Publication 54 |
2001 Tax Year |
How To Report Deductions
If you exclude foreign earned income or housing amounts, how you
show your deductions on your tax return and how you figure the amount
allocable to your excluded income depends on whether the expenses are
used in figuring adjusted gross income (Form 1040, line 34) or are
itemized deductions.
If you have deductions used in figuring adjusted gross income,
enter the total amount for each of these items on the
appropriate lines and schedules of Form 1040. Generally, you figure
the amount of a deduction related to the excluded income by
multiplying the deduction by a fraction, the numerator of which is
your foreign earned income exclusion and the denominator of which is
your foreign earned income. Enter the amount of the deduction(s)
related to excluded income on line 42 of Form 2555.
If you have itemized deductions related to excluded
income, enter on Schedule A (Form 1040) only the part not related to
excluded income. You figure that amount by subtracting from the
deduction the amount related to excluded income. Generally, you figure
the amount that is related to the excluded income by multiplying the
deduction by a fraction, the numerator of which is your foreign earned
income exclusion and the denominator of which is your foreign earned
income. Attach a statement to your return showing how you figured the
deductible amount.
Table 6-1
Example 1.
You are a U.S. citizen employed as an accountant. Your tax home is
in Germany for the entire tax year. You meet the physical presence
test. Your foreign earned income for the year was $100,000 and your
investment income was $12,000. After excluding $78,000, your AGI is
$34,000.
You had unreimbursed business expenses of $1,500 for travel and
entertainment in earning your foreign income, of which $500 were for
meals and entertainment. These expenses are deductible only as
miscellaneous deductions on Schedule A (Form 1040). You also have $500
of miscellaneous expenses that are not related to your foreign income
that you enter on line 22 of Schedule A.
You must fill out Form 2106. On that form, reduce your deductible
meal and entertainment expenses by 50% ($250). You must reduce the
remaining $1,250 of travel and entertainment expenses by 78% ($975)
because you excluded 78% ($78,000/$100,000) of your foreign earned
income. You carry the remaining total of $275 to line 20 of Schedule
A. Add the $275 to the $500 that you have on line 22 and enter the
total ($775) on line 23.
On line 25 of Schedule A, enter $680, which is 2% of your adjusted
gross income of $34,000 (line 34, Form 1040) and subtract it from the
amount on line 23.
Enter $95 on line 26 of Schedule A.
Example 2.
You are a U.S. citizen, have a tax home in France, and meet the
physical presence test. You are self-employed and personal services
produce the business income. Your gross income was $100,000, business
expenses $60,000, and net income (profit) $40,000. You choose the
foreign earned income exclusion and exclude $78,000 of your gross
income. Since your excluded income is 78% of your total income, 78% of
your business expenses are not deductible. Report your total income
and expenses on Schedule C (Form 1040). On Form 2555 you will show the
following:
- Line 20a, $100,000, gross income
- Lines 40 and 41, $78,000, foreign earned income
exclusion
- Line 42, $46,800 (78% × $60,000) business expenses
attributable to the exclusion.
In this situation (Example 2), you cannot use Form
2555-EZ since you had self-employment income and business
expenses.
Example 3.
Assume in Example 2, that both capital and personal
services combine to produce the business income. No more than 30% of
your net income, or $12,000, assuming that this amount is a reasonable
allowance for your services, is considered earned and can be excluded.
Your exclusion of $12,000 is 12% of your gross income
($12,000/$100,000). Because you excluded 12% of your total income,
$7,200, or 12% of your business expenses, are attributable to the
excluded income and are not deductible.
Example 4.
You are a U.S. citizen, have a tax home in Brazil, and meet the
physical presence test. You are self-employed and both capital and
personal services combine to produce business income. Your gross
income was $146,000, business expenses were $172,000, and your net
loss was $26,000. A reasonable allowance for the services you
performed for the business is $77,000. Because you incurred a net
loss, the earned income limit of 30% of your net profit does not
apply. The $77,000 is foreign earned income. If you choose to exclude
the $77,000, you exclude 52.74% of your gross income
($77,000/$146,000), and 52.74% of your business expenses ($90,712) are
attributable to that income and not deductible. Show your total income
and expenses on Schedule C (Form 1040). On Form 2555, exclude $77,000
and show $90,712 on line 42. Subtract line 42 from line 41, and enter
the difference as a negative (in parentheses) on line 43. Because this
amount is negative, enter it as a positive (no parentheses) on line
21, Form 1040, and combine it with your other income to arrive at
total income on line 22 of Form 1040.
In this situation (Example 4), you would probably not
want to choose the foreign earned income exclusion if this was the
first year you were eligible. If you had chosen the exclusion in an
earlier year, you might want to revoke the choice for this year. To do
so would mean that you could not claim the exclusion again for the
next 5 tax years without IRS approval. See Choosing the
Exclusion, in chapter 4.
Example 5.
You are a U.S. citizen, have a tax home in Venezuela, and meet the
bona fide residence test. You have been performing services for
clients as a partner in a firm that provides services exclusively in
Venezuela. Capital investment is not material in producing the
partnership's income. Under the terms of the partnership agreement,
you are to receive 50% of the net profits. The partnership received
gross income of $200,000 and incurred operating expenses of $80,000.
Of the net profits of $120,000, you received $60,000 as your
distributive share.
You choose to exclude $78,000 of your share of the gross income.
Because you exclude 78% ($78,000/$100,000) of your share of the gross
income, you cannot deduct $31,200, 78% of your share of the operating
expenses (78% × $40,000). Report $60,000, your distributive
share of the partnership net profit, on Schedule E (Form 1040). On
Form 2555, show $78,000 on line 40 and show $31,200 on line 42. Your
exclusion on Form 2555 is $46,800.
In this situation (Example 5), you would not use Form
2555-EZ since you had earned income other than salaries and
wages and you had business expenses.
Previous| First | Next
Publication Index | IRS-Forms Main | Home
|