonably could have expected to meet the minimum time requirement if not for the adverse conditions. Each year, the IRS publishes a list of the foreign countries for which the minimum time requirements are waived.
The second exception relates to being present in a foreign country in violation of US law. You will not be treated as a bona fide resident or be eligible for the exclusion if the income you earn is from sources within a foreign country in violation of the law. Currently, the only country to which travel restrictions apply is Cuba; however, civilian individuals performing services at the U.S. Naval Base in Guantanamo Bay are eligible for the FEIE, provided that they meet the tests’ requirements for residency.
You Can Have it Both Ways
Moreover, if you meet either the bona fide or physical presence test, you might also be eligible to exclude amounts your employer paid for your housing. Expenses which would qualify for the foreign housing exclusion include items such as rent, the fair rental value of housing provided by your employer, utilities, occupancy taxes, certain types of insurance, and parking fees. The following would not qualify for the housing exclusion: extravagant expenses, mortgage interest and taxes, cost of buying a home, domestic labor, home improvements, and depreciation.
Finally, you can claim both the income and the housing exclusion on your US expat income tax return. It bears repeating: the exclusions can be combined! The housing exclusion is generally used when your foreign earned income exceeds the total exclusion amount. Also, self-employed persons must use housing expenses as deductions rather than exclusions and must fill out the correct parts of Form 2555 for the proper calculations.
But remember: even if these deductions eliminate the taxes you owe, they do not eliminate your requirement to file annually!
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If all of these exclusions seem complicated, it’s because they are. Our experts can help you deftly navigate the changing seas of US expat income taxes. Contact us today, and we’ll help you realize how stress-free expat tax prep can be.