The Foreign Earned Income Exclusion and Housing Deductionby kyoffelaw

Are you a United States citizen or permanent resident working abroad? If so, it is important to keep in mind that the United States taxes you on your worldwide income. However, there are a number of important tax benefits that may be available for you, such as the foreign earned income exclusion, foreign housing exclusion and foreign housing deduction. Subject to certain rules, you may currently qualify to exclude up to $97,600 from your 2013 income.  Additionally, it is possible to exclude or deduct certain payments for foreign housing.

If your foreign source employment income falls below the excluded amount you still must file an annual tax return.

Generally if you are self employed abroad the foreign earned income exclusion only applies to income taxes and does not apply to self-employment taxes. Therefore even if your foreign earned self employment income falls below the exclusion amount you must still pay self employment taxes at the rate of 15% on your net foreign source self employment income.

The foreign earned income exclusion and the foreign housing exclusion/deduction are all based on foreign earned income. Foreign earned income is defined by the IRS as salaries, wages, commissions, bonuses and self-employment income for services performed in a foreign country. Foreign earned income must received for services  performed during a period that your tax home is in a foreign country and during which you meet either the “bona fide residence test” or the “physical presence test”.

Tax Home

Your tax home is the location in which you are permanently or indefinitely (you expect to remain in such location for more than one year) located for work. It is the location of your main place of employment regardless of your family home.

Bona Fide Residence Test

The Bona Fide Resident Test is met if you are a U.S. citizen or resident (who is a citizen of a country with which the U.S. has a tax treaty with non-discrimination provisions) and a bona fide resident of a foreign country for at least one full tax year. If you are a U.S. resident and citizen of a foreign country without a non-discrimination clause in its tax treaty with the U.S. you may use the physical presence test.

The IRS will determine whether you qualify as a bona fide resident based on your individual circumstances. Factors used to evaluate bona fide residence include:

-Residence (i.e. a purchase or rented home, employer provided housing, hotel)

-Whether family members reside with you overseas or in the U.S.

-Whether you pay taxes to a foreign government

-The terms of your employment

-Foreign visa type and duration

-Maintenance of U.S. home

Establishing bona fide residence is based on a careful evaluation of an individual’s particular circumstances. No single factor determines whether or not an individual meets the bona fide residence test.

Physical Presence Test

To meet the physical presence test an individual must be physically present in a foreign country/countries for 330 days in a period of 12 consecutive months. Or, to put it differently, an individual must have been physically present in the United States no more than 35 days during any 365 day period.

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