Expat Tax: Foreign Earned Income Exclusion Explained - Part 1

From time to time I will be featuring guest posts from professionals and businesses that support the expat community.   It is my hope that this information will be of value to both the expat professional and the expat entrepreneur and will help support their professional and business success abroad.

Today’s guest blogger is Chris Rusch, a California licensed attorney who has represented clients before the IRS from many US states. His practice is focused on international taxation, foreign corporate formations, and resolving complex tax controversies. Chris is going to share information regarding the often misunderstood the U.S. Foreign Earned Income Exclusion.

Take it away Chris…

The most important tool in the American expat’s U.S. tax toolbox is the Foreign Earned Income Exclusion (FEIE or Exclusion).  If you qualify, you can exclude up to $87,600 in 2008 foreign earned income from U.S. Federal income tax.

Filing Requirements for Citizens

All U.S. citizens and residents who earn more than $8,450 (single) or $16,900 (married filing joint) in a year must file a U.S. personal income tax return - no matter where you live. If you are a U.S. citizen living abroad, failing to file a U.S. tax return can result in the loss of your Exclusion.

As U.S. citizens, we are taxed on our worldwide income. One of the only ways to legally reduce that tax, and benefit from being in a foreign country, is to file before the IRS comes looking for you and maximize the benefit of the FEIE.

Foreign Earned Income

Only Foreign Earned Income can be excluded from Federal income tax. Foreign earned income is wages or self employment income (independent contractor earnings) you receive for services you perform while living outside of the U.S. Wages can come from a U.S. corporation or a foreign corporation, including an offshore corporation, and it does not matter that you are also a shareholder or owner of that foreign corporation.

Earned Income does not include interest, dividends, or other investment or passive income.

There are two ways to qualify for the exclusion:

1.    330 Day Test: You must be outside of the United States for 330 out of any 365 day period. It does not matter if the 330 days is over two calendar years (example: between November 1, 2007 to October 31, 2008) and a special extension to file your tax return is available to give you time to meet this requirement.

2.    Bona Fide Residency Test: Residency is achieved by moving to another country and making it your “home." You can intend to return to the United States in the future, but you must move to the foreign country for an “indefinite” or “extended” period of time, which must include one entire calendar year. This is discussed in detail below.

As you can see, the 330 day test is fact based, while the Residency test turns on your intentions and is therefore more difficult to use and prove. I often recommend relying on the 330 day test in the first year you claim the Exclusion, and then moving to the Residency test. 

In Part 2, Chris will share more about the Bona Fide Residency Test.

YOUR EXPAT SUCCESS TIP: If you are an American living overseas, speak with your accountant to make sure you are taking advantage of the Foreign Earned Income Exclusion – a great way to maximize your income and resources to enjoy your life abroad.

If you've found this post of value, feel free to give it a digg (below) so that others might become aware of it. Many thanks!