Foreign earned income exclusion

The United States taxes citizens and residents on their worldwide income. Citizens and residents living and working outside the U.S. may be entitled to a foreign earned income exclusion that reduces taxable income. For 2015, the maximum exclusion is $100,800 per taxpayer, $101,300 for 2016 (future years indexed for inflation). In addition, the taxpayer may exclude housing expenses in excess of 16% of this maximum ($44.19 per day in 2015) but with limits.

The exclusion is available only for wages or self-employment income earned for services performed outside the U.S. The exclusion is claimed on IRS Form 2555.

Only individuals are eligible for the exclusion. To qualify for the exclusion, the taxpayer's tax home must be outside the U.S. In addition, the taxpayer must meet either of two tests:

The bona fide residence test is not available to a resident alien, unless he/she is a citizen or national of a country with which the United States has an income tax treaty in effect. Further, the test is not met if the taxpayer declares to the foreign government that they are not a tax resident of that country. Such declaration could be on visa applications or tax returns, or imposed as a condition of a visa. Eligibility for the exclusion may be affected by some tax treaties.

Counting the days for the physical presence test requires a determination for each day separately. The IRS makes it clear in Publication 54 that each day can be in more than one 12-month period. A 12-month period may begin on any day of any month.

The maximum exclusion is $100,800 for tax year 2015 and $101,300 for 2016 (up from $99,200 for 2014, due to an annual adjustment based on the inflation rate) plus the "housing exclusion".

The amount of exclusion that a taxpayer is entitled to is equal to the lesser of foreign earned income for the year or the maximum exclusion, divided by the total number of days (365 or 366) in the year times the number of "qualifying days". The exclusion is then reduced by half of self-employment tax.

The "housing exclusion" is the amount of housing expenses in excess of 16% of the exclusion limit, computed on a daily basis. It is also based on the number of qualifying days, and is limited to a specific dollar amount based on the location of housing.

The exclusion is limited to income earned by a taxpayer for performance of services outside the U.S. This includes salary, bonus, and self-employment income. Where income relates to services both in the U.S. and outside the U.S., the income must be apportioned.

Special rules apply to Foreign Service and military personnel.

The exclusion is an election. Taxpayers may claim the exclusion only if they file IRS Form 2555 or Form 2555-EZ. The form must be attached to a timely filed U.S. Individual Income Tax Return (IRS [Form 1040]) for the first year of election, or an amended timely filed return. IRS regulations allow the election with late filed returns in some cases. The election to exclude may be revoked at any time; however, once revoked the exclusion may not be elected again for five years.

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