Publication 54 |
2000 Tax Year |
Requirements
To claim the foreign earned income exclusion, the foreign housing
exclusion, or the foreign housing deduction, you must have foreign
earned income, your tax home must be in a foreign country, and you
must be one of the following:
- 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.
Waiver of minimum time requirements.
The minimum time requirements for bona fide residence and physical
presence can be waived if you must leave a foreign country because of
war, civil unrest, or similar adverse conditions in that country. See
Waiver of Time Requirements under Exceptions to Tests,
later.
Figure 4-A Can I Claim the Exclusion Deduction?
Tax Home in
Foreign Country
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.
Tax Home
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, and you satisfy the tax home test
in the foreign country.
Temporary or
Indefinite Assignment
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.
Foreign Country
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
Virgin Islands, or U.S. possessions such as American Samoa. 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 Virgin Islands, and the
Antarctic region.
American Samoa,
Guam, and the
Commonwealth of the
Northern Mariana Islands
Residence or presence in a U.S. possession
does
not qualify you for the foreign earned income exclusion.
You may, however, qualify for the possession exclusion.
American Samoa.
There is a possession exclusion available to individuals who are
bona fide residents of American Samoa for the entire tax year. Gross
income from sources within American Samoa, Guam, or the Commonwealth
of the Northern Mariana Islands may be eligible for this exclusion.
Income that is effectively connected with the conduct of a trade or
business within those possessions also may be eligible for this
exclusion. Use Form
4563, Exclusion of Income for Bona
Fide Residents of American Samoa, to figure the exclusion.
Guam and the Commonwealth of the Northern Mariana Islands.
A possession exclusion will be available to residents of Guam and
the Commonwealth of the Northern Mariana Islands if, and when, new
implementation agreements take effect between the United States and
those possessions.
For more information, see Publication 570.
Puerto Rico
and Virgin Islands
Residents of Puerto Rico and the Virgin Islands are not entitled to
the possession exclusion (discussed above) or to the exclusion of
foreign earned income or the exclusion or deduction of foreign housing
amounts under the bona fide residence or physical presence rules
discussed later.
Puerto Rico.
Generally, if you are
a U.S. citizen who is a bona fide resident of Puerto Rico for the
entire tax year, you are not subject to U.S. tax on income from Puerto
Rican sources. This does not include amounts paid for services
performed as an employee of the United States. However, you are
subject to U.S. tax on your income from sources outside Puerto Rico.
You cannot deduct expenses allocable to the exempt income.
Bona Fide Residence Test
The bona fide residence test applies to U.S. citizens and to any
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.
Bona fide residence.
To see if you meet the test of bona fide residence in a foreign
country, you must find out if you have established such a residence in
a foreign country.
Your bona fide residence is not necessarily the same as your
domicile. Your domicile is your permanent home, the place to which you
always return or intend to return.
Example.
You could have your domicile in Cleveland, Ohio, and a bona fide
residence in London if you intend to return eventually to Cleveland.
The fact that you go to London does not automatically make London
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 London. But if you go to London 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 London in the first instance.
However, in the second, you are a resident because your stay in London
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.
Determination.
Questions of bona fide residence are determined according to each
individual case, taking into account such factors as your intention or
the purpose of your trip and the nature and length of your stay
abroad.
You must show the Internal Revenue Service (IRS) that you have been
a bona fide resident of a foreign country or countries for an
uninterrupted period that includes an entire tax year. The IRS decides
whether you qualify as a bona fide resident of a foreign country
largely on the basis of facts you report on Form 2555. IRS cannot make
this determination until you file Form 2555.
Statement to foreign authorities.
You are not considered a bona fide resident of a foreign country if
you make a statement to the authorities of that country that you are
not a resident of that country and the authorities hold that you are
not subject to their income tax laws as a resident.
If you have made such a statement and the authorities have not made
a final decision on your status, you are not considered to be a bona
fide resident of that foreign country.
Special agreements and treaties.
An income
tax exemption provided in a treaty or other international agreement
will not in itself prevent you from being a bona fide resident of a
foreign country. Whether a treaty prevents you from becoming a bona
fide resident of a foreign country is determined under all provisions
of the treaty, including specific provisions relating to residence or
privileges and immunities.
Example 1.
You are a U.S. citizen employed in the United Kingdom by a U.S.
employer under contract with the U.S. Armed Forces. You do not qualify
for special status under the North Atlantic Treaty Status of Forces
Agreement. You are subject to United Kingdom income taxes and may
qualify as a bona fide resident.
Example 2.
You are a U.S. citizen in the United Kingdom who qualifies as an
"employee" of an armed service or as a member of a "civilian
component" under the North Atlantic Treaty Status of Forces
Agreement. You do not qualify as a bona fide resident.
Example 3.
You are a U.S. citizen employed in Japan by a U.S. employer under
contract with the U.S. Armed Forces. You are subject to the agreement
of the Treaty of Mutual Cooperation and Security between the United
States and Japan. You do not qualify as a bona fide
resident.
Example 4.
You are a U.S. citizen employed as an "official" by the United
Nations in Switzerland. You are exempt from Swiss taxation on the
salary or wages paid to you by the United Nations. This does not
prevent you from qualifying as a bona fide resident if you meet
all the requirements for that status.
Effect of voting by absentee ballot.
If you are a U.S.
citizen living abroad, you can vote by absentee ballot in any election
held in the United States without risking your status as a bona fide
resident of a foreign country.
However, if you give information to the local election officials
about the nature and length of your stay abroad that does not match
the information you give for the bona fide residence test, the
information given in connection with absentee voting will be
considered in determining your status, but will not necessarily be
conclusive.
Uninterrupted period including entire tax year.
To qualify for bona fide residence, you must reside in a foreign
country for an uninterrupted period that includes an entire tax year.
An entire tax year is from January 1 through December 31 for taxpayers
who file their income tax returns on a calendar year basis.
During the period of bona fide residence in a foreign country, you
can leave the country for brief or temporary trips back to the United
States or elsewhere for vacation or business. To keep your status as a
bona fide resident of a foreign country, you must have a clear
intention of returning from such trips, without unreasonable delay, to
your foreign residence or to a new bona fide residence in another
foreign country.
Example 1.
You are the Lisbon representative of a U.S. employer. You arrived
with your family in Lisbon on November 1, 1998. Your assignment is
indefinite, and you intend to live there with your family until your
company sends you to a new post. You immediately established residence
there. On April 1, 1999, you arrived in the United States to meet with
your employer, leaving your family in Lisbon. You returned to Lisbon
on May 1, and continue living there. On January 1, 2000, you completed
an uninterrupted period of residence for a full tax year (1999), and
you may qualify as a bona fide resident of a foreign country.
Example 2.
Assume that in Example 1, you transferred back to the
United States on December 13, 1999. You would not qualify under the
bona fide residence test because your bona fide residence in the
foreign country, although it lasted more than a year, did not include
a full tax year. You may, however, qualify for the foreign earned
income exclusion or the housing exclusion or deduction under the
physical presence test discussed later.
Bona fide residence status not automatic.
You do not automatically acquire bona fide resident status merely
by living in a foreign country or countries for 1 year.
Example.
If you go to a foreign country to work on a particular construction
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 one 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.
Bona fide resident for part of a year.
Once you have established bona fide residence in a foreign country
for an uninterrupted period that includes an entire tax year, you will
qualify as a bona fide resident for the period starting with the date
you actually began the residence and ending with the date you abandon
the foreign residence. You could qualify as a bona fide resident for
an entire tax year plus parts of 1 or 2 other tax years.
Example.
You were a bona fide resident of England from March 1, 1998,
through September 14, 2000. On September 15, 2000, you returned to the
United States. Since you were a bona fide resident of a foreign
country for all of 1999, you also qualify as a bona fide resident from
March 1, 1998, through the end of 1998 and from January 1, 2000,
through September 14, 2000.
Reassignment.
If you are assigned from one foreign post to another, you may or
may not have a break in foreign residence between your assignments,
depending on the circumstances.
Example 1.
You were a resident of France from October 1, 1999, through
November 30, 2000. On December 1, 2000, you and your family returned
to the United States to wait for an assignment to another foreign
country. Your household goods also were returned to the United States.
Your foreign residence ended on November 30, 2000, and did not
begin again until after you were assigned to another foreign country
and physically entered that country. Since you were not a bona fide
resident of a foreign country for the entire tax year of 1999 or 2000,
you do not qualify under the bona fide residence test in either year.
You may, however, qualify for the foreign earned income exclusion or
the housing exclusion or deduction under the physical presence test,
discussed later.
Example 2.
Assume the same facts as in Example 1, except that upon
completion of your assignment in France you were given a new
assignment to England. On December 1, 2000, you and your family
returned to the United States for a month's vacation. On January 2,
2001, you arrived in England for your new assignment. Because you did
not interrupt your bona fide residence abroad, you qualify at the end
of 2000 as a bona fide resident of a foreign country.
Physical Presence Test
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 qualifying days do not have to be
consecutive. The physical presence test applies to both U.S. citizens
and resident aliens.
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. However, your intentions with
regard to the nature and purpose of your stay abroad are relevant in
determining whether you meet the tax home test explained earlier under
Tax Home in Foreign Country.
330 full days.
Generally, to meet the physical presence test, you must be
physically present in a foreign country or countries for at least 330
full days during the 12-month period. You can count days you spent
abroad for any reason. You do not have to be in a foreign country only
for employment purposes. You can be on vacation time.
You do not meet the physical presence test if illness, family
problems, a vacation, or your employer's orders cause you to be
present for less than the required amount of time.
Exception.
You can be physically present in a foreign country or countries for
less than 330 full days and still meet the physical presence test if
you are required to leave a country because of war or civil unrest.
See Waiver of Time Requirements, later.
Full day.
A full day is a period of 24
consecutive hours, beginning at midnight. You must spend each of the
330 full days in a foreign country. When you leave the United States
to go directly to a foreign country or when you return directly to the
United States from a foreign country, the time you spend on or over
international waters does not count toward the 330-day total.
Example.
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 in
France is June 12.
Passing over foreign country.
If, in traveling from the United States to a foreign country, you
pass over a foreign country before midnight of the day you leave, the
first day you can count toward the 330-day total is the day following
the day you leave the United States.
Example.
You leave the United States by air at 9:30 a.m. on June 10 to
travel to Spain. You pass over a part of France at 11:00 p.m. on June
10 and arrive in Spain at 12:30 a.m. on June 11. Your first full day
in a foreign country is June 11.
Change of location.
You can move about from one place to another in a foreign country
or to another foreign country without losing full days. But if any
part of your travel is not within a foreign country or countries and
takes 24 hours or more, you will lose full days.
Example 1.
You leave London by air at 11:00 p.m. on July 6 and arrive in
Stockholm at 5:00 a.m. on July 7. Your trip takes less than 24 hours
and you lose no full days.
Example 2.
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.
In United States while in transit.
If you are in transit between two points outside the United States
and are physically present in the United States for less than 24
hours, you are not treated as present in the United States during the
transit. You are treated as traveling over areas not within any
foreign country.
How to figure the 12-month period.
There are four rules you
should know when figuring the 12-month period.
- 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 to 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.
Example 1.
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.
Example 2.
You work in Canada for a 20-month period from January 1, 1999,
through August 31, 2000, except that you spend 28 days in February
1999 and 28 days in February 2000 on vacation in the United States.
You are present in Canada 330 full days during each of the following
two 12-month periods: January 1, 1999 -- December 31, 1999, and
September 1, 1999 -- August 31, 2000. By overlapping the 12-month
periods in this way, you meet the physical presence test for the whole
20-month period. See Table 4-1.
Table 4-1
Exceptions to Tests
There are two exceptions to meeting the requirements under the bona
fide residence and the physical presence tests.
Waiver of Time Requirements
Both the bona fide residence test and the physical presence test
contain minimum time requirements. The minimum time requirements can
be waived, however, if you must leave a foreign country because of
war, civil unrest, or similar adverse conditions in that
country. You also must be able to show that you reasonably could have
expected to meet the minimum time requirements if not for the adverse
conditions. To qualify for the waiver, you must actually have your tax
home in the foreign country and be a bona fide resident of, or be
physically present in, the foreign country on or before the beginning
date of the waiver.
Early in 2001, the IRS will publish in the Internal Revenue
Bulletin a list of countries qualifying for the waiver for 2000 and
the effective dates. If you left one of the countries on or after the
date listed for each country, you can qualify for the bona fide
residence test or physical presence test for 2000 without meeting the
minimum time requirement. However, in figuring your exclusion, the
number of your qualifying days of bona fide residence or physical
presence includes only days of actual residence or presence within the
country.
You can read the Internal Revenue Bulletins on the Internet at
www.irs.gov. Select Tax Info For You. Or, you
can get a copy of the list of countries by writing to:
Internal Revenue Service
International Returns Section
P.O. Box 920
Bensalem, PA 19020-8518.
U.S. Travel Restrictions
If you are present in a foreign country in violation of U.S. law,
you will not be treated as a bona fide resident of a foreign country
or as physically present in a foreign country while you are in
violation of the law. Income that you earn from sources within such a
country for services performed during a period of violation does not
qualify as foreign earned income. Your housing expenses within that
country (or outside that country for housing your spouse or
dependents) while you are in violation of the law cannot be included
in figuring your foreign housing amount.
Currently, the countries to which travel restrictions apply and the
beginning dates of the restrictions are as follows:
- Cuba -- January 1, 1987
- Iraq -- August 2, 1990
- Libya -- January 1, 1987
The restrictions are still in effect in all three countries.
Foreign Earned Income
The foreign earned income exclusion, the foreign housing exclusion,
and the foreign housing deduction are based on foreign earned income.
For this purpose, foreign earned income is income you receive for
services you perform in a foreign country during a period your tax
home is in a foreign country and during which you meet either the bona
fide residence test or the physical presence test, discussed earlier.
Foreign earned income does not include the following amounts.
- The previously excluded value of meals and lodging furnished
for the convenience of your employer.
- Pension or annuity payments including social security
benefits (see Pensions and annuities, later).
- U.S. Government payments to its employees (see U.S.
Government Employees, later).
- Amounts included in your income because of your employer's
contributions to a nonexempt employee trust or to a nonqualified
annuity contract.
- Recaptured unallowable moving expenses (see Moving
Expenses in chapter 5).
- Payments received after the end of the tax year following
the tax year in which you performed the services that earned the
income.
Earned income is
pay for personal
services performed, such as wages, salaries, or professional
fees. The list that follows classifies many types of income into three
categories. The column headed Variable Income lists income
that may fall into either the earned income category, the unearned
income category, or partly into both.
For more information on earned and
unearned income, see Earned and Unearned Income, later.
| Unearned |
Variable |
Earned Income |
Income |
Income |
Salaries and |
Dividends |
Business |
wages |
Interest |
profits |
Commissions |
Capital gains |
Royalties |
Bonuses |
Gambling |
Rents |
Professional fees |
winnings |
Tips |
Alimony |
| Social security |
| benefits |
| Pensions |
| Annuities |
In addition to the types of earned income listed, certain noncash
income and allowances or reimbursements are considered earned income.
Noncash income.
The fair market value of property or facilities provided to you by
your employer in the form of lodging, meals, or use of a car is earned
income.
Allowances or reimbursements.
Earned income includes amounts paid to you as allowances or
reimbursements for the following items.
- Cost of living.
- Overseas differential.
- Family.
- Education.
- Home leave.
- Quarters.
- Moving (unless excluded from income as discussed
later).
Source of Earned 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 performing personal services 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 France 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.
Example.
You are a U.S. citizen, a bona fide resident of Country A, 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.
Number of days worked in the United States during the year (30)
x Number of days of work during the year for which payment was
made (240) x Total income ($88,800) = $11,100.
Your U.S. source earned income is $11,100.
Earned and
Unearned Income
Earned income was defined earlier as pay for personal services
performed. Some types of income are not easily identified as earned or
unearned income. These types of income --specifically, income
from sole proprietor-ships, partnerships, and corporations, stock
options, pensions and annuities, royalties, rents, and fringe
benefits--are further explained here. Income from sole
proprietor-ships and partnerships is generally treated differently
than income from corporations.
Trade or business--sole proprietorship or partnership.
Income from a business in
which capital investment is an important part of producing the income
may be unearned income. If you are a sole proprietor or partner, and
your personal services are also an important part of producing the
income, the part of the income that represents the value of your
personal services will be treated as earned income.
If capital investment is an important part of producing income, no
more than 30% of your share of the net profits of the business is
earned income.
If you have no net profits, the part of your gross profit that
represents a reasonable allowance for personal services actually
performed is considered earned income. Because you do not have a net
profit, the 30% limit does not apply.
Example 1.
You are a U.S. citizen and meet the bona fide residence test. You
invest in a partnership based in Algeria that is engaged solely in
selling merchandise outside the United States. You perform no services
for the partnership. At the end of the tax year, your share of the net
profits is $80,000. The entire $80,000 is unearned income.
Example 2.
Assume that in Example 1 you spend time operating the
business. Your share of the net profits is $80,000, 30% of your share
of the profits is $24,000. If the value of your services for the year
is $15,000, your earned income is limited to the value of your
services, $15,000.
Capital not a factor.
If capital is not an income-producing factor and personal services
produce the business income, the 30% rule does not apply. The entire
amount of business income is earned income.
Example.
You and Lou Green are management consultants and operate as equal
partners in performing services outside the United States. Because
capital is not an income-producing factor, all the income from the
partnership is considered earned income.
Trade or business--corporation.
The salary you receive from a corporation is earned income only if
it represents a reasonable allowance as compensation for work you do
for the corporation. Any amount over what is considered a reasonable
salary is unearned income.
Example 1.
You are a U.S. citizen and an officer and stockholder of a
corporation in Canada. You perform no work or service of any kind for
the corporation. During the tax year you receive a $10,000 "salary"
from the corporation. The $10,000 clearly is not for personal services
and is unearned income.
Example 2.
You are a U.S. citizen and devote full time as secretary-treasurer
of your corporation. During the tax year you receive $100,000 as
salary from the corporation. If $80,000 is a reasonable allowance as
pay for the work you did, then $80,000 is earned income.
Stock options.
You may have earned income if
you disposed of stock that you got by exercising a stock option
granted to you under an employee stock purchase plan.
If your gain on the disposition of option stock is treated as
capital gain, your gain is unearned income.
However, if you disposed of the stock less than 2 years after you
were granted the option or less than 1 year after you got the stock,
part of the gain on the disposition may be earned income. It is
considered received in the year you disposed of the stock and earned
in the year you performed the services for which you were granted the
option. Any part of the earned income that is due to work you did
outside the United States is foreign earned income.
See Publication 525,
Taxable and Nontaxable Income, for
a discussion of treatment of stock options.
Pensions and annuities.
For purposes of the
foreign earned income exclusion, the foreign housing exclusion, and
the foreign housing deduction, amounts received as pensions or
annuities are unearned income.
Royalties.
Royalties from the leasing of oil
and mineral lands and patents generally are a form of rent or
dividends and are unearned income.
Royalties received by a writer are earned income if they
are received:
- For the transfer of property rights of the writer in the
writer's product, or
- Under a contract to write a book or series of
articles.
Rental income.
Generally, rental income is unearned
income. If you perform personal services in connection with the
production of rent, up to 30% of your net rental income can be
considered earned income.
Example.
Larry Smith, a U.S. citizen living in Australia, owns and operates
a rooming house in Sydney. If he is operating the rooming house as a
business that requires capital and personal services, he can consider
up to 30% of net rental income as earned income. On the other hand, if
he just owns the rooming house and performs no personal services
connected with its operation, except perhaps making minor repairs and
collecting rents, none of his net income from the house is considered
earned income. It is all unearned income.
Professional fees.
If you are engaged in a professional occupation (such as a doctor
or lawyer), all fees received in the performance of these services are
earned income.
Income of an artist.
Income you receive from the sale of
paintings is earned income if you painted the pictures yourself.
Use of employer's property or facilities.
If you
receive fringe benefits in the form of the right to use your
employer's property or facilities, you must add the fair market value
of that right to your pay. Fair market value is the price
at which the property would change hands between a willing buyer and a
willing seller, neither being required to buy or sell, and both having
reasonable knowledge of all the necessary facts.
Example.
You are privately employed and live in Japan all year. You are paid
a salary of $6,000 a month. You live rent-free in a house provided by
your employer that has a fair rental value of $3,000 a month. The
house is not provided for your employer's convenience. You report on
the calendar year, cash basis. You received $72,000 salary from
foreign sources plus $36,000 fair rental value of the house, or a
total of $108,000 of earned income.
Reimbursement of employee expenses.
If you
are reimbursed under an accountable plan (defined below) for expenses
you incur on your employer's behalf and you have adequately accounted
to your employer for the expenses, do not include the reimbursement
for those expenses in your earned income.
The expenses for which you are reimbursed are not considered
allocable (related) to your earned income. If expenses and
reimbursement are equal, there is nothing to allocate to excluded
income. If expenses are more than the reimbursement, the unreimbursed
expenses are considered to have been incurred in producing earned
income and must be divided between your excluded and included income
in determining the amount of unreimbursed expenses you can deduct.
(See chapter 5.)
If the reimbursement is more than the expenses, no
expenses remain to be divided between excluded and included income and
the excess must be included in earned income.
These rules do not apply to straight-commission
salespersons or other individuals who are employees and have
arrangements with their employers under which, for withholding tax
purposes, their employers consider a percentage of the commissions to
be attributable to the expenses of the employees and do not withhold
taxes on that percentage.
Accountable plan.
An accountable plan is a reimbursement or allowance arrangement
that includes all three of the following rules.
- The expenses covered under the plan must have a business
connection.
- The employee must adequately account to the employer for
these expenses within a reasonable period of time.
- The employee must return any excess reimbursement or
allowance within a reasonable period of time.
Reimbursement of moving expenses.
Earned income may include reimbursement of moving expenses. You
must include as earned income:
- Any reimbursements of, or payments for, nondeductible moving
expenses,
- Reimbursements that are more than your deductible expenses
and that you do not return to your employer,
- Any reimbursements made (or treated as made) under a
nonaccountable plan (any plan that does not meet the rules listed
above for an accountable plan), even if they are for deductible
expenses, and
- Any reimbursement of moving expenses you deducted in an
earlier year.
This section discusses reimbursements that must be included in
earned income. Publication 521,
Moving Expenses, discusses
additional rules that apply to moving expense deductions and
reimbursements.
The rules for determining when the reimbursement is
considered earned or where the reimbursement is considered
earned may differ somewhat from the general rules previously
discussed.
Although you receive the reimbursement in one tax year, it may be
considered earned for services performed, or to be performed, in
another tax year. You must report the reimbursement as
income on your return in the year you receive it, even if it is
considered earned during a different year.
Move from U.S. to foreign country.
If you move from the United States to a foreign country, your
moving expense reimbursement is considered pay for future services to
be performed at the new location. The reimbursement is considered
earned solely in the year of the move if your tax home is in a foreign
country and you qualify under the bona fide residence test or physical
presence test for at least 120 days during that tax year.
If you do not qualify under either test for 120 days during the
year of the move, the reimbursement is considered earned in the year
of the move and the year following the year of the move. To figure the
amount earned in the year of the move, multiply the reimbursement by a
fraction. The numerator (top number) is the number of days in your
qualifying period that fall within the year of the move, and the
denominator (bottom number) is the total number of days in the year of
the move.
The difference between the total reimbursement and the amount
considered earned in the year of the move is the amount considered
earned in the year following the year of the move. The part earned in
each year is figured as shown in the following example.
Example.
You are a U.S. citizen working in the United States. You were told
in October 1999 that you were being transferred to a foreign country.
You arrived in the foreign country on December 15, 1999, and you
qualify as a bona fide resident for the remainder of 1999 and all of
2000. Your employer reimbursed you $2,000 in January 2000 for the part
of the moving expense that you were not allowed to deduct. Because you
did not qualify as a bona fide resident for at least 120 days last
year (the year of the move), the reimbursement is considered pay for
services performed in the foreign country for both 1999 and 2000.
You figure the part of the moving expense reimbursement for
services performed in the foreign country in 1999 by multiplying the
total reimbursement by a fraction. The fraction is the number of days
during which you were a bona fide resident during the year of the move
divided by 365. The remaining part of the reimbursement is for
services performed in the foreign country in 2000.
This computation is used only to determine when the
reimbursement is considered earned. You would report the amount you
include in income in this tax year, the year you received it.
Move between foreign countries.
If you move between foreign countries and you qualify for at least
120 days during the tax year under the bona fide residence test or the
physical presence test, the moving expense reimbursement that you must
include in income is considered earned in the tax year of the move.
Move to U.S.
If you move to the United States, the moving expense reimbursement
that you must include in income is generally considered to be U.S.
source income.
However, if under either an agreement between you and your employer
or a statement of company policy that is reduced to writing before
your move to the foreign country, your employer will reimburse you for
your move back to the United States regardless of whether you continue
to work for the employer, the includible reimbursement is considered
compensation for past services performed in the foreign country. The
includible reimbursement is considered earned in the tax year of the
move if you qualify under the bona fide residence test or the physical
presence test for at least 120 days during that tax year. Otherwise,
you treat the includible reimbursement as received for services
performed in the foreign country in the year of the move and the year
immediately before the year of the move.
See the discussion under Move from U.S. to foreign country
(earlier) to figure the amount of the includible reimbursement
considered earned in the year of the move. The amount earned in the
year before the year of the move is the difference between the total
includible reimbursement and the amount earned in the year of the
move.
Example.
You are a U.S. citizen employed in a foreign country. You retired
from employment with your employer on March 31, 2000, and returned to
the United States after having been a bona fide resident of the
foreign country for several years. A written agreement with your
employer entered into before you went abroad provided that you would
be reimbursed for your move back to the United States.
In April 2000, your former employer reimbursed you $2,000 for the
part of the cost of your move back to the United States that you were
not allowed to deduct. Because you were not a bona fide resident for
at least 120 days last year (the year of the move), the includible
reimbursement is considered pay for services performed in the foreign
country for both 2000 and 1999.
You figure the part of the moving expense reimbursement for
services performed in the foreign country last year by multiplying the
total includible reimbursement by a fraction. The fraction is the
number of days of foreign residence during the year (90) divided by
the number of days in the year (365 or 366). The remaining part of the
includible reimbursement is for services performed in the foreign
country in 1999. You report the amount of the includible reimbursement
on your Form 1040 for 2000, the tax year you received it.
In this example, if you qualify to exclude income under the
physical presence test instead of the bona fide residence test for
last year, you may have had more than 120 qualifying days in the year
of the move because you can choose the 12-month qualifying period that
is most advantageous to you. (See Physical presence test,
later, under Part-year exclusion.) If so, the moving
expense reimbursement would be considered earned entirely in the year
of the move (2000).
Storage expense reimbursements.
If you are reimbursed for storage expenses, the reimbursement is
for services you perform during the period you are in the foreign
country.
U.S. Government Employees
For purposes of the foreign earned income exclusion and the foreign
housing exclusion or deduction, foreign earned income does not include
any amounts paid by the United States or any of its agencies to its
employees. Payments to employees of nonappropriated fund activities
are not foreign earned income. Nonappropriated fund activities include
the following employers.
- Armed forces post exchanges.
- Officers' and enlisted personnel clubs.
- Post and station theaters.
- Embassy commissaries.
Amounts paid by the United States or its agencies to persons who
are not their employees may qualify for exclusion or
deduction.
If you are a U.S. Government employee paid by a U.S. agency that
assigned you to a foreign government to perform specific services for
which the agency is reimbursed by the foreign government, your pay is
from the U.S. Government and does not qualify for the exclusion or
deduction.
If you have questions about whether you are an employee or an
independent contractor, get Publication 15-A, Employer's
Supplemental Tax Guide.
Panama Canal Commission.
U.S. employees of the Panama Canal Commission
are
employees of a U.S. Government agency and are not eligible for the
foreign earned income exclusion on their salaries from that source.
Furthermore, no provision of the Panama Canal Treaty or Agreement
exempts their income from U.S. taxation. Employees of the Panama Canal
Commission and civilian employees of the Defense Department of the
United States stationed in Panama can exclude certain foreign-area and
cost-of-living allowances. See Publication 516,
U.S. Government
Civilian Employees Stationed Abroad, for more information.
These employees cannot exclude any overseas tropical differential
they receive.
American Institute in Taiwan.
Amounts paid by the American Institute in Taiwan are not considered
foreign earned income for purposes of the exclusion of foreign earned
income or the exclusion or deduction of foreign housing amounts. If
you are an employee of the American Institute in Taiwan, allowances
you receive are exempt from U.S. tax up to the amount that equals
tax-exempt allowances received by civilian employees of the U.S.
Government.
Allowances.
Cost-of-living and foreign-area allowances paid under certain Acts
of Congress to U.S. civilian officers and employees stationed in
Alaska and Hawaii or elsewhere outside the 48 contiguous states and
the District of Columbia can be excluded from gross income. See
Publication 516
for more information. Post differentials are wages
that must be included in gross income, regardless of the Act of
Congress under which they are paid.
Exclusion of
Meals and Lodging
You do not include in your income the value of meals and lodging
provided to you and your family by your employer at no charge if the
following conditions are met.
- The meals are:
- Furnished on the business premises of your employer,
and
- Furnished for the convenience of your employer.
- The lodging is:
- Furnished on the business premises of your employer,
- Furnished for the convenience of your employer, and
- A condition of your employment. (You are required to accept
it).
Amounts you do not include in income because of these rules are
not foreign earned income.
Family.
Your family, for this purpose, includes only your spouse and your
dependents.
Lodging.
The value of lodging includes the cost of heat, electricity, gas,
water, sewer service, and similar items needed to make the lodging fit
to live in.
Business premises of employer.
Generally, the business premises of your employer is wherever you
work. For example, if you work as a housekeeper, meals and lodging
provided in your employer's home are provided on the business premises
of your employer. Similarly, meals provided to cowhands while herding
cattle on land leased or owned by their employer are considered
provided on the premises of their employer.
Convenience of employer.
Whether meals or lodging are provided for your employer's
convenience must be determined from all the facts. Meals or lodging
provided to you and your family by your employer will be considered
provided for your employer's convenience if there is a good business
reason for providing the meals or lodging, other than to give you more
pay.
If your employer has a good business reason for providing the meals
or lodging, do not include their value in your income, even though
your employer may also intend them as part of your pay. You can
exclude the value of meals or lodging from your income even if a law
or your employment contract says that they are provided as
compensation.
On the other hand, if meals or lodging are provided to you or your
family by your employer as a means of giving you more pay, and there
is no other business reason for providing them, their value is extra
income to you.
Condition of employment.
Lodging is provided as a condition of employment if you must accept
the lodging to properly carry out the duties of your job. You must
accept lodging to properly carry out your duties if, for example, you
must be available for duty at all times.
Foreign camps.
If you are provided lodging by or for your employer in a camp
located in a foreign country, the camp is considered to be part of
your employer's business premises. For this purpose, a camp is lodging
that is:
- Provided for your employer's convenience because the place
where you work is in a remote area where satisfactory housing is not
available to you on the open market within a reasonable commuting
distance,
- Located as close as reasonably possible in the area where
you render services, and
- Provided in a common area or enclave that is not available
to the general public for lodging or accommodations and that normally
houses at least ten employees.
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