The Two Most Important Tax Benefits

As an American working in a foreign country, you have a lot of details that need to be taken care of: Learning a new language, acclimating to a new culture, making sure that everything that you’re leaving behind in the United States is well taken care of are just the beginning of the many complications of working abroad. Learning that in addition to all of the other changes you’re going through, your job puts you into a completely different tax category can be overwhelming, but there’s no need to worry when you have Tax911 on your side. 

For more information on some of the tax laws that have been specifically created for Americans working overseas, read below. Whether you are an American citizen, resident alien of the United States, a non-resident alien or a business owner, you can trust in our professionalism and expertise to make sure that you know what your tax obligation is and that all of your paperwork is properly prepared.

The Foreign Earned Income Exclusion and the Foreign Tax Credit

As an American working overseas, the two most important tax benefits that you need to be aware of are the 1116 Foreign Tax Credit and the 2555 Foreign Earned Income Exclusion

While one provides an exclusion of up to $108,000 in compensation for monies earned outside of the country, regardless of whether your employer is an American company or not, the other is a credit that provides a method of adjusting your U. S. tax liability by crediting you for foreign taxes that you pay. 

The exclusion cannot be applied against interest, dividends, stock sales or pension income.  The credit is not dollar for dollar, but rather a ratio. The more that you know about these laws and capabilities, the more benefits you are able to reap.

The 1116 Foreign Tax Credit

This credit was created to ensure that American taxpayers who are working in foreign countries and who pay foreign taxes are not economically penalized and are not taxed twice. Though the ratios and adjustments that are applied vary depending upon the country that you are working in and the amount of income you earn, the basic idea is that if you are taxed by your host country at a higher rate than you would have paid for the same amount while working in the United States, you will not owe U.S. income tax, and if the tax rate in the host country is lower then the amount that you would owe in the U.S. for the same income, your tax liability in the U.S. will be reduced.

The 2555 Foreign Earned Income Exclusion

This exclusion allows American taxpayers who are working abroad to exclude their foreign wages from US income tax. In order to receive this benefit, you must meet three requirements:

 1. You must file form 2555 with your 1040. 
2.  You must live and work in a foreign country. 
3. Lastly you must pass one of two tests, either the Physical Presence Test or the Bona Fide Residence Test.  

The Physical Presence Test allows for approximately one month per year to be spent in the U.S., with 330 full 24-hour days spent in the foreign country in any 365-day period.  To meet the Bona Fide Resident Test you must prove yourself to be a Bona Fide Resident for a period that includes an entire calendar year.  

Under both tests, a US Citizen can move overseas and live in a foreign country for four months of year one.  The taxpayer can exclude 4 months of income in year 1as long as the taxpayer continues living in the foreign country until January 1 of year 3.  

Form 2350 permits a taxpayer to delay filing the year one return until January 30, of year three when the taxpayer has met the Bona Fide Residence test.

At Tax911, our accounting professionals prepare tax returns for overseas Americans every day.  Each return we prepare we evaluate which test will maximize the taxpayers refund or minimize the tax.  

There are a number of different ways to allocate income based on US and Foreign work days. We will review your work history and documentation to determine the best test and allocation for you and your situation. Though the requirements may seem stringent and the calculation complex, it is our experience that incidentals such as vacation days, stateside assignments that bring you back into the U.S. and other details are generally viewed by the IRS with great flexibility. 

For more information on how we can help you address these and many of the other complications that are part and parcel of working abroad as an American taxpayer, contact our office today.

Our staff will be happy to provide you with a personal consultation that will review your options and make sure that you are compliant with your foreign tax reporting.