OTHER, TAXES & LICENSES

Foreign Earned Income Exclusion

If you are a U.S. citizen or if you are taxed as a U.S. citizen (resident aliens) your income from all over the world may be subject to taxation. The good news is that if you meet certain requirements you may be able to exclude some or all of your foreign earned income when calculating your U.S. tax liability through the foreign earned income exclusion. Like most things tax related, there are many limits and fine print you need to look out for, but if you meet the requirements you may be able to exclude $104,100 of foreign earned income in 2018 (102,100 in 2017). Rather than deduct a portion of your foreign income, use Form 2555 to calculate the amount of foreign earned income you should include in the income section of your 1040.

ENTREPRENEUR

Jill is sole-proprietor U.S.citizen who lived in India for 350 days last year to lead a project for an Indian client. While Jill was away she subleased her home in the states, rented an apartment in India, opened up an Indian bank account and obtained an Indian driver's license. Jill was paid $120,000 for her work in India. When Jill prepares her 2018 tax return, she could exclude up to $104,100 of Indian income from her 1040 and only have to pay U.S. tax on $15,900 of these earnings (note however that Jill may be subject to Indian taxes on the full amount of her income).

AUTHOR / SPEAKER

Thomas is a U.S. citizen who lives in New York and makes a living traveling around the world giving lectures on global warming. Last year, Thomas was out of the U.S. for 300 days, during which time he earned $90,000 of foreign income. Unfortunately for Thomas, since his tax home was not in a foreign country, he would not be eligible to exclude any portion of his foreign earned income from his 1040. Note That if Thomas's tax home was outside of the U.S., he would need to have been considered a bonafide resident of another country to qualify for the foreign earned income exclusion since he was not physically present in a foreign country for 330 days or more during the year (physical presence test).

ARTIST

Pierre is a painter from France whose tax home is in Paris. Despite living in Paris, Pierre is considered a U.S. resident alien for tax purposes since he has a U.S. green card. Last year Pierre made $80,000, $50,000 of which was earned in the U.S., $30,000 earned in France. Since Pierre meets the requirements to take the foreign earned income exclusion, when he prepares his U.S. tax return he would include all $80,000 of business income on his Schedule C, then exclude the $30,000 he earned in France from his Form 1040 on line 21 after completing Form 2555.

REAL ESTATE AGENT

Karen is a Phoenix based real estate agent who moved to Australia for six months last year to teach a class on real estate development in the U.S.. Karen was paid $56,000 for her time in Australia. During the other six months of the year, she made $35,000 of commission income. When Karen prepares her Schedule C, she would include all $91,000 of worldwide income. Unfortunately for Karen, she would not be eligible to exclude any of the $56,000 using the foreign earned income exclusion because she was not a bona fide resident of Australia for an entire tax year or physically present for more than 330 full days over a twelve month period.

PROFESSIONAL SERVICES

Kelly is a U.S. citizen and sole proprietor who makes a living as an investor. Last year, Kelly had $2,000 of interest income from a foreign investment. Unfortunately, since interest income is not considered earned income, Kelly would not be allowed to exclude any of this income, even if she met all of the other requirements necessary to take advantage of the foreign earned income exclusion.

MORE ON THE FOREIGN EARNED INCOME TAX EXLUSION

To be eligible for the foreign earned income credit you must have foreign earned income, have a tax home in a foreign country, be a U.S. citizen or resident alien (who is a citizen or national of a country with which the U.S. has an income tax treaty in effect), be a bona fide resident of a foreign country uninterrupted for an entire tax year OR be physically present in in a foreign country or countries for 330 days or more during 12 consecutive months. See our diagram for nuances between which of these requirements U.S. citizens must meet vs. resident aliens. If you do meet IRS requirements, you may be able to exclude up to $104,100 of foreign earned income in 2018.
Earned income includes salaries and wages, commissions, bonuses, professional fees and tips. Unearned income including but not limited to dividends, interest, capital gains, annuities, gambling winnings, rents, scholarships, business profits and royalties cannot be included in the foreign earned income exclusion.
If you were present in a foreign country or countries for 330 full days (do not have to be consecutive) during a period of 12 consecutive months you generally would meet the physical presence test. The purpose of your stay abroad / nature of the days (i.e. vacation vs. work) do not matter.
Your tax home is your main place of business / the place where you are permanently or indefinitely working. If you travel frequently for your business, your tax home may be where you live. Note that if you have an "abode" in the U.S. during the same period you are away you may not be considered to have a tax home in a foreign country (i.e. If you move to Japan for 15 months to promote your business but you stay with a friend and keep your home / all your belongings in the U.S. Japan could not be your tax home. Alternatively, if you rented an apartment in Japan, opened up a japanese bank account, put your belongs in storage and rented your home in the U.S., your tax home could be considered to be in Japan).
If you are a U.S. citizen, you can pass the bona fide residence test if you live in a foreign country uninterrupted for a period that includes an entire tax year AND establish a legitimate residence there. In other words, simply moving to another country to work for one year does not make you a bona fide resident. The IRS makes this determination on a case by case basis and considers your intention, the purpose of your trip and the length and nature of your time away. If you are a resident alien, to pass the bona fide residence test you also need to be a citizen or national of a country the U.S. has a tax treaty with (start at page 29 of Publication 54).
If you meet the requirements to take the foreign earned income exclusion and you are self employed you may also be eligible to take the foreign housing deduction (See IRS / link below for details).

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