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Foreign Income Exclusion Rules

The overseas earned income exclusion is designed to avoid double taxation by shielding income from U.S. taxation that has already been paid in taxes in another nation. The Internal Revenue Service (IRS) of the United States will tax your worldwide income; but, if you are an American expat, this means you will pay two taxes on this income. You may be subject to additional taxation by the IRS if you receive income from a foreign country.

Understanding Foreign Earned Income Exclusion

On IRS tax Form 2555, the overseas earned income exclusion option is selected. Furthermore, individuals who utilize this exclusion can also contribute to domestic retirement plans using this income and claim the international tax credit or deduction for taxes paid to a foreign government for this income.

To be eligible to claim the foreign earned income exclusion, you must fulfill the following criteria:

You must be an American citizen or a lawful permanent resident alien. An alien who resides in a country permanently without being granted citizenship is referred to as a resident alien. A person must either now possess a green card or have one from the previous calendar year in order to qualify for this category in the United States.

Your presence in a foreign nation meets the requirements. Being a bona fide resident for the entirety of the tax year satisfies the requirement for qualifying presence status. By physically being there for at least 330 days throughout the course of a 12-month period, you can also pass the physical presence test.

You have income from a foreign source. If you receive wages from a job or compensation from self-employment for work you do abroad, this is considered foreign earned income. You do not have foreign earned income if you receive pensions, investments, alimony, or gaming revenue from a foreign country.

Other Rules

Foreign-earned income: Wages, salaries, professional fees, and other sums received to you in exchange for personal services you provided are considered foreign-earned income. It excludes payments made in exchange for non-compensatory personal services rendered to a firm that are distributed earnings and profits.

Self-employment income: The overseas earned self-employment income exclusion is available to those who meet the requirements. Your normal income tax will be reduced by the excluded amount, but your self-employment tax will not be reduced. Additionally, if you are a self-employed person, you could be able to use the foreign housing deduction rather than the foreign housing exclusion.

Not foreign earned income:The following sums are not included in foreign earned income:

  1. Pay obtained while working for the American government or any of its agencies as a military or civilian employee
  2. Payment for services rendered in international airspace or waterways (not a foreign country)
  3. payments made following the close of the tax year in which the services that generated the income were rendered
  4. Pay that is ordinarily exempt from income, such as the cost of food and lodging you provide to your employer so they can use them on their property (and, in the case of lodging, as a condition of employment)
  5. Social Security benefits that are included in pension or annuity payments.

Foreign tax home: If you anticipate working in a foreign nation permanently rather than just temporarily and if you do your job there, you may have a foreign tax home. Unless you labour in a Presidentially declared conflict zone in support of the United States Armed Forces, you do not have a foreign tax home if your primary residence is in the United States (where you have stronger familial, economic, and personal links). See Tax Home in a Foreign Country for further details.

Key Takeaways

  • In order to protect Americans who live overseas from double taxation, the foreign earned income exclusion was developed.
  • The foreign earned income inclusion is only available to U.S. citizens who meet certain requirements, one of which is being a citizen or resident alien of the United States.
  • Potential candidates include resident aliens who are nationals or citizens of nations with which the United States has income tax treaties.
  • Before you prepare your taxes, it can be worthwhile to look at the foreign earned income exclusion if you live and work abroad.
  • The housing expenses you pay while living abroad using income earned abroad are represented by a foreign housing amount.
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