Overview:
While all U.S. citizens and resident aliens are taxed on their worldwide income, you may be able to exclude some or all of it (up to 92,900 dollars for 2011) by taking advantage of the foreign earned income exclusion. Also, you can eliminate or deduct certain foreign housing amounts.
In order to qualify, a few conditions need to be met. You can qualify based on either the Bona Fide Residence Test or the Physical Presence Test:
To qualify under the Bona Fide Residence Test:
- You need to be a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. Questions of bona fide residence are determined according to each individual case, taking into account factors such as your intention, the purpose of your trip, and the nature and length of your stay abroad. The foreign country will need to consider you as one of its residents for tax purposes. Having some sort of long-term immigration status, speaking the local language, having a local driving license all help to demonstrate bona fide residence.
To qualify under the Physical presence test:
- You need to be physically present in a foreign country for 330 days during a period of 12 consecutive months.
IRS Publication 54, “Tax Guide for U.S. citizens and resident aliens living abroad” describes the requirements for the Foreign Earned Income and Housing Exclusions. Click here to view the complete publication.
Qualify under the Bona Fide Residence Test:
You meet the bona fide resident test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. You can use the bona fide residence test to qualify for the exclusions and deductions only if you are:
- A U.S. citizen or
- A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect.
You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for 1 year.
Bona fide residence test: To meet the bona fide residence test, you must have established a bona fide residence in a foreign country.
Your bona fide residence is not necessarily the same as your domicile. Your domicile is your permanent home, the place to which you always return or intend to return.
- You could have your domicile in Cleveland, Ohio, and a bona fide residence in London if you intend to return eventually to Cleveland. The fact that you go to London does not automatically make London your bona fide residence. If you go there as a tourist, or on a short business trip, and return to the United States, you have not established bona fide residence in London. But if you go to London to work for an indefinite or extended period and you set up permanent quarters there for yourself and your family, you probably have established a bona fide residence in a foreign country, even though you intend to return eventually to the United States. You are clearly not a resident of London in the first instance. However, in the second, you are a resident because your stay in London appears to be permanent. If your residency is not as clearly defined as either of these illustrations, it may be more difficult to decide whether you have established a bona fide residence.
- Questions of bona fide residence are determined based on each individual case, taking into account factors such as your intention, the purpose of your trip, and the nature and length of your stay abroad.
To meet the bona fide residence test, 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 are a bona fide resident of a foreign country largely on the basis of facts you report on Form 2555. The IRS cannot make this determination until you file Form 2555.
Statement to foreign authorities. You are not considered a bona fide resident of a foreign country if you make a statement to the authorities of that country that you are not a resident of that country, and the authorities:
- Hold that you are not subject to their income tax laws as a resident, or
- Have not made a final decision on your status.
Uninterrupted period including the entire fiscal year. For proof of bona fide residence, must reside in a foreign country or countries for an uninterrupted period that includes an entire tax year. An entire fiscal year is January 1 to December 31 for taxpayers who file their returns of income tax on the basis of the calendar year.
During the period of bona fide residence in a foreign country, you can leave the country for short trips or temporary return to the United States or elsewhere for vacation or business. To keep your status as a bona fide resident of a foreign country, you should have a clear intention to return as travel without unjustified delay, to your residence abroad, or to a new bona fide residence in another foreign country.
Example 1. You arrived with your family in Lisbon, Portugal on November 1st, 2006. Your job is indefinite, and you want to live with your family until your company sends you a new post. You immediately established residence. You spent the month of April 2007 in a business conference in the United States. Your family stayed in Lisbon. Immediately after the conference, you returned to Lisbon and continued to live there. On January 1, 2008, you completed an uninterrupted period of residence for a full fiscal year (2007), and have proof of bona fide residence.
Example 2. Assume the same facts as in example 1, except that you are transferred back to the United States on December 13, 2007. You will not meet the bona fide residence test, because your bona fide residence in the foreign country, while it lasted over a year, did not include a full fiscal year. You can, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction under the physical presence test, discussed later.
Once you have established bona fide residence in a foreign country for an uninterrupted period that includes an entire tax year, you are a bona fide resident of that country for the period that begins on the date you actually began the residence and ending date it leaves the residence abroad. Your period of bona fide residence may include an entire tax year plus parts of other fiscal years, including the part of the fiscal year during which you moved abroad.
Example: You were a bona fide resident of Singapore from March 1st, 2006 until September 14, 2008. On 15 September 2008, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2007, you were also a bona fide resident of a foreign country from March 1st, 2006 until late 2006 and from January 1st, 2008 to September 14, 2008.
Reassignments: If you are assigned from a post to another foreign location, you may or may not have a break in foreign residence between your assignments, depending on circumstances.
Example 1. You were a resident of Pakistan from October 1st 2007, through November 30, 2008. On December 1st, 2008, you and your family came to the United States to wait for an assignment to another foreign country. Your personal belongings were also returned to the United States.
Your residence abroad ended on November 30, 2008, and it will not start again until after you are assigned to another foreign country and physically enter that country. Since you did not spend a full tax year abroad, you do not meet the bona fide residence test in any year. You can, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction according to the physical presence test (330 days out of 12 consecutive months), discussed later.
Example 2: Assume the same facts as in example 1, except that after the completion of your work in Pakistan you were given a new mission in Turkey. On December 1st, 2008, you and your family came to America for a month’s vacation. On 02 January 2009, you arrived in Turkey for your new assignment.
Because you did not interrupt your bona fide residence abroad, you meet the bona fide residence test.
Qualify under the Physical presence test:
Were you physically present in a foreign country for 330 days during a period of 12 consecutive months? If so, you qualify for the foreign earned income exclusion based on the physical presence test. The 330 days need not be consecutive. Every U.S. citizen or resident alien may use physical presence to qualify for the exclusions and deductions.
The physical presence test is based only on how long you stay in a foreign country or countries. This test does not depend on the type of residence you establish, your intentions regarding the return or the nature or the purpose of your stay abroad.
330 days. Generally, to meet the physical presence test, you must be physically present in a foreign country or countries for at least 330 full days during a period of 12 months. You can count the days you spent abroad for any reason. There must be a foreign country only for employment purposes. You may be on vacation.
The exception: You may be physically present in a foreign country or countries for less than 330 full days and still meet the physical presence test if you are forced to leave a country because of war or civil unrest.
Definition of a day: A day is a period of 24 consecutive hours, beginning at midnight.
Travel: When you leave the United States to go directly to a foreign country or when returning to the United States directly from a foreign country, the time you spend on or over international waters does not count towards the total of 330 days.
Example: You leave the United States for France by air on June 10. You arrive in France at 9am on 11 June. Your first full day of physical presence in France is June 12.
Going through a foreign country: When leaving the United States to go to a foreign country, you pass over another foreign country before midnight. The first day you can count on for the full 330 days is the day after the day you leave the United States.
Example: You leave the United States by air at 9:30 on June 10 to travel to Kenya. You pass over West Africa at 23:00 on June 10 and arrive in Kenya 0:30 on June 11. Your first full day in a foreign country is June 11.
Travel between places abroad. You can move from one place to another while abroad or travel between foreign countries without losing full days. If any part of your trip is not in any foreign country and takes less than 24 hours, it is considered to be in a foreign country during that part of the trip.
Example 1. You leave Ireland by air at 11pm on July 6 and arrive in Sweden at 5am on July 7. Your journey takes less than 24 hours and no days lost entirely.
Example 2. You leave Norway by ship at 10pm on July 6 and arrive at in Portugal on July 8 at 6am. Since your trip is not in a foreign country or countries and the trip lasts more than 24 hours, you lose as full days of July 6, 7 and 8. If you remain in Portugal, his next day in a foreign country is July 09.
In the United States while in transit: If you are in transit between two points outside the United States and are physically present in the United States for less than 24 hours, you are not treated as present in the United States during the transit. You are treated as traveling over areas not within any foreign country.
How to calculate the 12 months period? There are four rules you should know when you find out the period of 12 months.
- The 12-month period can begin with any day of the month. It ends the day before the same calendar day, 12 months later.
- The 12-month period should be made of consecutive months. Any period of 12 months with 330 days in a foreign country fall within the foreign earned exclusion.
- You do not have to begin your 12-month period with your first full day in a foreign country or end it with the day you leave. You can choose the period of 12 months which gives the highest exclusion.
- To determine the period of 12 months which falls within a longer stay in a foreign country, the 12-month periods can overlap one another.
Example 1: You are a construction worker who works on and off in a foreign country over a 20-month period. You might pick up the 330 full days in a 12-month period only during the middle months of the time you work in the foreign country because the first few and last few months of the 20-month period are broken up by long visits to the United States.
Example 2. You work in New Zealand for a period of 20 months starting January 1st, 2007, through August 31, 2008, except that you spend 28 days in February 2007 and 28 days in February 2008 on holiday in the United States. You are present in New Zealand for 330 full days each of the following two periods of 12 months: January 1st, 2007 – December 31, 2007 and September 1st, 2007 – August 31, 2008. By overlapping periods of 12 months in this way, you have proof of physical presence for the 20 month period over.
Application of the Foreign Earned Income Exclusion
You can also choose to exclude from your income a foreign housing amount.
If you claim the exclusion, you cannot claim any credits or deductions related to excluded income, including a credit or deduction for any foreign income tax paid on the excluded income.
Dollar limits:
You may be able to exclude up to $ 92,900 dollars of foreign income, earned in 2011.
If you and your spouse work abroad and each of you qualify under the bona fide residence or physical presence test, you can each take advantage of the foreign earned income exclusion. You don’t even need to qualify using the same test. Together, you and your spouse can remove as much as $185,800.
Part-year exclusion: If the period for which you are qualified for the foreign earned income exclusion includes only part of the year, your maximum exclusion will be the annual exclusion pro-rated to the number of days in which you qualify for the exclusion during the qualifying year. The number of qualifying days is the number of days per year during which you:
- Have your tax home in a foreign country, and
- Qualify using either proof of bona fide residence or proof of physical presence.
Foreign Housing Exclusion and Deduction
On top of the foreign earned income exclusion, you may also be able to claim an exclusion or deduction from gross income for your housing expenditures in a foreign country.
The housing exclusion applies only to the amounts considered paid for with employer-provided amounts. The housing deduction applies only to amounts paid with self-employment income.
You can exclude (up to the limits) your entire housing amount from income if it is paid for with employer-provided amounts. Employer-provided amounts are any amounts paid to or for you by your employer, including your salary, housing reimbursements, and the fair market value of pay given in the form of goods and services. If you have no self-employment income, your entire housing amount is considered paid for with employer-provided amounts.
If you claim the exclusion, you cannot claim any credits or deductions related to excluded income, including credit or deduction for any foreign income tax paid on the excluded income.
Related: Things to Know About Taxes Before Becoming an Expat
