U.S. Citizens and Resident Aliens who live and work abroad may be able to exclude all or part of their Foreign Salary or Wages from their Income when filing their U.S. Federal Tax Return. They may also qualify to exclude compensation for their personal services or certain Foreign Housing costs. The Foreign Earned Income Exclusion is adjusted annually for inflation.
To qualify for the Foreign Earned Income Exclusion, a U.S. Citizen or Resident Alien must have a Tax Home in a Foreign Country and income received for working in a Foreign Country, otherwise known as Foreign Earned Income. The Taxpayer must also meet one of two tests:
- the Bona Fide Residence Test, or
- the Physical Presence Test.
The Foreign Earned Income Exclusion and the Foreign Housing Exclusion or Deduction are claimed using Form 2555, which should be attached to the taxpayer’s Form 1040.
Once the Foreign Earned Income Exclusion is chosen, a Foreign Tax Credit or Deduction for Taxes cannot be claimed on the Excluded Income. If a Foreign Tax Credit or Tax Deduction is taken on any of the Excluded Income, the Foreign Earned Income Exclusion will be considered revoked. Additionally, the taxpayer cannot exclude or deduct more than their foreign earned income for the year.
What Is Foreign Earned Income?
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 the services are performed is what defines the income as foreign, not where or how you are paid. It does not matter whether earned income is paid by a U.S. employer or a foreign employer, however wages paid by the U.S. government to its employees are not eligible for the exclusion. Amounts paid by the U.S. government to independent contractors may be eligible for the exclusion.
Foreign earned income does not include the following amounts:
- The previously excluded value of meals and lodging furnished for the convenience of your employer.
- Pension or annuity payments including social security benefits.
- Payments by the U.S. Government, or any U.S. government agency or instrumentality, to its employees.
- Amounts included in your income because of your employer's contributions to a nonexempt employee trust or to a nonqualifying annuity contract.
- Recaptured unallowable moving expenses.
- Payments received after the end of the tax year following the tax year in which you performed the services that earned the income.
If a specific amount is received for work done in the United States, this amount must be reported as U.S. Source Income. If you cannot determine how much is for work done in the United States or for work done partly in the United States and partly in a Foreign Country, determine the amount of U.S. Source Income using the method that most correctly shows the proper source of your income. In most cases you can make this determination on a time basis. U.S. Source Income is the amount that results from multiplying your total pay (including allowances, reimbursements other than for foreign moves, and noncash fringe benefits) by a fraction. The numerator (top number) is the number of days you worked within the United States. The denominator (bottom number) is the total number of days of work for which you were paid.
Foreign Earned Income Exclusion
A taxpayer may be able to claim an exclusion for income earned while the taxpayer lived and worked in a foreign country. To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income and your tax home must be in a foreign country. You must also meet either the bona fide residence test or the physical presence test and you must be one of the following:
- A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year
- A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
- A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months
Earned and Unearned Income
Some types of income are not easily identified as earned or unearned income. These types of income - specifically income from Sole Proprietorships, Partnerships, and Corporations; Stock Options; Pensions and Annuities; Royalties; Rents; and Fringe Benefits - are further explained in Chapter 4 of Publication 54.
Examples of earned income
- Compensation from participation in a business, including wages, salary, tips, commissions and bonuses.
- Salaries and Wages
- Income from self-employment
- Commissions or Tips
- Severance pay, if based on accrued leave time
- Vacation pay
- Sick pay, if based on accrued leave time
- Compensation from the employer's vacation donation program, if paid and taxed in the same manner as the employee's usual pay
- AmeriCorps State and National and AmeriCorps NCCC living allowances
- Housing allowances paid in cash to members of the clergy, regardless of whether the cash payment is a reimbursement for housing costs already paid
- Wages paid to participants in programs carried out under the Community Service Employment Program (Experience Works (formerly Green Thumb) Program, The Senior Aides Program)
- Wages paid to participants in programs carried out under the National and Community Service Act of 1990 (Serve America, Higher Education Innovative Projects, Conservation and Youth Service Corps, National and Community Service Models)
- Other income received in exchange for work or service (Jury duty pay, Picket duty pay, Blood and blood plasma sales, Royalties and honoraria which result from client's work or service)
In addition to the Types of Earned Income listed above, certain noncash income and allowances or reimbursements are considered Earned Income.
- The Fair Market Value of Property or Facilities provided to you by your Employer in the form of lodging, meals, or use of a car is Earned Income.
- Any reimbursements of, or payments for, nondeductible moving expenses.
- Reimbursements that are more than your deductible expenses and that you do not return to your employer.
- Any reimbursements made (or treated as made) under a Non Accountable Plan, even if they are for Deductible Expenses.
- Any reimbursement of moving expenses you deducted in an earlier year.
- Amounts paid to you as allowances or reimbursements for the following items: Cost of Living - Overseas Differential - Family - Education - Home leave - Quarters - Moving.
Examples of unearned income
- An individual's income derived from sources other than employment, such as interest and dividends from investments, or income from rental property.
- Spousal maintenance
- Child support income
- Annuity payments
- Pension or retirement benefits from public or private sources, such as Railroad Retirement
- Disability payments that are part of the employer’s benefit package. Medicare, Social Security, and other tax withholding from such payments do not change this designation as unearned income
- Retirement, Survivor's, and Disability Insurance (RCSDI)
- Supplemental Security Income (SSI) Unemployment Insurance
- Extended income support payments through the Trade Adjustment Reform Act of 2002 (TAA)
- Worker's Compensation
- Veteran's Administration (VA) benefits
- Trust Disbursements
- Severance pay that is not based on accrued leave time
- Tribal per capita payments from casinos
- Interest and dividends, if not earned as part of a self-employment operation
- Public Assistance Payments
To access Form 2555 in the tax program, from the Main Menu of the Tax Return (Form 1040), select:
- Income Menu
- Other Income (W-2G, 2555)
- Foreign Earned Income Exclusion (2555)
NOTE: This is a guide on entering Foreign Tax Credit into the TaxSlayer Pro program. This is not intended as tax advice.
If the information you need is not addressed here, you may call the IRS International Tax Law hotline. The number is 215.516.2000.