If you meet certain requirements, you may qualify for the foreign earned income and foreign housing exclusions and the foreign housing deduction.
If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude from income up to $86,700 of your foreign earnings. In addition, you can exclude or deduct certain foreign housing amounts. See Foreign Earned Income Exclusion and Foreign Housing Exclusion and Deduction, later.
You may also be entitled to exclude from income the value of meals and lodging provided to you by your employer. See Exclusion of Meals and Lodging, later.
To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must satisfy all three of the following requirements.
Your tax home must be in a foreign country.
You must have foreign earned income.
You must be either:
A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,
A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
See Publication 519 to find out if you qualify as a U.S. resident alien for tax purposes and whether you keep that alien status when you temporarily work abroad.
If you are a nonresident alien married to a U.S. citizen or resident, and both you and your spouse choose to treat you as a resident, you are a resident alien for tax purposes. For information on making the choice, see the discussion in chapter 1 under Nonresident Spouse Treated as a Resident.
To qualify for the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, your tax home must be in a foreign country throughout your period of bona fide residence or physical presence abroad. Bona fide residence and physical presence are explained later.
Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. Having a “tax home” in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes.
If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and your tax home is wherever you work.
You are not considered to have a tax home in a foreign country for any period in which your abode is in the United States. However, your abode is not necessarily in the United States while you are temporarily in the United States. Your abode is also not necessarily in the United States merely because you maintain a dwelling in the United States, whether or not your spouse or dependents use the dwelling.
“Abode” has been variously defined as one's home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. “Abode” has a domestic rather than a vocational meaning and does not mean the same as “tax home.” The location of your abode often will depend on where you maintain your economic, family, and personal ties.
Example 1.
You are employed on an offshore oil rig in the territorial waters of a foreign country and work a 28-day on/28-day off schedule. You return to your family residence in the United States during your off periods. You are considered to have an abode in the United States and do not satisfy the tax home test in the foreign country. You cannot claim either of the exclusions or the housing deduction.
Example 2.
For several years, you were a marketing executive with a producer of machine tools in Toledo, Ohio. In November of last year, your employer transferred you to London, England, for a minimum of 18 months to set up a sales operation for Europe. Before you left, you distributed business cards showing your business and home addresses in London. You kept ownership of your home in Toledo but rented it to another family. You placed your car in storage. In November of last year, you moved your spouse, children, furniture, and family pets to a home your employer rented for you in London.
Shortly after moving, you leased a car and you and your spouse got British driving licenses. Your entire family got library cards for the local public library. You and your spouse opened bank accounts with a London bank and secured consumer credit. You joined a local business league and both you and your spouse became active in the neighborhood civic association and worked with a local charity. Your abode is in London for the time you live there. You satisfy the tax home test in the foreign country.
The location of your tax home often depends on whether your assignment is temporary or indefinite. If you are temporarily absent from your tax home in the United States on business, you may be able to deduct your away-from-home expenses (for travel, meals, and lodging), but you would not qualify for the foreign earned income exclusion. If your new work assignment is for an indefinite period, your new place of employment becomes your tax home and you would not be able to deduct any of the related expenses that you have in the general area of this new work assignment. If your new tax home is in a foreign country and you meet the other requirements, your earnings may qualify for the foreign earned income exclusion.
If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise. If you expect it to last for more than 1 year, it is indefinite. If you expect it to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary (in the absence of facts and circumstances indicating otherwise) until your expectation changes.
To meet the bona fide residence test or the physical presence test, you must live in or be present in a foreign country. A foreign country usually is any territory (including the air space and territorial waters) under the sovereignty of a government other than that of the United States.
The term “foreign country” includes the seabed and subsoil of those submarine areas adjacent to the territorial waters of a foreign country and over which the foreign country has exclusive rights under international law to explore and exploit the natural resources.
The term “foreign country” does not include Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or U.S. possessions such as Johnston Island. For purposes of the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction, the terms “foreign,” “abroad,” and “overseas” refer to areas outside the United States, American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, Puerto Rico, the U.S. Virgin Islands, and the Antarctic region.
You meet the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. You can use the bona fide residence test to qualify for the exclusions and the deduction only if you are either:
A U.S. citizen, or
A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect.
You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for 1 year. If you go to a foreign country to work on a particular job for a specified period of time, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for 1 tax year or longer. The length of your stay and the nature of your job are only some of the factors to be considered in determining whether you meet the bona fide residence test.
Example.
You could have your domicile in Cleveland, Ohio, and a bona fide residence in Edinburgh, Scotland, if you intend to return eventually to Cleveland.
The fact that you go to Scotland does not automatically make Scotland your bona fide residence. If you go there as a tourist, or on a short business trip, and return to the United States, you have not established bona fide residence in Scotland. But if you go to Scotland to work for an indefinite or extended period and you set up permanent quarters there for yourself and your family, you probably have established a bona fide residence in a foreign country, even though you intend to return eventually to the United States.
You are clearly not a resident of Scotland in the first instance. However, in the second, you are a resident because your stay in Scotland appears to be permanent. If your residency is not as clearly defined as either of these illustrations, it may be more difficult to decide whether you have established a bona fide residence.
You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive. Any U.S. citizen or resident can use the physical presence test to qualify for the exclusions and the deduction.
The physical presence test is based only on how long you stay in a foreign country or countries. This test does not depend on the kind of residence you establish, your intentions about returning, or the nature and purpose of your stay abroad.
You leave the United States for France by air on June 10. You arrive in France at 9:00 a.m. on June 11. Your first full day of physical presence in France is June 12.
You leave the United States by air at 9:30 a.m. on June 10 to travel to Kenya. You pass over western Africa at 11:00 p.m. on June 10 and arrive in Kenya at 12:30 a.m. on June 11. Your first full day in a foreign country is June 11.
You leave Ireland by air at 11:00 p.m. on July 6 and arrive in Sweden at 5:00 a.m. on July 7. Your trip takes less than 24 hours and you lose no full days.
You leave Norway by ship at 10:00 p.m. on July 6 and arrive in Portugal at 6:00 a.m. on July 8. Since your travel is not within a foreign country or countries and the trip takes more than 24 hours, you lose as full days July 6, 7, and 8. If you remain in Portugal, your next full day in a foreign country is July 9.
Your 12-month period can begin with any day of the month. It ends the day before the same calendar day, 12 months later.
Your 12-month period must be made up of consecutive months. Any 12-month period can be used if the 330 days in a foreign country fall within that period.
You do not have to begin your 12-month period with your first full day in a foreign country or end it with the day you leave. You can choose the 12-month period that gives you the greatest exclusion.
In determining whether the 12-month period falls within a longer stay in the foreign country, 12-month periods can overlap one another.
You are a construction worker who works on and off in a foreign country over a 20-month period. You might pick up the 330 full days in a 12-month period only during the middle months of the time you work in the foreign country because the first few and last few months of the 20-month period are broken up by long visits to the United States.
You work in New Zealand for a 20-month period from January 1, 2004, through August 31, 2005, except that you spend 28 days in February 2004 and 28 days in February 2005 on vacation in the United States. You are present in New Zealand 330 full days during each of the following two 12-month periods: January 1, 2004 - December 31, 2004, and September 1, 2004 - August 31, 2005. By overlapping the 12-month periods in this way, you meet the physical presence test for the whole 20-month period. See Figure 4-B on the next page.
To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income.
Foreign earned income generally is income you receive for services you perform during a period in which you meet both of the following requirements.
Your tax home is in a foreign country.
You meet either the bona fide residence test or the physical presence test.
To determine whether your tax home is in a foreign country, see Tax Home in Foreign Country, earlier. To determine whether you meet either the bona fide residence test or the physical presence test, see Bona Fide Residence Test and Physical Presence Test, earlier.
Foreign earned income does not include the following amounts.
The value of meals and lodging that you exclude from your income because it was furnished for the convenience of your employer.
Pension or annuity payments you receive, including social security benefits (see Pensions and annuities, later).
Pay you receive as an employee of the U.S. Government. (See U.S. Government Employees, later.)
Amounts you include in your income because of your employer's contributions to a nonexempt employee trust or to a nonqualified annuity contract.
Any unallowable moving expense deduction that you choose to recapture as explained under Moving Expense Attributable to Foreign Earnings in 2 Years in chapter 5.
Payments you receive after the end of the tax year following the tax year in which you performed the services that earned the income.
Cost of living allowances.
Overseas differential.
Family allowance.
Reimbursement for education or education allowance.
Home leave allowance.
Quarters allowance.
Reimbursement for moving or moving allowance (unless excluded from income as discussed later in Reimbursement of employee expenses under Earned and Unearned Income).
The source of your earned income is the place where you perform the services for which you received the income. Foreign earned income is income you receive for working in a foreign country. Where or how you are paid has no effect on the source of the income. For example, income you receive for work done in Austria is income from a foreign source even if the income is paid directly to your bank account in the United States and your employer is located in New York City.
If you receive a specific amount for work done in the United States, you must report that amount as U.S. source income. If you cannot determine how much is for work done in the United States, or for work done partly in the United States and partly in a foreign country, determine the amount of U.S. source income using the method that most correctly shows the proper source of your income.
In most cases you can make this determination on a time basis. U.S. source income is the amount that results from multiplying your total pay (including allowances, reimbursements other than for foreign moves, and noncash fringe benefits) by a fraction. The numerator (top number) is the number of days you worked within the United States. The denominator (bottom number) is the total number of days of work for which you were paid.
You are a U.S. citizen, a bona fide resident of Canada, and working as a mining engineer. Your salary is $76,800 per year. You also receive a $6,000 cost of living allowance, and a $6,000 education allowance. Your employment contract did not indicate that you were entitled to these allowances only while outside the United States. Your total income is $88,800. You work a 5-day week, Monday through Friday. After subtracting your vacation, you have a total of 240 workdays in the year. You worked in the United States during the year for 6 weeks (30 workdays). The following shows how to figure the part for work done in the United States during the year.
Your U.S. source earned income is $11,100.
Earned income was defined earlier as pay for personal services performed. Some types of income are not easily identified as earned or unearned income. Some of these types of income are further explained here.
In addition to the foreign earned income exclusion, you can also claim an exclusion or a deduction from gross income for your housing amount if your tax home is in a foreign country and you qualify under either the bona fide residence test or the physical presence test.
The housing exclusion applies only to amounts considered paid for with employer- provided amounts. The housing deduction applies only to amounts paid for with self-employment earnings.
If you are married and you and your spouse each qualifies under one of the tests, see Married Couples, later.
Your housing amount is the total of your housing expenses for the year minus a base amount.
You qualify under the physical presence test for all of 2005. During the year, you spend $14,000 for your housing. Your housing amount is $14,000 minus $11,894, or $2,106.
Rent,
The fair rental value of housing provided in kind by your employer,
Repairs,
Utilities (other than telephone charges),
Real and personal property insurance,
Nondeductible occupancy taxes,
Nonrefundable fees for securing a leasehold,
Rental of furniture and accessories, and
Residential parking.
Expenses that are lavish or extravagant under the circumstances,
Deductible interest and taxes (including deductible interest and taxes of a tenant-stockholder in a cooperative housing corporation),
The cost of buying property, including principal payments on a mortgage,
The cost of domestic labor (maids, gardeners, etc.),
Pay television subscriptions,
Improvements and other expenses that increase the value or appreciably prolong the life of property,
Purchased furniture or accessories, or
Depreciation or amortization of property or improvements.
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