Section 911 of the U.S. tax law permits U.S. taxpayers to earn up to $91,400 per year of tax free income. (This amount is adjusted for inflation each year.) But there
is a "small" catch.
The taxpayer must earn that income by living and working outside the U.S. for at least 330 days out of 12 consecutive months or must become a permanment resident of the foreign country. This rule exists to encourage U.S. employees to accept assignments by their multi-national employers in various countries that may have poor living conditions and to encourge the employee to accept extended separation from his or her family in the U.S. There are two ways to qualify for this income exclusion. The first
and the simplest is to live and work outside the U.S. and its
territories for at least 330 days in any consecutive 12 month period.
The second method is to establish bone fide permanent residence in the foreign country. This test is subject to an assortment of criteria such as whether the taxpayer becomes a resident of the foreign country for tax purposes and thereby becomes subject to their tax rules. Another factor is whether the employee takes his or her family to the foreign country. In a simplified way, it would be much like moving from Fresno, Califonia to Houston, Texas without any plans to return. If the residence test is met, the taxpayer is not required to meet the 330 day test. If either of these two tests are met, the taxpayer can exclude up to $91,400 of earned income from U.S. taxes. If a married couple are both working and living outside the U.S., they can each use the exclusion. If the taxpayer lives and works in a country with an income tax, they will be subject to taxes in that country. If there are any foreign taxes imposed on that income, they are not available as a foreign tax credit or a tax deduction. Earned income in excess of the annual limit will continue to be subject to U.S. income taxes along with any other income such as investment earnings. There are special rules for foreign housing expenses which may also be deductible. The limitation on housing expenses is generally 30% of the maximum foreign earned income exclusion. A few years ago, taxpayers could use the foreign earned income exclusion and then compute their tax on other income starting at the bottom of the tax brackets. However, the law now requires taxpayers to compute their tax with and without the exclusion and to deduct the tax that would be paid if the exclusion were not available. This has the effect of taxing any other non-excludable income at higher tax rates. The taxpayer can be self employed, but if the business requires a substantial amount of capital (for inventory, receivables and equipment) then only 30% of the profits of the business are treated as earned income that is eligible for the exclusion. One way to bypass that restriction would be have the business become a taxable corporation and to pay a salary to the owner. If the corporation is a foreign corporation, it will be subject to the controlled foreign corporation tax rules. The specific details of this tax break are extensive and this article is a very brief summary of the basic rules. The exclusion requires the taxpayer to file Form 2555 and the instructions to that form provide further details about the limitations on this tax break. Here are some useful links to addiional information on this topic. http://www.irs.gov/businesses/article/0,,id=182017,00.html IRS Publication 54 Tax Form 2555 and Instructions Vernon Jacobs (C) Copyright, September, 2009 All rights reserved.
|