Let’s Talk About the Foreign Income Exclusion!

We are often asked questions regarding the foreign income exclusion and what type of income can be excluded.  As the name of the benefit applies, “earned income” is excluded…but the IRS definition may be very different from what you may assume.

First, in order to qualify for the “foreign earned income exclusion”, it is all about where you live and how long you live there.   You must reside in a foreign country and you must live there for a minimum of 330 days within a 365 window of time. The income does not have to be foreign or earned from a foreign employer, nor does it apply to foreign income earned while you live in the US.

Second, it must be “earned income”, as defined in the IRS regs, that is: wages, salaries, professional fees, commissions, tips.  “Investment” and “other” income such as interest, dividends, capital gains, gambling winnings, alimony, social security benefits, pension retirement/annuity distributions, rents, royalties and K-1 income are considered “unearned” or “variable” income and are all fully taxable, even if you meet the foreign residency requirements.

The term “earned income” can also include amounts paid to you as allowances or reimbursements for the following items:  cost of living, overseas differential, education, home leave, living quarters, moving expenses which are job related.

For 2012 the maximum amount for the Foreign Earned Income Exclusion under the Internal Revenue Code is at $95,100 (for 2013 it is $97,200).

To claim this exclusion you must attach form 2555 to a timey filed US tax return.  The application for this exclusion is voluntary, but once made, must be used for five years if you have income earned while abroad.

Still have questions? Please contact us and we can help you decide if  this exclusion makes the most sense considering your individual tax situation.