Author: Jurate Gulbinas
At least a couple times a month I hear, “I live in a foreign country and earn less than foreign earned income exclusion amount. I do not need to file a U.S. income tax return”. This is a common misconception among U.S. citizens and Green Card holders living and working outside of the U.S.
Let’s review Foreign Earned Income Exclusion (FEIE or IRC Section 911 exclusion) requirements. To claim FEIE you must have foreign earned income, your tax home must be in a foreign country, you have to meet either Bona Fide Residence or Physical Residence Test, and you must make a valid election. Let’s briefly analyze every FEIE requirement below.
What is a foreign earned income? Usually it’s your salary in a foreign country. It can also be severance pay, sick leave pay, and noncash income such as an employer provided lodging or car. If you live outside of the U.S. and you are self-employed, your income from self-employment is earned income.
The IRS has ruled that tax home is the location of the taxpayer’s principal place of employment. Tax home is not the location of principal residence. Tax home must be in a foreign country or countries for FEIE purposes. Antarctica is not considered a foreign country and as a result income earned there won’t qualify as foreign earned income and residence won’t be considered eligible for either bona fide residence or the physical presence test. There were numerous cases regarding U.S. citizens employed on fishing vessels. Generally income earned while working on a fishing vessel won’t qualify for the foreign earned income exclusion as fishing vessel do not meet the foreign presence requirement. For those more interested in fishing vessel employment cases, check Revenue Ruling 73-181 and Bebb v. Commissioner, 36 T.C. 170.
Bona fide residence is another term that is not defined by the Internal Revenue Code. All relevant facts and circumstances are analyzed for each particular case. You won’t automatically acquire bona fide resident status by merely living in a foreign country for one year, despite that the bona fide residence test is met if you are a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. As per Section 911(d)(1)(A), your bona fide residence must be maintained for an uninterrupted period that includes an entire taxable year. Taxable year for U.S. income tax purposes is generally a calendar year. Thus your first year in a foreign country most likely won’t qualify under the bona fide residency test.
Physical presence test is slightly easier to understand. You meet this test if you are physically present in a foreign country 330 days during 12 consecutive months. Once you meet the physical presence test requirements, you are eligible for Section 911 exclusion despite your nature or purposes of your foreign stay. Also keep in mind that 330 days during 12 consecutive months do not necessarily have to start January 1 and end on December 31. If you left the U.S. June 1, 2015, came back for vacation for 35 days in December 2015 and January 2016, you were physically present 330 days on May 31, 2016 and you are qualified to claim foreign earned income exclusion on your 2015 U.S. income tax return for the period of June 1, 2015 – December 31, 2015.
Most taxpayers do not have any problems meeting the above requirements (foreign earned income, foreign tax home, bona fide residence or physical presence in a foreign country). The most misunderstood requirement is an election to claim foreign earned income exclusion. Foreign earned income exclusion is an election that a taxpayer makes on a timely filed U.S. income tax return. The mere fact that you earned less than the applicable FEIE for the year (USD 100,800 for 2015) and met the other requirements discussed earlier does not automatically qualify you for the Section 911 exclusion. You have to file Form 2555 and attach it to the timely filed individual income tax return for the year. In our practice we see many taxpayers who live in foreign countries and who do not file U.S. tax returns for years simply because they misunderstood or were erroneously advised about foreign earned income exclusion requirements. In many circumstances there were other reporting requirements (such as foreign bank account ownership, interest in a foreign entity or a trust, distribution, gift or inheritance received from the foreign entity or foreign individual).
In a recent tax conference, IRS speakers emphasized Form 2555 and a foreign tax home requirement to claim foreign earned income exclusion. IRS recently released a fact sheet (FS-2016-22) describing the foreign earned income exclusion and how to claim it a month ago. IRS also had a free webinar on foreign earned income exclusion for U.S. taxpayers residing in foreign countries on June 29. The webinar recording will be available later on the IRS website (www.irs.gov). The IRS technical specialist for the International Individual Compliance unit that I spoke with at the Tax Forum last week could not emphasize more that the Internal Revenue Service finds the foreign earned income exclusion requirement misunderstood by the taxpayers and as a result wants to educate and bring into compliance U.S. residents living abroad.
Please feel free to email me your questions regarding foreign earned income exclusion at j[email protected]
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