Taxes aren’t always a fun and easy task. It can be challenging to process, particularly with all the documents and forms you have to remember. Moreover, the tax filing and payment process can be quite different for American expats under the current Foreign Account Tax Compliance Act, stating that all American citizens must report their foreign holdings and assets to the IRS.
This situation makes American expats vulnerable to double taxation. Their income can be taxed in the foreign country they’re in and in the U.S., which you definitely want to avoid. One tax benefit that can help you avoid this problem is the Foreign Earned Income Exclusion (FEIE). But what is the foreign earned income exclusion?
5 Ways to Determine Your Foreign Earned Income Exclusion Eligibility
The FEIE helps American expats reduce their income tax by deducting some or all income made outside of the U.S. Check out the eligibility requirements below to know if you can claim the foreign earned income tax benefit.
1. You have foreign earned income
You can be eligible for the FEIE if you’re receiving earned income from outside the U.S. for services performed in a foreign country. For example, you can be an American expatriate working in Canada and earning income in Canada.
A U.S. citizen can have several kinds of foreign income, such as earned, unearned, or variable income. However, only foreign earned income is viable for this tax benefit. This means only income from performing personal services is deducted from the total taxable income, which includes wages, salaries, professional fees, tips, self-employment income, and the like.
2. You have a foreign tax home
Your earned income may be subject to foreign tax if you work in a foreign country that you are not a citizen of and your employment period is indefinite. In this case, the country you’ll be owing income tax to is called your foreign tax home.
Jumping off from the previous example, your income may incur foreign income tax based on the Canadian tax system, making that country your foreign tax home. This can make your salary prone to double taxation from your tax home and the U.S.
However, this only applies to those staying or working in that country for an extended period. This means you may not have a foreign tax home if you will only be there temporarily, with your residency remaining in the U.S.
3. You are a bona fide resident of another country
U.S. citizens who are bona fide residents of a foreign country are eligible for an FEIE. In other words, you’ll need to have proof that you have a qualifying presence in a foreign country. You may have to go through certain tests to prove this eligibility requirement.
For example, you’ll have to prove that you are currently a resident of a foreign country for a full tax year with no interruptions. If you have been outside of the country for an entire tax year and earning income elsewhere, you can claim an FEIE deduction.
4. You are a resident alien of a country with an income tax treaty with the U.S.
A resident alien is either a foreign-born U.S. resident but not an American citizen or a citizen of a country with an income tax treaty with the U.S. Resident aliens are legally and lawfully recorded residents of the U.S., provided that they have a green card or passed a presence test, such as the Bona Fide Residence Test.
Staying in a foreign country for a year or two is not enough to prove your bona fide residency. You’ll have to supplement it with documents showcasing your intent to permanently reside there, such as opening a personal bank account, having a local driver’s license, registering to vote, getting a permanent residence visa, etc.
5. You are physically present in a foreign country for at least 330 full days during any period of 12 consecutive months
Another way to stay compliant with the current U.S. tax system through the FEIE is to pass the Physical Presence Test. In this test, you’ll have to be residing in a foreign country or outside the U.S. for 330 full days within 12 consecutive months.
During this time, pay close attention to the time–every minute counts, with a full day starting its 24-hour count at midnight. Keep in mind that any domestic visits to the U.S. will reset the day count, even for work assignments. Indicate the times and dates of your location, in and out of the U.S., to qualify for the test.
For example, your employer assigned you to their branch in Australia. You’ll have to stay there for 330 full, 24-hour days within 12 consecutive months to become eligible for the FEIE. If they ask you to come back to the U.S. for some site work, your days in the U.S. will not count to the 330 days and could make you ineligible for the Physical Presence Test.
Avoid Double Taxation Today
With the current citizenship-based tax system in the U.S., American expats draw the short end of the stick. You are prone to double taxation, which you can incur from your tax home country and the U.S., reducing your take-home pay.
However, all hope is not lost. The foreign earned income exclusion tax benefit can help reduce the taxable income you owe to the IRS. All you need is to prove your eligibility. Tax Samaritan offers the best tax resolution services for your taxation needs.