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Information provided on this site is for general guidance
only and is often simplified. Actual IRS procedures
are complex, and taxpayers should obtain professional
assistance or use IRS sources for complete information.
Foreign
Earned Income Exclusion
If a person's tax home is in a foreign country and
they meet either the bona fide residence test or the
physical presence test, they can choose to exclude
from gross income a limited amount of their foreign
earned income. The income must be for services performed
in a foreign country during a period of foreign residence
or presence, whichever applies.
Prior
to the Tax Reconciliation Act of 2005 (see below),
the amount of foreign wages and salary that could
be excluded was limited to the lesser of a person's
actual foreign wages or $80,000. For an established
foreign resident, the exclusion can be pro-rated based
on the amount of time actually spent abroad.
A person who claims the Exclusion cannot claim any
credits or deductions that are related to the excluded
income, for instance a foreign tax credit or deduction
for any foreign income tax paid on the excluded income.
The earned income credit is also unavailable. Furthermore,
for IRA purposes, the excluded income is not considered
compensation and, for figuring deductible contributions
in an employer retirement plan, is included in modified
adjusted gross income.
The
IRS confirmed that:
"Effective
for tax years beginning after 2005, the amount of
foreign earned income (and foreign housing costs)
excluded from an individual's gross income will be
used for purposes of determining the rate of income
and alternative minimum tax (AMT) that applies to
his or her nonexcluded income."
"The
Tax Increase Prevention and Reconciliation Act of
2005 (P.L. 109-222) adds a new section 911(f) to the
Internal Revenue Code. An individual's tax will be
the excess of the tax that would be imposed if his
or her taxable income were increased by the amount(s)
excluded, and the tax that would be imposed if his
or her taxable income were equal to the excluded amount(s)."
"For
this purpose, the excluded amount(s) will be reduced
by the aggregate amount of any deductions or other
exclusions otherwise disallowed. In many cases this
will have the effect of increasing an individual’s
U.S. federal income tax to an amount greater than
it would have been under prior law."
For tax
year 2006 the maximum amount of the Foreign Earned
Income Exclusion under section 911 of the Internal
Revenue Code was increased to $82,400.
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