US Tax Exemptions and Credits for Expats

Foreign Income Exclusions and Credit Definitions:

Tax Home:

Your tax home is the place where you perform work or are self-employed permanently or indefinitely.  You aren’t considered to have a tax home in a foreign country if your abode is in the US. 

Foreign Country: 

The following are not considered “foreign countries” under IRS definitions; Puerto Rico, Guam, US Virgin Islands, American Samoa, Commonwealth of Northern Mariana Islands. (these US territories have separate rules as to income exclusions and credits) 

Foreign Earned Income: 

Income earned in a foreign country outside the United States.  Income is foreign earned if the services that produced the income were physically performed, or sourced form outside the US.  Where or how you are paid has no effect on where the source of your income is derived.  The foreign earned income exclusion is not applicable to income earned within the US.

Earned income does not include, passive income (investments/real estate), social security, unemployment income.  Does not include income received as an employee of the US government or while working in international waters. 

Earned income does include non-cash items provided to you by your employer (i.e. housing, automobile) and allowances or reimbursements (housing allowance, foreign service premium, hardship premium, education, transportation allowances, moving allowance). 

Physical Presence Test: 

In order to meet the physical presence test, a taxpayer must be physically present outside the United States 330 days in a 12-month period.

• The months must be consecutive, but the days do not need to be consecutive.

• The IRS definition of a day is a 24-hour period that begins at midnight.

• Time in transit over international waters does not count as time spent in another country.

• All time spent abroad, whether for business or personal purposes, is included.

• The 12-month period does not have to begin on the 1st of January.  It can begin with any day of any month so long as it ends 12 months later.

• The 12-month periods can overlap, and can differ from one year to the next.

The calculation gets complicated and there is also availability of filing an extension to enable you to meet the physical presence test to enable exclusion of FEI.  This is an extension beyond the October 15th extension deadline and is requested via Form 2350.  The date of this extension request is generally one month past the date you expect to qualify for physical presence or bona fide residence test.  This request is not automatically granted. 

A discussion of your situation with one of our tax professionals is best for determining if you qualify or will qualify for the FEI exclusion.    

Tracking Time Abroad for Expats:

The taxpayer needs to keep a detailed log or calendar of time spent abroad and in the US, including details of travel departure and arrival times when traveling to/from the US.  The taxpayer should also keep track of time spent in the US, segregating days by business and non-business and documenting business earnings (if any) while in the US.

Bona Fide Residence Test

1. To meet the bona fide residence test, a taxpayer must:

2. Reside in a foreign country or countries outside of the US for an entire tax year (does not mean you cannot visit the US).

3. Must intend to stay indefinitely (i.e. longer than a business trip, vacation).

4. Must be liable for income taxes in the foreign country.

5. Must not claim non-resident status in the foreign country.

The IRS determines if you meet the qualifications for bona fide residence.  The IRS looks at factors such as your intention and length of stay.

Foreign Housing Exclusion or Deduction

You might be able to take the exclusion or deduction for housing expenses that include; rent, utilities, furniture rental, insurance.  The foreign housing exclusion applies only to amounts of employer provided housing.  The housing deduction applies only to amounts considered paid for with self-employment earnings.    The calculations depend on the foreign country you reside and your foreign earned income amounts.  One of our expat tax professionals can help you determine if you have housing expenses that qualify for the housing exclusion or deduction. 

Choosing the Exclusion

You chose to utilize the foreign earned income exclusion by completing Form 2555.  If you choose to utilize the FEI exclusion, your choice remains in effect for that and all future years unless it is revoked.  If revoked, the FEI exclusion cannot be used again for the next 5 years tax filings without special approval from the IRS. 

Note:  The tax on any non-excluded income is figured using tax rates that would have been applied had there been no excluded income. 

The Additional Child Tax Credit and Earned Income Tax Credit cannot be taken if you utilize the foreign earned income tax exclusion. 

Foreign Tax Credit

The Foreign Tax Credit reduces your tax liability dollar-for-dollar by the amount of the foreign taxes paid.  The tax credit can be taken for income taxes paid to a foreign government via filing of Form 1116.  The tax credit can be taken only for foreign income taxes that you are legally obligated to pay, not on the amount of tax a foreign country might withhold from your pay (unless the withholding equals your final tax liability).  Thus, the credit is the net amount of income taxes paid to the foreign government after calculating final tax and should be netted against any refunds to be received.  The foreign tax credit relates to income tax only.  It is not applicable to Social taxes or any other taxes the foreign government might levy.  Social Taxes or other taxes paid should be excluded from the amount of foreign tax credit claimed on the Form 1116. 

Limit: 

The foreign tax credit is limited to the part of your total US tax that is in proportion to your taxable income from sources outside the US compared to your total taxable income.  The allowable foreign tax credit can’t be more than your actual foreign tax liability.  The limit is calculated on a separate basis with regards to general category income, passive category income, section 951A category income, etc. 

Foreign Tax Credit Carryback and Carryover: 

The amount of the credit not allowed due to the limits can be carried back 1 year and forward 10 years.  If not utilized, the credit carryover is not refundable. 

The Foreign Tax Credit is usually the preferred method if the foreign tax jurisdiction has a higher tax rate than your US tax rate.  The Foreign Tax Credit can be used even if you don’t meet the residency tests applicable to the FEI exclusion. 

You can use both the FEI and Foreign Tax Credit in the same return.  This is applicable to taxpayers who have foreign earned income that exceeds the FEI exclusion limit.  However, the foreign tax credit can only be used against the income in excess of the FEI exclusion and is subject to FTC limit calculations.