Expat Taxes

Global Economy: The Tax Advantages of Working Abroad

Global Economy: The Tax Advantages of Working Abroad

Taxes apply to income earned everywhere, including outside of the United States, and that rule applies whether you're living in U.S. territory or abroad and whether you are a citizen or a resident alien. However, there are certain exclusions that both resident aliens and qualifying U.S. citizens are able to take advantage of when filing their income tax. Those who live and work abroad are able to deduct or exclude all or part of their foreign wages or compensation, as well as some foreign housing costs, as long as they meet certain criteria, including:

  • Their tax home must be located in a foreign country
  • They must have income that they received for work done in the foreign county
  • They must be able to pass one of two tests: a physical presence test or a bona fide residence test

The amount of foreign earned income that can be excluded from taxes changes from year to year, as it undergoes an annual inflationary adjustment, but in the current tax year (2015) there is a maximum exclusion of up to $100,800 per qualifying person for foreign earned income. This exclusion amount can be applied to both spouses in a married couple where both are working abroad and can each pass the residency or physical presence test, which means that such couples are eligible to exclude as much as $201,600 in 2015. It is important to note that this maximum can only be reached by having each partner take their individual maximum – one spouse is not permitted to transfer any unused exclusion to the other.

A foreign housing exclusion or deduction of 30% of the maximum foreign earned income exclusion is also available to qualifying individuals: this amounts to $30,240 for 2015, but this percentage is not universally applicable The actual limit is based upon the country in which the foreign tax home is located, as the length of time that the taxpayer qualifies as having earned foreign tax income. Because the foreign earned income exclusion can't be greater than the actual amount earned less the amount that is being deducted for foreign housing expenses, the taxpayer needs to first calculate their foreign housing exclusion amount.

There are a number of situations in which income may be earned abroad but may not qualify as foreign earned income. These include: any monies earned as either a civilian employee of the federal government or any of its agencies or military; social security benefits, or any other pension or annuity payments; items such as the value of meals or lodgings furnished for the employer's convenience and excluded from income; monies earned while working in international waters; monies earned in areas that have been designated by Presidential Executive Order as specific combat zones; and monies earned during one tax year but not received until after the end of the following tax year.

It is possible to claim the foreign earned income exclusion on income earned while self-employed. A qualified individual can reduce their regular income tax by excluding the foreign earned income, but is still responsible for the full self-employment tax. The amount that employed individuals are eligible to take as a deduction for foreign housing expenses can be taken by self-employed individuals, but only as an exclusion. 

The challenge of filing taxes when taking the foreign earned income exclusion, housing exclusion, or a combination of the two, is that any non-excluded income that remains after the exclusions have been taken have to be paid using the tax rates that would have originally applied. The taxes will appear to be calculated at a disproportionately high percentage for the amount being taxed.

It is important to remember that if an individual chooses to take a foreign tax credit or claim a deduction for foreign taxes paid, they are not eligible to take the foreign earned income exclusion too. The opportunity to take advantage of that exclusion is revoked when the foreign tax credit or deduction for foreign taxes paid is taken.

There are a number of other important points for those working abroad to remember. If a foreign earned income exclusion is claimed, then you cannot also claim the earned income credit. Only one of the two can be elected. It is also important to keep timing in mind when making the decision to take advantage of the foreign earned income exclusion. This is because the exclusion must be included with the return, whether it is a return filed by the due date or an amendment that is filed on time for the deadline. They can also be included with returns filed within a year of the original due date (regardless of extensions) or with amended returns filed by the later of two years after the taxes are paid or three years after the filing date of the original return.

Once a foreign earned income exclusion has been claimed, it can still be revoked. In order to do this a statement must be attached to the tax return indicating the revocation of a previously made choice or choices. This statement is required to provide specific reasons for the revocation, and if both the foreign earned income exclusion and the foreign housing exclusion are taken, they must be removed separately. If the individual changes their mind again and decides to return to choosing the exclusion, the switch must be made within five years of the revocation and the exclusion must be applied for directly to the IRS.

The rules that apply to taxation for those working abroad are complex, but they can work to your favor if you have a good understanding of your rights and eligibilities. If you are considering accepting or applying for a position that involves foreign employment, and have additional questions, contact Ashraf Khatib for tax help and counseling, including how to ensure that you meet all of the requirements for qualification.

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Ashraf Khatib

Ashraf Khatib

Ashraf Khatib is the founder and the Managing Director of Tax for Expats, LLC in 2000. Prior to establish the firm, Ashraf was employed by the Big Four (4) CPA firms as the head of international client services group, where he managed the individual expatriate and foreign national tax programs for an impressive array of their clients which included high net-worth individual clients, multi-national companies and professional firms.

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