The requirements to claim the foreign earned income exclusion is that the taxpayer's tax home is in the foreign country and the taxpayer meets either the 1-year foreign residence test or the 330-day foreign physical presence test. If the taxpayer does not satisfy either time test to claim the foreign earned income exclusion or the housing exclusion or deduction by the due date of the return, but expects to do so, then the taxpayer can either file for an extension of time on Form 2350, Application for Extension of Time to File US Income Tax Return for US Citizens and Resident Aliens Abroad Who Expect to Qualify for Special Tax Treatment until she qualifies under the time test or she can file a return on the due date, reporting the income and paying the tax, then file for a refund when the time test is satisfied.
An additional qualification is that the taxpayer be either a US citizen or a resident entitled to tax treaty benefits who meets either the foreign residence or physical presence test in a foreign country. Tax treaties with foreign countries are generally designed to prevent double taxation. More information can be found in IRS Publications 54, Tax Guide for US Citizens and Resident Aliens Abroad and 901, US Tax Treaties.
If the taxpayer qualifies for the foreign residence or physical presence test for only part of the tax year, then the exclusion limit is reduced by the percentage equal to the qualifying time divided by the number of days in the year. So if a taxpayer satisfies the foreign or physical presence test for 293 days in 2016, then the maximum exclusion is $80,916 (= $100,800 × 293/365). If married, the spouses can each claim the foreign earned income exclusion and the foreign housing exclusion if both meet the foreign residence or physical presence test, even if their permanent home is in a community property state. However, they must each file a separate Form 2555, even if they file jointly.
The following are not considered foreign countries:
- Puerto Rico, Virgin Islands, Guam, Commonwealth of the Northern Mariana Islands, American Samoa, Johnston Island, or Antarctica.
Furthermore, income earned in international airspace or international waters is not considered income earned in a foreign country. That the foreign earned income exclusion does not apply to Antarctica or to international areas makes sense since there are no taxing authorities in those areas.
If the tax home is within the United States, then the taxpayer may claim the foreign tax credit and deduct living expenses while away from home if the assignment was temporary and was expected to last and actually did last for 1 year or less. A taxpayer with the tax home in the United States may not claim the foreign income exclusion but only the foreign tax credit and deduct living expenses while away from home.
The foreign earned income exclusion or the housing exclusion or deduction cannot be claimed if the taxpayer lives in a country, listed in Form 2555, that is subject to United States government imposed travel restrictions.
If the failure from satisfying the foreign residence or physical presence test was because of a war or civil unrest, then the exclusion can be claimed for the period in which the taxpayer was a resident or physically present. Foreign locations and the time periods to qualify for the waiver are listed in the Form 2555 instructions.
Foreign Residence Test
The foreign residence test is satisfied by a US citizen who is a bona fide resident of a foreign country for at least 1 full tax year. This also applies to a US resident alien who is a citizen of a country that has an income tax treaty with the US and meets the full-year foreign residence test. Business or vacation trips outside of the country, including to the United States, does not disqualify the taxpayer from satisfying the foreign residence test.
A bona fide resident of a foreign country is one who takes actions that would indicate an actual relocation to the country, including:
- bringing the family; buying a house or renting an apartment rather than going to a hotel room; having a permanent foreign address; joining clubs there; opening charge accounts and stores in the foreign country; and participating in foreign community activities.
However, a taxpayer who does not qualify as a bona fide resident can still qualify under the physical presence test.
Physical Presence Test
To satisfy the physical presence test, the taxpayer must be present on foreign soil 330 days during a 12 consecutive month period. However, the days do not necessarily have to be consecutive. A full day is considered from midnight to midnight. The 330 day period can include time spent traveling between foreign countries while on vacation, since there is no requirement that the days were spent working; even working for the US government also counts. If the 330 day physical presence test is satisfied, then the taxpayer can claim an exclusion equal to the maximum foreign income exclusion multiplied by the number of days in the tax year when the foreign presence test was satisfied divided by the number of days in the tax year:
A person's earned income for a given year can be found on her W-2 forms.
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Earned income is income earned from work. If someone works at a lemonade stand and receives money for it, for example, this would be earned income. This is in contrast with unearned income. To borrow the lemonade stand example again, if someone invested in a lemonade stand and received dividends, these dividends would be considered unearned income because they were not the result of work. Earned and unearned income are treated differently for tax purposes.
A number of different types of compensation can fall under earned income. All income from wages, salaries, and tips is part of someone's earned income. Likewise, disability benefits are sometimes treated as income for tax purposes as long as someone is below retirement age. Profits from self employment are earned income, and in some regions of the world any benefits paid out by a union to striking workers are also taxed as income.
By contrast, things like rents received, interest, capital gains. and dividends are unearned income. While these monies are indisputably income, the recipient did not work for them. Usually tax forms provide clear descriptions for each field so that people can be assured that they are documenting their income correctly. If someone is confused about where on a tax form a given piece of information about income needs to be disclosed, an accountant or tax attorney can be consulted for more information.
Tax benefits like the Earned Income Tax Credit (EITC) in the United States are based on earned income, and earned income is also usually taxed at the base income tax rate. Taxpayers are also entitled to take deductions when filing their taxes to reflect expenses incurred over the course of the year. Not every expense is tax deductible and there can be penalties for claiming expenses which do not legally count as deductions.
There are several ways in which people may document their earned income. Employers are usually required to send out annual disclosures documenting how much they paid to their employees. Employees can also keep paystubs and use them as records of earned income. It is advisable to keep track of pay over the course of the year and to check one's own figures against those provided in an employer's income disclosure statement for the purpose of confirming that it is correct. If the figures do not agree the statement should be amended to reflect the right figures and refiled.
