When it comes to working overseas tax for Americans abroad, planning ahead is the key to saving money on your US expat taxes. This is because taking advantage of credits, deductions and exclusions typically requires that you live in a foreign country for a certain amount of time and that you meet very specific criteria. One such way to save is with the Foreign Earned Income Exclusion – read on for details on how to use this helpful exclusion.
What is the Foreign Earned Income Exclusion?
The Foreign Earned Income Exclusion (FEIE) is a tool provided by the IRS to help Americans living abroad reduce or eliminate being double taxed – by the US and by their host country. If you qualify, you can exclude $101,300 from your 2016 working overseas tax (and $102,100 for 2017 taxes) by including Form 2555 with your expat tax return. Check out an example of an expat completing Form 2555 here.
In order to use the FEIE to reduce or eliminate your expat tax liability, you must pass one of two residency tests to qualify. Below, we’ll explain the differences between the two to help you determine which option is best for your situation.
Using the Physical Presence Test to Qualify for the FEIE
- Foreign Earned Income. This would include a salary, wages, bonus or self-employment income. Note that this does not include dividends, interest, pension distributions or capital gains.
- A “Tax Home” in the Foreign Country. This is often misunderstood when attempting to qualify for tax benefits, but a “tax home” is where an individual is permanently or indefinitely engaged in work – regardless of where their personal residence is. To establish a “tax home,”, you must have a work engagement expected to last at least one year. If you’ve retained a personal residence (abode) in the US, you can’t be considered to have a tax home in a foreign country. Learn more about this requirement on the IRS website.
- Been Physically Present in a Foreign Country for the Necessary Time frame. This time frame is 330 days out of a 365-day period. This does not have to be on a calendar-year basis, and can be adjusted over a two-year span as needed to qualify. An important thing to note is that you must spend 330 full days in the foreign country, as partial days and time spent traveling do not count. It’s critical that you track travel days carefully if planning to use the PPT, as you’ll need to be able to show details to the IRS if requested. Visit this link to download an app that will help you keep track of your days and travel.
Using the Bona Fide Residence Test to Qualify for the FEIE
The alternative to qualifying with the PPT is by using the Bona Fide Residence Test (BFT). In order to use this test, you must have:
- Foreign Earned Income. This is the same requirement as for the PPT; you must have income earned in a foreign country in order to pass the test and use the FEIE to save on your working overseas tax.
- A “Tax Home” in a Foreign Country. This is the same requirement for using the PPT to qualify. You must establish a “tax home” by having a work engagement expected to last a year or more, and retaining a personal residence in the US means you do not have a “tax home” in a foreign country.
- Been a Bona Fide Resident for the Specified Amount of Time. This means you must have been a bona fide resident of a foreign country for an entire tax year. The biggest factor here for passing the test is that you must demonstrate intent to stay in the foreign country indefinitely with no immediate plans to return to the US. You can read more about the specifics of a bona fide resident here.
Your specific situation as a US expat will determine which test is the best option for qualifying for the FEIE. If you are a contractor or are on an assignment that has a specified end date (but for at least 330 full days), you’ll likely need to use the PPT to save on your working overseas tax (see expat tax implications for contractors here). In any event, it’s a good idea to consult with an expat tax professional to better understand requirements for your US expat taxes.
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