Basics of the Foreign Earned Income Exclusion

So you’ve decided take the big leap and move abroad.  Whether it’s for a new job, traveling the world, or family reasons, the same issue puzzles all US citizens that are employed outside of the United States – What to do when it’s tax time?  Do you really need to pay US taxes on the income you earned abroad or have you managed to escape the reign of everyone’s favorite uncle by moving across the world?   

Well, unfortunately, the answer is that it just depends.    In general, it does not make much of a difference to Uncle Sam whether you are working in Indonesia or in the middle of Kansas.  He still wants your money! Fortunately, however, thanks to the foreign earned income exclusion regulation, if an individual meets certain criteria, he/she may exclude up to a specified amount of income earned abroad from US taxes (in 2009, the maximum exclusion was $91,400 for single taxpayers).  Sounds great, right? But what’s the catch?  Of course Uncle Sam doesn’t want to just lose all the tax revenue from US citizens living abroad, so the requirements to qualify for the exclusion aren’t exactly easy to meet.

First, an individual must establish a tax home in a foreign country.  Now, what exactly does that mean?  A tax home is main place of business, employment, or post of duty.  According to the IRS, you cannot have a tax home in a foreign country if your abode is in the United States.  Abode is another term that frequently confuses taxpayers.  It usually refers to one’s home or place of residence.  It does not necessarily mean the location of your employment, but rather will depend on where you maintain your economic, family, and personal ties.  So, once you can establish that your tax home and abode are outside of the United States, an individual can qualify for the foreign earned income exclusion if one of two criterions is met.

The bona fide residence test is one way that an individual can qualify for the foreign earned income exclusion.  Basically, in order to qualify for the bona fide residence test, you need to reside in a foreign country for an uninterrupted period that includes an entire tax year.  In addition, the bona fide residence test takes into account factors such as your intention, the purpose of your trip, and the length and nature of your stay.

The second way to qualify for the foreign earned income exclusion is by meeting the physical presence test.  You must be physically present in a foreign country or countries for at least 330 full days during the 12-month period.

It’s important to take these factors into account if you are working abroad or considering moving outside of the US for employment purposes.  An extra day spent outside of your tax home and on vacation in the U.S. might sound very different if you knew you were only one day away from meeting the physical presence test and excluding thousands of dollars from your taxable income.


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