If you are a U.S. citizen or a U.S. resident alien living in a foreign country, you are subject to the same U.S. income tax laws that apply to citizens and resident aliens living in the United States. One potential benefit for U.S. taxpayers living abroad is the foreign earned income exclusion and housing exclusion or deduction. Qualifying taxpayers may exclude compensation or wages for their personal services and certain foreign housing costs from their gross income. For the 2018 calendar year, the foreign earned income exclusion is $104,100 USD.
- What is “earned” income?
Earned income is pay for personal services performed such as salaries and wages and includes commissions, bonuses, professional fees and tips. Be aware that the foreign earned income exclusion does not apply to unearned income such as interests, dividends, capital gains, social security benefits and pensions. Variable income like rents, royalties and business profits may be considered earned or unearned income subject to different situations.
- Who may qualify for the foreign earned income exclusion?
U.S. citizens and resident aliens who live and work abroad may be eligible to claim the foreign earned income exclusion when filing their U.S. federal tax return. A resident alien is a U.S. taxpayer who currently holds a green card or held a green card at any time during the calendar year.
- Amount of foreign earned income exclusion
For 2017, the maximum foreign earned income exclusion is USD $102,100 per qualifying taxpayer. For married taxpayers filing jointly, each qualifying taxpayer may be eligible to claim the USD $102,100 exclusion. However, any unused foreign earned income exclusion of one spouse cannot be used by the other spouse. In addition to the foreign earned income exclusion, qualifying taxpayers may be eligible to claim an exclusion or deduction from gross income for housing amounts paid or incurred on their behalf.
- How a taxpayer qualifies for the foreign earned income exclusion?
To qualify for the foreign earned income exclusion, a taxpayer must have a tax home in a foreign country and have foreign earned income. Also, a taxpayer must be either a U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year; or a U.S. resident alien who is a citizen or national of a country with which the U.S. has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year; or a U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
Note: (Hong Kong currently does not have an income tax treaty with the USA)
- What is the bona fide residence test?
To meet the bona fide residence test, taxpayers must have established a bona fide residence in a foreign country(s) for an uninterrupted period that includes an entire tax year… which is usually, January 1 – December 31 for taxpayers filing on a calendar year basis. The IRS explains “Questions of bona fide residence are determined on a case-by-case basis, taking into account such factors as your intention or the purpose of your trip and the nature and length of your stay abroad. You must show the Internal Revenue Service (IRS) that you have been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. The IRS decides whether you qualify as a bona fide resident of a foreign country largely on the basis of facts you report on Form 2555, Foreign Earned Income. The IRS cannot make this determination until you file Form 2555.” Via the
- What is the physical presence test?
A taxpayer qualify for the physical presence test means that the taxpayer is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
- Limitation and Effect of Choosing the Exclusion
Taxpayers who exclude the foreign earned income, cannot take a foreign tax credit or deduction for that portion of income that was excluded. Taxpayer can revoke the choice for any year by attaching a statement that taxpayer is revoking one or more previously made choices to the return or amended return for the first year that taxpayer do not wish to claim the exclusion(s). Taxpayer must specify which choice(s) are revoking and revoke separately a choice to exclude foreign earned income and a choice to exclude foreign housing amounts. If taxpayer revoked a choice and within 5 years again wish to choose the same exclusion, taxpayer must apply for IRS approval. Taxpayer can do this by requesting a ruling from the IRS, which can be complex procedure and may need professional help. Also, the IRS charges a fee for issuing these rulings.
- How to claim the foreign earned income exclusion?
The foreign earned income exclusion and foreign housing exclusion or deduction is claimed using IRS Form 2555. A shorter Form 2555-EZ is available for certain taxpayers claiming only the foreign earned income exclusion.
- Does the foreign earned income exclusion apply to self-employment tax?
Please note that the foreign earned income exclusion does not apply to U.S. Self-Employment tax, only income tax. So, a self-employed person living abroad and qualifying for the exclusion may still need to pay self-employment tax if there is no tax treaty.
- Additional information
The IRS provides additional information in Publication 54, “Tax Guide for U.S. Citizens and Resident Aliens Abroad”. It you have other question, please contact us for more information.
The information contained herein serves as a guideline and is only provided for general informational purposes. It should not be considered as offering any tax advice. Since tax laws are complex, you should consult your tax advisor on specific issues related to your tax situation.