Tuesday, September 10, 2013

Foreign Earned Income Exclusion Made Simple

Pic Courtesy: Google Images
Today's workplace is global and the average worker has to be mobile to be successful. This means he should even be ready to pack his rucksack & move to any part of the world his work takes him. Many upwardly mobile US Citizens now do not hesitate to do just that. 

Wait a minute! The IRS wants to help? Yes! Yes! It does! There is a foreign earned income exclusion that a US Citizen or Permanent Resident can avail of if (of course) certain conditions apply. Let's back up however, what is Earned Income & what is Foreign Earned Income? 

Earned Income is pay for personal services performed. These can be in the form of salaries, wages, commissions, tips, bonuses or professional fees. Business profits, royalties and rents may also fall under this category. 

Foreign Earned Income is the above income earned for services performed in a foreign country during a period one's tax home is in such foreign country and during which one must meet either the bonafide residence test or the physical presence test. 

One must meet the Bona fide Residence Test OR the Physical Presence Test and fulfill the following requirements:  
Pic Courtesy: money.cnn.com


  • 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.
If one fulfills the above requirements, the maximum foreign earned income exclusion for 2013 is $97,600 ($95,100 for 2012; $92,900 for 2011). 

How This Works 
  • An Individual’s Tax = (Total Income - Any Foreign Earned Income) X Determined Tax Rate
    Pic Courtesy: Google Images
  • The Tax Rate is determined by including the amount(s) excluded, and the tax that would be imposed as if his or her taxable income were equal to the excluded amount(s). 
  • For this purpose, the excluded amount(s) will be reduced by the aggregate amount of any deductions or other exclusions otherwise disallowed.
  • In many cases this will have the effect of increasing an individual’s U.S. federal income tax to an amount greater than it would have been under prior law. 
  • Form 2555 or Form 2555-EZ are the forms used to claim this exclusion. The form is then attached to Form 1040. 

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