Know Your Tax Benefits and Exclusions

If you are a U.S. citizen or resident alien, and you are living and working abroad, then you may be eligible for a number of tax benefits. Though you are still obligated to pay taxes on income whether you are living inside or outside of the country, there are certain parts of your foreign salary, wages, or compensation earned for personal services provided, that you may be able to exclude from your total income. Similarly, certain foreign housing costs may be able to be deducted or excluded.

The exclusions that are available for foreign earned income are only available in specific circumstances. The U.S. citizen or resident alien must be able to show that they meet the following requirements:

  • They must have earned income by working in a foreign country
  • They must have a tax home in a foreign country
  • They must be able to prove their residence, either through a physical presence test or a bone fide residence test

The exclusion that has been established for those earning foreign earned income is inflation adjusted every year, and for tax year 2015 the maximum exclusion has been established at $100,800 per person who qualifies.

For married taxpayers where both spouses work abroad and meet the residence requirements, both are eligible for the exclusion, with a maximum combined exclusion of $201,600 during 2015. It is important to note that when married couples are both eligible for the exclusion, neither can use their spouse’s unused exemption. Each is limited to their maximum exclusion.

The foreign earned income exclusion is not the only tax advantage offered to those working abroad. Another expense that is available as a deduction or exclusion is the amount spent on foreign housing, though there are limitations on how much can be excluded or deducted. The limitations for 2015 have been established at 30 percent of the maximum foreign earned income exclusion, or $30,240. The amount that is allowable may be impacted by where the individual’s foreign tax home base is, as well as the how many days they lived there during the tax year.

When calculating all of the available deductions and exclusions, it is important to remember that amount that was actually earned less the housing exclusion, which means that in order to make the calculation the taxpayer needs to first determine what their housing exclusion is, followed by the amount of the income exclusion.

Though all of these potential exclusions and deductions sound very good, there are important qualifiers that preclude certain individuals from taking advantage of them. Any pay that has been received by an individual as compensation as a civilian employee of the U.S. government or as a member of the military is not eligible. Neither is pay received for work provided in international waters or in areas that have been designated as a combat zone by Presidential Executive Order. 

Any payments that the taxpayer received after the tax year following the year the services were rendered are disqualified, and so is the value of lodging and meals provided simply for the employer’s convenience. Finally, neither pension payments nor annuity payments, including social security benefits, can be excluded.

For those taxpayers that are qualified and who are self-employed, the foreign earned income exclusion is also available, though the calculation is done differently. The amount that can be excluded is used to reduce regular income tax but is not applied to self-employment tax, and the housing tax benefit is to be applied as a deduction rather than as an exclusion.

Whether claiming the foreign earned income exclusion, the housing exclusion, or both, the taxpayer is required to calculate how much tax they owe on the amount that they have not applied the exclusions to based upon the original tax rates that would have been in effect without the exclusions. 

It is also important to remember that taxpayers working in foreign lands may not take both the foreign earned income exclusion and the foreign tax credit or deduction. Generally, a choice must be made between the two.  Should a taxpayer elect to claim the foreign tax credit or tax deduction on any taxes levied on the excluded income, it is considered a revocation of the foreign earned income exclusion.

For those who to whom these rules apply there are other essentials to be kept in mind. With reference to the earned income credit, if a taxpayer claims their exclusion then the credit cannot be claimed for that tax year. It is also important to keep the timing in mind when making your selections about foreign earned income exclusion, as they can only be reflected on the following types of returns:

  • An income tax return filed by the deadline, or the deadline for its extension
  • An amended income tax return filed for a tax return that was filed by the deadline
  • The deadline for filing an amended return is either two years after the tax has been paid or three years after the original return was filed, whichever is later
  • An income tax return filed within a year of its original due date

Once a taxpayer has elected to claim the foreign earned income exclusion for a particular year, they are able to revok their decision by attaching a statement to their tax return stating which choice they are revoking. If a taxpayer wishes to revoke both the foreign earned income exclusion and the foreign housing exclusion, then they must submit two different revocation statements. Whatever election is revoked may be reapplied for within five years, but in order to do so the taxpayer must make a request directly of the IRS.

Taxpayers who are working and living in foreign countries face a number of complexities in filing their tax returns. In order to ensure that you are taking advantage of all of the various advantages to which you are entitled, take the time to consult with a qualified expat tax professional.

Our staff will be happy to provide you with a personal consultation that will review your options and make sure that you are making the most tax-advantaged decisions.