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If you’re an American citizen working outside of the country, you may be able to exclude some (or even all) of that income from your US income taxes by using Form 2555, the Foreign Earned Income form. Here are some things you need to know about the form:
1. Currently, the exclusion for 2012 is $95,100. The exclusion for 2013 will be $97,600.
2. In order to claim the exclusion, you must have a tax home in a foreign county. You must also meet the bona fide residence test or the substantial presence test. Basically, if you work full-time inside a foreign country for the entire calendar year, then you’ll meet the bona fide residence test. If you work outside the United States for 330 days out of a 365 day period, then you’ll meet the substantial presence test.
3. If you are in a foreign country as a US government employee, then you are not allowed to claim the foreign earned income exclusion.
4. When reporting your foreign income, remember to convert any income and expense amounts into US dollars. You can get foreign currency exchange rates from the US Department of the Treasury: http://fms.treas.gov/intn.html
5. If your income turns out to be higher than the exclusion amount, your tax rate will be the higher rate, as if you had to pay tax on the full amount of income. For example, if you prepared your tax return and after claiming the Foreign Earned Income exclusion and any other deductions that you were entitled to, let’s say you have $5,000 of taxable income left. Normally for a single person, $5,000 of taxable income would mean $500 of tax—because that’s the 10% income tax bracket. But not in this case. It’s more likely to be $1400, because when you add back the excluded income, it puts that single person back into the 28% tax bracket.
6. If you are married and your spouse works, you may each claim an exclusion for foreign earned income.
7. If you claim the foreign earned income exclusion, you cannot take the credit for taxes paid to a foreign country on any income that was excluded. If your income exceeds the exclusion amount, it’s generally a good idea to run the numbers both ways to see which gives you the better tax advantage.
Expat taxes can be confusing. If you’re trying to navigate your way through the Form 2555, give us a call, we can help.