The United States taxes its citizens and resident aliens on their world wide income. Taxpayers who meet certain requirements can exclude a limited amount of foreign earned income and housing cost from U.S Taxation.
Code Section 911 (d)(6) and Reg 1.911-6(c)
The foreign earned income exclusion does not apply to FICA taxes. If an American Citizen or a resident alien is employed abroad by an “American Employer” he / she must pay FICA taxes on his / her wages. If host country has a social security totalization agreement with the United States FICA is exempt. Expatriates who are not employed by an American Employer are exempt from FICA taxes.
Exclusion or Credit
An expatriate must elect whether to take the exclusion or rely on foreign tax credit.
Exclusion completely eliminates the U.S income tax on the qualifying amount of foreign earned income. Expatriates who work in low tax foreign countries or who qualify for special tax exemptions in those countries can benefit from the lower foreign tax rates.
Under the option of foreign tax credit, the United States will collect any residual U.S tax and the expatriate gets no benefit from the lower foreign rates.
Exclusion will eliminate the U.S tax on the qualifying amount of foreign earned income derived by an expatriate who works in a high tax jurisdiction foreign country. Because higher foreign taxes can fully offset U.S taxes on the foreign earned income, credit option can also achieve this result.
Foreign tax credit can also be carries over.
Code Section 904 (c)
Foreign taxes in excess of the foreign tax credit can be carried back one year or carried forward 10 years.
Code Section 862 (a)(3)
Expatriates who return to U.S may be able to use their foreign tax credit carry forwards to the extent their future compensation is attributable to foreign business trips. Compensation is treated as foreign source income to the extent the related services are performed abroad.
The foreign earned income exclusion is available to U.S citizens and resident aliens who meet the following requirements.
A U.S citizen who is a bona fide resident of a foreign country for the whole taxable year without any interruption or an individual is physically present in a foreign country for 330 days during the 12 month period.
According to code section 911 (d)(1) the individual’s home is a foreign country.
Example:
Alex is a U.S citizen who takes a job in a foreign country “F” and resides there from Jan 01 – 2012 to March 31 – 2013. During 2012, Alex earns $90,000 in foreign country. Foreign country does not impose any tax.
Alex would file form 2555 to qualify for physical presence test.
An individual who has foreign earned income from a foreign country but he claims to be non-resident of that country, he is not considered a bona fide resident of that country.
A bona fide foreign resident should have:
- Presence of family in a foreign country.
- A long term lease.
- Acquisition of a home.
- Involvement in social life of a foreign country.
In case both spouses work abroad, they separately determine if they qualify for foreign earned income exclusion. They both can individually elect for exclusion. Also one can elect the exclusion and other may not choose to elect for exclusion.
Code Section 911 (b)(2)(D)(i)
Computation of Exclusion
Eligible exclusion amount of foreign earned income is adjusted annually for inflation. For 2013 this amount is USD 97,600.
If someone is qualified to claim foreign earned income exclusion and has 290 qualifying days, his maximum exclusion in 2013 is (97,600*(290/362)) = 77,545.20
This exclusion only applies to foreign earned income.
Reg 1.911-3(e)(1)
The determination factor is whether the reimbursement is attributable to the services that are performed during the qualifying period.
Reg 1.911-3 (e)(5)(i)
Foreign housing and automobile allowance also qualify for exclusion if compensation represents compensation for services performed abroad during the qualifying period.
Any taxable reimbursements received for expenses incurred in moving back to the United States are usually treated as U.S source income. However, if prior to moving abroad, a written agreement was made that the expatriate would be reimbursed for the expenses incurred to move back to the United States, the reimbursement would be treated as foreign source income.
Reg 1.911-6 (a)
Some other items fully deductible from gross income:
- Medical Expenses
- Charitable Contributions
- Alimony Payments
- IRA contributions
- Real Estate Taxes
- Mortgage interest on personal residence
- Personal exemption
Code Section 911 (a)(2)
An expatriate who qualifies for foreign earned income exclusion can also claim exclusion for housing amount.
List of eligible housing expenses:
- Rent
- Utilities (Telephone charges are not included).
- Real and personal property insurance.
- Certain occupancy taxes.
- Non-refundable security deposits.
- Rental of furniture and accessories.
- Household repairs.
- Residential parking.
Non-eligible Housing Expenses:
- Home improvement costs.
- Purchase of furniture
- Television subscriptions.
Foreign earned income exclusion and housing cost amount is made by filing form 2555.
Foreign earned income exclusion remains in effect until revoked by the taxpayer.
Once an exclusion election is revoked a taxpayer must wait five years to reinstate exclusion.
Disclaimer:
This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.
References:
www.jct.gov/publications.html
http://www.law.cornell.edu
http://www.irs.gov/publications
U.S Taxation of International Transactions by Robert J. Misey, Michael S. Schadewald
Introduction to United states International Taxation by Paul R. McDaniel, Hugh j. Ault and James R. Repetti
International Taxation by Joseph Isenbergh
International Taxation in a nutshell by Richard L. Doernberg.
International Income Taxation, Code and Regulations by Robert J. Peroni – CCH
Mansoor Suhail (Mani)
Accountant
BSBA – EA – ICIA – RA
Tax for Canada and U.S.A
Web: www.theaccountingandtax.com and www.taxservicesguru.com
Blog: http://taxservicesguru.blogspot.ca
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