US taxpayers, both citizens and residents, are often surprised to learn that they need to pay taxes on all income earned whether generated in the US or abroad. This includes income that is earned while working overseas as an employee, independent contractor or from supplementary income sources such as investments, pensions or other such accounts.
While paying taxes on income earned outside the US may seem unusual, it’s a reality that all taxpayers must comply with. The good news is that qualifying taxpayers living abroad can leverage the Foreign Earned Income Exclusion, which allows for a complete or partial exclusion of foreign income from taxes. To help you understand the exclusion and how it can benefit your situation, H2R CPA has provided a summary below.
To exclude any overseas earnings from US taxation, you must:
- Pass the IRS Bona Fide Residence Test, which means the taxpayer must have a “tax home” in a foreign country, which includes a regular or principal place of business, employment or post of duty
- Meet the IRS’s residence or Physical Presence Test by being either:
- A US citizen who is a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year
- A US resident alien who is a citizen or national of a country with which the United States has an income tax treaty and resides in that foreign country for an uninterrupted period that includes an entire tax year
- A US citizen or a US resident alien who is physically present in a foreign country for at least 330 full days during any 12-month consecutive period
Generally, only an “earned” salary or business income from paid work or labor can be excluded from United States taxes while living abroad. You may also be entitled to exclude the value of meals and lodging provided by your employer from income. The foreign earned income exclusion does not cover passive income, such as rent, royalties, dividends and capital gains. It also doesn’t include:
- Pay received as a military or civilian employee of the US government or any of its agencies
- Pay for services conducted in international waters
- Pay in specific combat zones that is excludable from income
- Payments received after the tax year in which the services that earned the income were performed
- The value of meals and lodging that are excluded from income because it was furnished for the convenience of the employer
- Pension or annuity payments, including social security benefits
It’s important to note that the exclusion can be claimed on foreign-earned self-employment income, but it only reduces regular income tax and doesn’t apply to the 15% self-employment tax.
How Much Can Be Deducted?
The foreign earned income exclusion is indexed annually for inflation. If you qualify for the 2017 tax year and earn $102,100 (up $800 from 2016) or less in wages, you will not have to pay federal income taxes. Both spouses can apply the exclusion individually, doubling the total possible benefit to $204,200 for qualifying households in 2017.
The tax laws regarding foreign income earned by a US citizen are complex and can be challenging to understand when taxes need to be paid to the IRS. For this reason, it’s important to work with a qualified tax advisor to help navigate this complex issue. If you have questions about the foreign earned income exclusion or need assistance with another international tax issue, H2R CPA can help. For additional information call us at 412-391-2920 or click here to contact us.