Today, I spoke with a man who was planning to take up a work opportunity overseas. He came to me wanting to understand the rules surrounding the foreign-earned income exclusion and the foreign tax credit. A U.S. taxpayer working overseas has an additional opportunity to reduce their taxable income via the foreign-earned income exclusion.
What is the foreign-earned income exclusion?
Essentially, a taxpayer is allowed to exclude $104,100 (in 2018) of income earned, while living and working in a foreign country, from their taxable income. However, it is not sufficient to simply have lived and worked overseas. One has to meet certain requirements to be eligible to use this option.
There are two ways to meet the eligibility requirements for the foreign-earned income exclusion.
1) Physical Presence Test
During a movable twelve month period, the taxpayer must be physically present in a foreign country for 330 days. This twelve month period does not have to match the calendar year. It can start mid-year and continue for twelve consecutive months.
2) Bona fide Residence Test
If a taxpayer has in fact established a residence in a foreign country with no definitive plans to return to the U.S., they may qualify for the foreign-earned income exclusion. This test is based on several facts and circumstances to determine whether the taxpayer is truly a foreign resident, such as employment contracts, limitations on time spent in the country, foreign visas, and the residence of immediate family members.
Calculating How Much Income To Exclude
Once it is determined that a taxpayer is eligibile for the foreign-earned income exclusion, the amount of the exclusion must be calculated. If qualifying time was for the full twelve calendar months, 100% of the exclusion could be used. However, if the qualifying time began mid-year, the exclusion would have to be prorated based on the portion of the qualifying time situated in the actual tax calendar year. For example, if the taxpayer first moved overseas on July 1 and was overseas for 330 days through June 30 of the following year, 50% of the calendar year was in the qualifying 12-month period. This would allow the taxpayer to use 50% of the $104,100 exclusion amount or $52,050.
Planning Your Visit to the U.S.
Since the ability to exclude foreign-earned income may depend on one’s physical presence outside the U.S., it is important to carefully plan any trips back to the U.S.. Spending more than 35 days in the U.S. during the year could disqualify the taxpayer from using the foreign-earned income exclusion. Even missing the requirement by one day, there would be no exclusion and tax would be owed on all of the foreign-earned income.
Your Situation is Unique
Every situation is unique. It is important to consult with a tax advisor who understands how the foreign-earned income exclusion works in your situation. Here at Jeffrey D. Reimer, CPA, PLLC, we work with several dozen clients working in foreign countries, making use of the foreign-earned income exclusion. We understand what is needed and how to frame a foreign employment opportunity in a way that maximizes the tax benefit made available by the U.S. tax law. Feel free to reach out to us.