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January 5, 2009
Chris Rusch is the author of The Expat Tax Bible 2010, published by International Living. For additional information click here.
Dear Reader,
The most important tool in the ExPat’s U.S. tax toolbox is the Foreign Earned Income Exclusion (FEIE or Exclusion). If you qualify, you can exclude up to $87,600 in 2008 and $91,400 in 2009 of foreign earned income from U.S. Federal income tax.
Filing Requirements for Citizens
All U.S. citizens and residents who earn more than $8,450 (single) or $16,900 (married filing joint) in a year must file a U.S. personal income tax return - no matter where you live. If you are a U.S. citizen living abroad, failing to file a U.S. tax return can result in the loss of your Exclusion.
As U.S. citizens, we are taxed on our worldwide income. One of the only ways to legally reduce that tax, and benefit from being in a foreign country, is to file before the IRS comes looking for you and maximize the benefit of the FEIE.
Foreign Earned Income
Only Foreign Earned Income can be excluded from Federal income tax. Foreign earned income is wages or self employment income (independent contractor earnings) you receive for services you perform while living outside of the U.S. Wages can come from a U.S. corporation or a foreign corporation, including an offshore corporation, and it does not matter that you are also a shareholder or owner of that foreign corporation.
Earned Income does not include interest, dividends, or other investment or passive income.
There are two ways to qualify for the exclusion:
As you can see, the 330 day test is fact based, while the Residency test turns on your intentions and is therefore more difficult to use and prove. I often recommend relying on the 330 day test in the first year you claim the Exclusion, and then moving to the Residency test.
Bona Fide Residency Test
bona fide residency test is one of the most misunderstood and misused sections of the tax code by those working and living abroad...especially by contractors in military zones.
You are a bona fide resident if you move to a foreign country and make it your home. You do this by filing and paying taxes in that country, moving there and planning to stay indefinitely, etc.
The perfect example of a resident is someone who moves to a foreign country, does not intend to return to the U.S., files and pays taxes in that country, is on a long term visa that allows them to work in that country, they sell their U.S. home an buy one in the foreign country, and they relocate with their family.
The problem with the residency test is that very few cases are perfect. For example, a husband might move to France to work indefinitely, leaving his family in California, may return to the US for 40 days per year to visit, and intends to return as soon as financially possible. He might have a high probability of being allowed the Exclusion, assuming he is out of the U.S. for at least one year, but it will depend on the many facts and circumstances of his situation.
Also, being out of the U.S. for one calendar year does not make you a resident of a foreign country. For example, if you go to a foreign country to work on a particular construction job for a specified period of time, say 14 months, 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 some of the factors to be considered in determining whether you meet the bona fide residence test.
If the residency test is so complex, why should you use it? Most importantly, it allows you to return to the U.S. for a few months each year, rather than only 35 days. Second, once you qualify as a resident of a foreign country, you will remain a resident of that country until you give up that residency. With the 330 day test, you must be out of the country for 330 of each 365 day period. With the residency test, you can qualify for all or part of a year. Here is an example from the IRS website:
You were a bona fide resident of England from March 1, 2006, through September 14, 2008. On September 15, 2008, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2007, you also qualify as a bona fide resident from March 1, 2006, through the end of 2006 and from January 1, 2008, through September 14, 2008.
Conclusion
I hope this article sheds some light on the misunderstood Foreign Earned Income Exclusion. It is a great benefit to those living and working abroad and can significantly reduce your U.S. tax obligations.
However, if you are audited and you have not filed your returns, you will lose this deduction and pay U.S. tax on all of your income. In other words, use it or lose it!
Regards,
Chris Rusch
ABOUT THE AUTHOR:
Chris Rusch is a California licensed attorney who has represented clients before the IRS in many states. His practice is focused on international taxation and preparation, foreign corporate formations, and resolving complex tax controversies.
Chris Rusch is the author of The Expat Tax Bible 2010, published by International Living. For additional information click here.
Dear Reader,
The most important tool in the ExPat’s U.S. tax toolbox is the Foreign Earned Income Exclusion (FEIE or Exclusion). If you qualify, you can exclude up to $87,600 in 2008 and $91,400 in 2009 of foreign earned income from U.S. Federal income tax.
Filing Requirements for Citizens
All U.S. citizens and residents who earn more than $8,450 (single) or $16,900 (married filing joint) in a year must file a U.S. personal income tax return - no matter where you live. If you are a U.S. citizen living abroad, failing to file a U.S. tax return can result in the loss of your Exclusion.
As U.S. citizens, we are taxed on our worldwide income. One of the only ways to legally reduce that tax, and benefit from being in a foreign country, is to file before the IRS comes looking for you and maximize the benefit of the FEIE.
Foreign Earned Income
Only Foreign Earned Income can be excluded from Federal income tax. Foreign earned income is wages or self employment income (independent contractor earnings) you receive for services you perform while living outside of the U.S. Wages can come from a U.S. corporation or a foreign corporation, including an offshore corporation, and it does not matter that you are also a shareholder or owner of that foreign corporation.
Earned Income does not include interest, dividends, or other investment or passive income.
There are two ways to qualify for the exclusion:
- 330 Day Test: You must be outside of the United States for 330 out of any 365 day period. It does not matter if the 330 days is over two calendar years (example: between November 1, 2007 to October 31, 2008) and a special extension to file your tax return is available to give you time to meet this requirement.
- Bona Fide Residency Test: Residency is achieved by moving to another country and making it your “home." You can intend to return to the United States in the future, but you must move to the foreign country for an “indefinite” or “extended” period of time, which must include one entire calendar year. This is discussed in detail below.
As you can see, the 330 day test is fact based, while the Residency test turns on your intentions and is therefore more difficult to use and prove. I often recommend relying on the 330 day test in the first year you claim the Exclusion, and then moving to the Residency test.
Bona Fide Residency Test
bona fide residency test is one of the most misunderstood and misused sections of the tax code by those working and living abroad...especially by contractors in military zones.
You are a bona fide resident if you move to a foreign country and make it your home. You do this by filing and paying taxes in that country, moving there and planning to stay indefinitely, etc.
The perfect example of a resident is someone who moves to a foreign country, does not intend to return to the U.S., files and pays taxes in that country, is on a long term visa that allows them to work in that country, they sell their U.S. home an buy one in the foreign country, and they relocate with their family.
The problem with the residency test is that very few cases are perfect. For example, a husband might move to France to work indefinitely, leaving his family in California, may return to the US for 40 days per year to visit, and intends to return as soon as financially possible. He might have a high probability of being allowed the Exclusion, assuming he is out of the U.S. for at least one year, but it will depend on the many facts and circumstances of his situation.
Also, being out of the U.S. for one calendar year does not make you a resident of a foreign country. For example, if you go to a foreign country to work on a particular construction job for a specified period of time, say 14 months, 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 some of the factors to be considered in determining whether you meet the bona fide residence test.
If the residency test is so complex, why should you use it? Most importantly, it allows you to return to the U.S. for a few months each year, rather than only 35 days. Second, once you qualify as a resident of a foreign country, you will remain a resident of that country until you give up that residency. With the 330 day test, you must be out of the country for 330 of each 365 day period. With the residency test, you can qualify for all or part of a year. Here is an example from the IRS website:
You were a bona fide resident of England from March 1, 2006, through September 14, 2008. On September 15, 2008, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2007, you also qualify as a bona fide resident from March 1, 2006, through the end of 2006 and from January 1, 2008, through September 14, 2008.
Conclusion
I hope this article sheds some light on the misunderstood Foreign Earned Income Exclusion. It is a great benefit to those living and working abroad and can significantly reduce your U.S. tax obligations.
However, if you are audited and you have not filed your returns, you will lose this deduction and pay U.S. tax on all of your income. In other words, use it or lose it!
Regards,
Chris Rusch
ABOUT THE AUTHOR:
Chris Rusch is a California licensed attorney who has represented clients before the IRS in many states. His practice is focused on international taxation and preparation, foreign corporate formations, and resolving complex tax controversies.