If you are a United States citizen or a resident alien who lives and works abroad, you may qualify to exclude all or part of your foreign salary or wages, or amounts received as compensation for personal services rendered from your income. If you are a United States citizen with a tax home in a foreign country and you meet the bona fide residence test or physical presence test, you may exclude up to $80,000 for the year 2004 and thereafter. Resident aliens of the United States with a tax home in a foreign country may be eligible for the exclusion if they meet the physical presence test, or if they are citizens or nationals of a country with which the United States has an income tax treaty with an applicable nondiscrimination clause, and they meet the bona fide residence test.
The foreign earned income exclusion and the foreign housing cost amount exclusion are figured on Form 2555, which must be attached to Form 1040. However, if you claim only the foreign earned income exclusion, you may be able to use Form 2555-EZ instead.
Who Qualifies for Foreign Earned Income Exclusion ?
To be eligible to claim the foreign earned income exclusion or the foreign housing exclusion, you must have a tax home in a foreign country and meet either the bona fide residence test or the physical presence test.
The bona fide residence test can be used by United States citizens; and by United States resident aliens who are citizens or nationals of a country with which the United States has an income tax treaty with an applicable nondiscrimination clause. You must be a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. The characteristics which qualify you as a bona fide resident usually include establishing a home and settling in that country with some degree of permanence. An individual is not a bona fide resident of a foreign country of the individual claims to be a nonresident to the authorities of the foreign country and his/her earned income is not subject to tax in the foreign country because the individual is considered a nonresident in the foreign country.
The physical presence test can be used by any United States citizen or resident alien. You must be physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. The 12-month period can begin with any day of any calendar month.
If you violate U.S. restrictions that prohibit travel to certain countries, you will not be able to count your presence or residence in those countries in meeting the bona fide residence test or the physical presence test.
Generally, your tax home is the general area of your main place of business or post of duty, regardless of where you maintain your family home. If you do not have a regular or main place of business because of the nature of your work, then your tax home may be the place where you regularly live. You are not considered to have a tax home in a foreign country for any period for which your household is in the United States. However, if you are temporarily present in the United States on vacation or for your employment, it does not necessarily mean that your household is in the United States during that time.
What Qualifies?
If you live and work abroad, you may qualify to exclude all or part of your foreign earned income from United States income tax. Foreign earned income is defined as wages, salaries, professional fees, and other amounts received as compensation for personal services performed in a foreign country. The place where you perform the services is what defines your income as foreign, not where or how you are paid. For instance, income received for personal services performed in France is foreign earned income, even if the employer is American and your pay is deposited in an American bank. Wages paid by the U.S. government to its employees are not eligible for the exclusion. However, amounts paid to independent contractors by the U.S. government may be eligible for the exclusion. You must have a tax home in a foreign country and meet either the bona fide residence test of the physical presence test.
Foreign earned income does not include such items as interest, dividends, pensions, annuities, or amounts attributable to certain employee trusts. If you are self-employed, and both capital investment and personal services are factors in producing your income, your earned income is the smaller of the value of your personal services or 30% of net profits.
Your net self-employment income is generally subject to self-employment tax even if it is excluded for income tax purposes. However, if it was earned in a country that has a social security agreement with the United States, which is called a totalization agreement, it may be exempt from U.S. social security taxes, including the self-employment tax.