Independence. It has different meanings for different people. For some, it means the ability to live and work anywhere in the world. Taxpayers who have the opportunity to work or travel abroad this year may be so excited about their upcoming travels that income taxes are their last concern. But planning ahead can allow these taxpayers to declare their independence from what otherwise could be a large tax bill.
A Firecracker of a Tax Benefit
U.S. citizens and resident aliens of the U.S. are generally required to report all worldwide income on their U.S. federal income tax returns each year, whether they live abroad or reside state-side. The Foreign Earned Income Exclusion, however, has the potential to create an explosion of tax savings on the money expatriates earn overseas.
For the 2017 tax year, certain taxpayers are eligible to exclude up to $102,100 of their foreign earned income from their U.S. federal income tax base ($204,200 for married taxpayers filing jointly if both spouses have foreign earned income). These amounts are indexed for inflation and therefore typically increase each year.
Foreign earned income is any pay that a taxpayer receives while working overseas – regardless of how the wages are paid or from whom they are paid. This means that it is possible for a taxpayer to work for a U.S.-based company, have his or her salary deposited into a U.S. bank account, and still be eligible to exclude foreign earned income.
Wages, professional fees, and self-employment income are eligible for the exclusion. Military compensation, passive income (like dividends or capital gains), and social security benefits are not considered foreign-earned for purposes of the exclusion.
Two Ways to Declare Your Independence
The Foreign Earned Income Exclusion is available to taxpayers who meet one of the following two tests.
1. The Physical Presence Test
This is the easiest, most straightforward test of the two. To qualify, the taxpayer must be living or traveling in another country (or countries) for 330 days during any 12 consecutive months. This test does not require the taxpayer to declare intentions regarding return (or not) to the U.S. or to share reasons for living abroad. Whether the taxpayer establishes official residencies while overseas is irrelevant. This test even allows taxpayers who are simply vacationing to qualify for the exclusion, assuming they meet the 330 day requirement.
2. The Bona Fide Residence Test
To pass the bona fide residence test, a taxpayer must demonstrate long-term intention to stay in the foreign country. In addition to intent, the taxpayer will need to be a resident of a foreign country for a minimum of an entire tax year. The IRS performs the bona fide residence test on a case-by-case basis and will evaluate the true substance of the taxpayer’s situation rather than perform any hardline assessments. It will consider things like the length of the taxpayer’s stay, any intentions of moving, and whether or not the taxpayer has spoken to that country’s authorities about any local tax responsibilities.
Getting the Party Started With CRI
Expatriates and travelers have special tax opportunities and obligations, including the foreign tax credit, the foreign housing exclusion, and reporting use of foreign bank accounts. Contact CRI’s CPAs and advisors for help addressing these concerns and keeping the tax-saving fireworks going long past the summer months.