Foreign Earned Income Exclusion

What Is the Foreign Earned Income Exclusion?

The foreign earned income exclusion is planned to forestall double taxation by excluding income taxed in one more country from U.S. taxation. The U.S. Internal Revenue System (IRS) will tax your income earned worldwide. Nonetheless, assuming you are an American ex-pat, this means you are taxed two times on this income. The income you receive overseas, sees the foreign country tax and can be taxed again by the IRS.

Grasping Foreign Earned Income Exclusion

The foreign earned income exclusion is chosen on IRS tax Form 2555. Moreover, taxpayers who claim this exclusion make domestic retirement arrangement contributions of any sort that are based on this income or claim the foreign tax credit or deduction for any taxes paid to a foreign government on this income.

You must meet specific capabilities to claim the foreign earned income exclusion.

You are a U.S citizen or resident alien. A resident alien is a foreign person and is a permanent resident without citizenship of the country wherein they live. To fall under this classification in the United States, a person needs to either have a current green card or have had one during the last calendar year.
You have a qualifying presence in a foreign country. Qualifying presence status is met by fulfilling the Bonafide Resident Test by being a resident in the country for a full tax year. You may likewise satisfy the Physical Presence Test by being physically present there for no less than 330 days inside a year sequential period.
You have foreign earned income. You have foreign earned income on the off chance that you receive wages through employment or compensation through self-employment for services you perform in a foreign country. The income you receive from foreign-source pensions, investments, alimony, or gambling isn't foreign earned income.

Foreign Housing Amount

There is a statutory maximum exclusion amount plus a foreign housing amount which limits the exclusion. It is customized on the off chance that the number of qualifying days in a foreign country is under a full tax year.

The foreign housing amount is the housing costs you paid with foreign earned income that surpasses 16% of the maximum exclusion, or base, amount. This amount has a cap amount at 30% of the maximum exclusion amount. The foreign housing amount is taken as exclusion by employees and as a deduction by the self-employed people.

For the 2021 tax year, the maximum exclusion amount is $108,700 and it goes up to $112,000 in 2022.

Illustration of Foreign Earned Income Exclusion

How about we perceive how the foreign earned income exclusion functions. MP is an American working in Vietnam. They resided in Hanoi for 345 days of the tax year and were missing for 10 days on a trip home for Thanksgiving. They earned a salary of $225,000 and paid $30,596 of it to lease a flat for the year. MP paid $75,000 in Vietnamese income tax and owed $81,000 in US income tax on this income. The end result is that their foreign earned income is being taxed two times.

Since MP is a U.S. citizen who paid foreign taxes on income they earned during 335 qualifying days in a foreign country, they might choose to reject the foreign earned income from their U.S. taxable income.

MP's 2018 exclusion is $111,000. ($105,900 maximum exclusion amount + $15,040 foreign housing amount x 335/365 ratio of qualifying days to total days). MP's 2018 foreign housing amount is $15,040. ($30,596 in housing costs - $16,944 base amount). Since $13,652 is not exactly the $31,770 cap amount, no further reduction is important. The foreign earned income exclusion permits MP to avoid $111,000 from their taxable income. Be that as it may, $114,000 stays included, and since they have paid foreign taxes of $37,000 yet owe U.S. taxes of $36,000, it stays double taxed.

MP ought to take a $37,000 nonrefundable foreign tax credit against the $36,000 U.S. taxes they owe. However long they ideal file Form 2555 to choose the foreign earned income exclusion and Form 1116 claiming the foreign tax credit, they won't owe U.S. taxes on the foreign income.

Features

It is important to realize every one of the rules and regulations on the off chance that you are living and working abroad.
Resident aliens who are citizens or nationals of a country with which the U.S. has an income tax treaty in effect may likewise qualify.
To fit the bill for the credit, you must be a U.S. citizen who is a bona fide resident of a foreign country or countries for a continuous period that incorporates a whole tax year.
The foreign housing amount addresses the housing costs you paid abroad with foreign earned income. It must surpass 16% of the maximum exclusion, or base, amount.
The foreign earned income exclusion is planned to forestall double taxation by excluding income taxed in one more country from U.S. taxation.