Foreign Earned Income and US Tax Returns
The rules for filing a United States - US - tax return generally apply to you if you are a US citizen or resident alien (Green Card Holder) and you live and/or work in a foreign country. When you start a free tax return on eFile.com, you do not have to think about these rules. Answer a few simple questions and the eFile.com software will select the correct tax forms for you based on your answers. eFile.com will also help you complete and e-File the forms.
Do You Need to File a US Tax Return?
If you lived and/or worked abroad during the Tax Year and you have gross income from worldwide sources that is at least the amount shown for your filing status, you must file a tax return. This also applies to you if you are a U.S. citizens working for the federal government (including the Foreign Service) and you are stationed abroad.
These factors generally determine whether or not you must file a tax return:
What to Report on Your Tax Return
You may need to report the following items on your tax return:
- Gross Income: includes all income your received throughout the Tax Year, including goods, money, services, self-employment earnings (reported on Gross Income line of Schedule C, Profit or Loss from Business, or the Gross Receipts line of Schedule C-EZ, Net Profit from Business), and property that's not exempt from taxes; also includes income you excluded as foreign earned income or foreign housing amounts
- Foreign Income: you must convert your foreign currency into U.S. dollars if you either received part or all your or paid all or some of your expenses with it
What is Foreign Earned Income?
Foreign earned income is income you receive for services performed in a foreign country during the period your tax home (the general area of your main place of business, employment, or post of duty where you are permanently or indefinitely engaged to work) is in a foreign country and whether you meet the bona fide residence test or physical presence test . How or where you are paid has no affect on the income's source. For instance, income you received from work you've done in Brazil is income from a foreign source. This applies even if the income is directly paid to your U.S. bank account and your employer is located in Chicago.
If you received a specific amount for work you've done in the U.S., you must report that amount as U.S. source income. U.S. source income is the amount that results from multiplying your total pay (includes allowances, reimbursements other than foreign moves, and noncash fringe benefits) by a fraction. The numerator (top number) is the number of days you worked in the U.S., and the denominator (bottom number) is the total number of days for which you were paid.
If you can't determine how much is for work done in the U.S., or for work done partly in that country and partly in a foreign country, you should determine the U.S. source income amount using the method that correctly shows the proper source of your income the most. You can make this determination on a time basis in most cases.
Most payments received by U.S. Government civilian employees for working overseas are taxed. These payments include pay differentials. Pay differentials are financial incentives you received for overseas employment under adverse conditions, like severe climate, or because the post location is outside of the U.S. (the area doesn't have to be a qualified hazardous duty area) Examples of pay differentials include special incentive differentials, post differentials, and danger pay. They should be included on your W-2 Form as wages.
Here are other types of foreign income that may be taxed if you are a U.S. government civilian employee:
- Sale of Your Home: This may include part or all of the gain on the sale of your main home, within or outside of the U.S. Losses are not deductible, but you may be able to exclude any gain up to $250,000 (joint return: $500,000) from your income. In general, you must have used and owned the home as your main residence for 2 of the 5 years preceding the home sale date. You can choose to have the 5-year test period for use and ownership suspended during any period you or your spouse is serving on qualified extended duty as a member of the Foreign Service of the United States, as an employee of the intelligence community, or as an volunteer or employee of the Peace Corps.
- Sale of Personal Property: If you have a gain from a personal property sale (automobile, home appliance, etc.), whether directly or through a favorable exchange rate in converting the proceeds to U.S. dollars, the excess of the amount received over the cost or other basis of the property is a capital gain and should be reported on a Schedule D (Capital Gains and Losses). Losses from sales of your personal property, whether directly or through an unfavorable exchange rate, are not deductible.
What is Not Foreign Earned Income?
There are items that the IRS doesn't include as foreign earned income, including:
- Previously excluded value of meals and lodging furnished for the employer's convenience
- Pay you received as an U.S. Government employee
- Recaptured unallowable moving expenses
- Annuity or pension payments (includes Social Security benefits)
- Payments received after the end of the Tax Year following the Tax Year in which you performed the services that resulted in earned income
- Amounts that are included in your income because of your employer's contributions to a nonexempt employee trust or to a nonqualified annuity contract
Non-Taxable Allowance Income
There are three types of allowances from overseas services employment that are not taxed:
- Foreign areas: motor vehicle shipment, transportation for medical treatment, repairs on a leased home, temporary living quarters, separate maintenance for dependents, travel/moving, storage, education of dependents in special situations
- Cost of living: apply to U.S. citizens stationed outside the continental United States or in Alaska (including federal court employees). The allowances are usually not included in their gross incomes, and this is granted by regulations approved by the President. Therefore, they're not included on W-2 Forms.
- Business travel: generally paid under an accountable plan, thus not being included in your wages on your W-2 Form. You don't need to show your expenses or reimbursements on your return if the expenses aren't more than the reimbursements. However, if you don't account to your employer for a travel advance or you don't return any excess advance within a reasonable amount of time, the excess or advance will be included on your W-2 Form.
The allowances that foreign service employees receive for representation expenses are also tax free under the provisions above. Certain foreign areas allowances should not be added to your W-2 Form as wages by your employer.
There are some exceptions to allowance income taxability if you are a Peace Corps volunteer or volunteer leader. Some allowances are taxed and others are not. Taxable allowances are received by you when credited to your account. The expenses below must be reported as wages on your tax return (refer to your W-2 Form):
- Those paid to your spouse and minor children during your training in the United States (if you are a volunteer leader)
- Part of living allowances designated by the Director as basic compensation for personal items (laundry and clothing maintenance, domestic help, transportation, entertainment and recreation, other miscellaneous expenses)
- Readjustment allowances or "termination payments"
- Leave allowances
Nontaxable allowances should not be included on your W-2 since they are tax free, whether they're paid by the U.S. government or the foreign country in which you are stationed. They include:
- Travel allowances
- Part-of-living allowances for utilities, housing, clothing, food, and household supplies
Taxes On Foreign Income
U.S. citizens and resident aliens earning over a certain amount of income from foreign sources may have to pay income taxes on the foreign income. You must pay US taxes on income you earned abroad in the same way you pay taxes on income you earned in the United States. In other words, Social Security and Medicare taxes may apply to wages you earned for services in a foreign country for the following situations:
- You performed the services on or in connection with an American aircraft or vessel and you either entered into your employment contract with the U.S. or the aircraft or vessel lands at a U.S. port while you were employed on it.
- You were working in one of the countries with which the U.S. has entered into a bilateral Social Security agreement.
- You are working for a U.S. employer.
- You are working for a foreign affiliate of a U.S. employer under a voluntary agreement that was entered between the U.S. employer and the U.S. Treasury Department.
Generally, if you do not meet any of the exceptions above, Medicare and Social Security taxes will not be withheld from your foreign wages. If you are an employee of a U.S. company and your employer doesn't withhold income tax or doesn't withhold enough taxes, you may have to pay estimated tax. Though your international income is taxed regardless of where you reside, you may qualify to claim a foreign earned income exclusion.
How to Withhold Taxes From Foreign Income
Here are three ways to withhold taxes from your foreign income:
- Limit or discontinue tax withholding: If you expect to qualify for the foreign income tax withholding under the bona fide residence test or physical presence test, you may be able to have your employer discontinue withholding income tax from a part or all of your wages.
- Pension payment withholding: U.S. payers of benefits from employer deferred compensation plans (annuity, employer pension, or profit-sharing plans), commercial annuities, or individual retirement plans generally must withhold income tax from the distributions or payments. If you want to claim an exemption from the withholding, you must provide the benefits payer with a residence address in the United States or a U.S. possession unless you certify to the payer that you are not a U.S. citizen or resident alien or someone who left the U.S. to avoid paying tax.
- Estimated tax: You may have to pay estimated tax if you are working abroad for a foreign employer, since foreign employers generally don't withhold U.S. taxes from your wages. In general, your estimated tax is the total of your estimated income tax and self-employment for the year minus your expected withholding for the year. Don't include the income you expect to exclude when you estimate your gross income. In order to figure out your estimated tax liability, you can subtract your estimated housing deduction from your income. However, you may be subject to a penalty on the underpayment if the actual deduction or exclusion is less than you expected.
How to Qualify for the Foreign Income Tax Exclusion
You may qualify for a foreign income tax exclusion from a limited amount of foreign earned income. In order to qualify for the exclusion, you must:
Starting in Tax Year 2018, U.S. citizens or resident aliens supporting the U.S. Armed forces in designated combat zones overseas (specifically contractors or employees of contractors) may also qualify for the exclusion, even if their home is in the United States.
Foreign Housing Exclusion
If you work and live outside the U.S. during the Tax Year, you may be able to exclude amounts paid by your employer for housing expenses. You must meet the requirements of either the Bona Fide or the Physical Presence Test in order to exclude these costs. Housing expenses that qualify for the exclusion include:
- Utilities (other than telephone)
- Real/personal property insurance (homeowners & renters insurance)
- Nonrefundable security deposits or lease payments
These expenses don't qualify for the exclusion:
- Cost of buying property (such as main mortgage payments)
- Home improvements
- Extravagant expenses (based on your situation)
- Domestic labor (such as gardeners and maids)
- Deductible taxes and interest (mortgage interest)
Maximum Foreign Earned Income Exclusion Amount
The amount of foreign income that you can exclude is limited to your annual maximum dollar amount limit or actual foreign wages, whichever is less. Below are the maximum amounts for foreign income tax exclusion since the 2006 Tax Year (adjusted for inflation):
||Maximum Amount Foreign Income Exclusion
How to Claim the Foreign Income Tax Exclusion
To claim the foreign income tax exclusion, you must file or efile either Form 2555, Foreign Earned Income efile it (if you are also claiming foreign housing cost amount exclusion) or Form 2555-EZ, Foreign Earned Income Exclusion efile it (if you are only claiming the foreign income tax exclusion) Form 2555 or Form 2555-EZ should be filed with your timely filed Form 1040, U.S. Individual Income Tax Return efile it or Form 1040X (Amended U.S. Individual Income Tax Return).
More Foreign Earned Income Information
Self-Employment Taxes For a Business in a Foreign Country or U.S. Territory
Generally, you are required to pay self-employment taxes if you are abroad and a self-employed U.S. citizen or resident alien. There is a Social Security and Medicare tax on net earnings from self-employment of $400 or more per Tax Year. Your net self-employment income is used to figure your net earnings from self-employment. Net self-employment income usually includes all business income minus all business deductions allowed for income tax purposes, while net earnings from self-employment is a portion of net self-employment income. This amount is figured on Schedule SE, Self-Employment Tax, The actual self-employment tax is figured on net earnings from self-employment. You must take all of your self-employment income into account when figuring your net earnings from self-employment, including income that's exempt from income tax because of the foreign earned income exclusion.
If you are a U.S. citizen or resident and you own and operate a business in Guam, Puerto Rico, American Samoa, the Commonwealth of the Northern Mariana Islands, or the US Virgin Islands, you must pay taxes on your net earnings from self-employment ($400 or more) from these sources. In addition, you must pay the self-employment tax regardless of whether the income is exempt from U.S. taxes or not (or whether or not you must otherwise file a tax return).
Tax Return and Tax Payment Extensions for Being in a Combat Zone
If you were a civilian who served in a combat zone or a qualified hazardous duty area in support of the U.S. Armed Forces, you can receive a deadline extension for the following:
- Filing tax returns (for the period of your service, plus 180 days after you last day there; the extension period will also include the 46 days that were left before the Tax Day deadline when you entered the combat zone; during your 226-day extension period, assessment and collection deadlines will be extended and you won't be charged penalties or interest connected to the extension period)
- Paying taxes (same period as returns)
- Filing claims for refund(s)
- Doing other tax-related acts (which were performed on or after the start date for your combat zone, or the date you began serving in that combat zone, whichever is later; deadline extensions begin on the day you started the services)
Forgiven Debt for Taxpayers Who Died in Terrorist or Military Action Overseas
Income taxes are forgiven for a U.S. Government civilian employee who dies as a result of injuries or wounds incurred while employed by the U.S. Government. The injuries or wounds must have been caused by military or terrorist action directed against the United States or its allies. The taxes are forgiven for the deceased employee's Tax Years beginning with the year immediately before the year in which the injury or wounds occurred and ending with the year of death. If you and your deceased spouse filed a joint return, only your spouse's part of the joint tax liability is forgiven.
Related Foreign Income Information