If your tax home is in a foreign country and you meet the bona fide residence test or the physical presence test, you can choose to exclude from your income a limited amount of your foreign earned income. Foreign earned income is defined earlier. You cannot deduct expenses directly connected with the earning of excluded income. See chapter 5.

You can also choose to exclude from your income a foreign housing amount. This is explained later. If you choose to exclude a foreign housing amount, you must figure the foreign housing exclusion first. Your foreign earned income exclusion is limited to your foreign earned income minus your foreign housing exclusion.

Limit on Excludable Amount

You may be able to exclude up to $76,000 of income earned in 2000. See Table 4.2 for the maximum amount excludable for other years.

Limits. For 2000, you cannot exclude more than the smaller of:

1. $76,000, or
2. Your foreign earned income (discussed earlier) for the tax year minus your foreign housing exclusion (discussed later).

If both you and your spouse work abroad and you each meet either the bona fide residence test or the physical presence test, you can each choose the foreign earned income exclusion. It is possible for a married couple together to exclude as much as $152,000.

These limits apply to the foreign earned income exclusion only; you may also qualify for the foreign housing exclusion.

If you perform services one year but do not get paid for those services until the following year, the income is generally considered earned in the year you performed the services. If you report your income on the cash basis, you report the income on your return for the year you receive it. You can exclude as much of the income in the year you receive it as you could have excluded in the year you performed the services had you received the income that year.

Example. You qualify as a bona fide resident of a foreign country for all of last year and this year. You report your income on the cash basis. You received $65,000 last year for services you performed last year in the foreign country. You can exclude all of the $65,000.

This year you will receive $87,000: $10,000 for services performed in the foreign country last year and $77,000 for services performed in the foreign country this year. You can exclude $9,000 of the $10,000 received for services performed last year. This is the $74,000 maximum exclusion allowable last year minus the $65,000 you excluded last year. You must include the remaining $1,000 in income (this year) because you could not have excluded that income last year had you received it then. You can also exclude $76,000 of the $77,000 received for services performed during this year.

Your total foreign earned income excluded on your return for this year would be $85,000 ($9,000 attributable to last year and $76,000 attributable to this year). You would have $2,000 of includible income.

Table 4.2. The maximum amount you can exclude depends on the calendar year.

Year	Maximum Excludable Amount
1997 and earlier	$70,000
1998	$72,000
1999	$74,000
2000	$76,000
2001	$78,000
2002 and later	$80,000

Year-end payroll period. There is an exception to the rule that you exclude income in the year you earn it. If you are a cash basis taxpayer, a salary or wage payment that you receive after the end of the tax year in which you perform the services is considered earned entirely in the year you receive it if all four of the following apply.

1. The period for which the payment is made is a normal payroll period of your employer that regularly applies to you.
2. The payroll period includes the last day of your tax year.
3. The payroll period is not longer than 16 days.
4. The payday comes at the same time in relation to the payroll period that it would normally come and it comes before the end of the next payroll period.

Income earned over more than 1 year. Regardless of when you actually receive income, you must credit it to the tax year in which you earned it in figuring your excludable amount for that year. For example, a bonus that you receive in 1 year may be based on services you performed over several tax years. You determine the amount of the bonus that is considered earned in a particular tax year by dividing the bonus by the number of calendar months in the period when you performed the services that resulted in the bonus and then multiplying the result by the number of months you performed these services during the tax year. This is the amount that is subject to the exclusion limit for that tax year.

Income received more than 1 year after it was earned. You cannot exclude income you receive after the end of the tax year following the tax year in which you perform the services that earned it.

Example. You qualify as a bona fide resident of a foreign country for 1998, 1999, and 2000. You report your income on the cash basis. You received $65,000 for 1998 and $70,000 for 1999 for services performed in the foreign country. You excluded $65,000 on your 1998 federal income tax return and $70,000 for your 1999 return.

In 2000 you receive $90,000; $80,000 for services performed in the foreign country during 2000, and $10,000 for services performed in the foreign country in 1998. You cannot exclude any of the $10,000 received for services performed in 1998 because you received it after the year following the year in which you earned it. You must include the $10,000 in income. You can exclude $76,000 of the $80,000 received for services performed in 2000.

Community income. The maximum exclusion applies individually to the earnings of a husband and wife. Ignore any community property laws when you figure your limit on the foreign earned income exclusion.

Part-year exclusion. If you qualify under either the bona fide residence test or the physical presence test for only part of the tax year, you must adjust the maximum limit based on the number of qualifying days in your tax year. The number of qualifying days in your tax year is the number of days within the period on which you both have your tax home in a foreign country and meet either test.

For this purpose, you can count as qualifying days all days within a period of 12 consecutive months once you are physically present and have your tax home in a foreign country for 330 full days. To figure your maximum exclusion, multiply the maximum excludable amount for the year by the number of your qualifying days in the year, and then divide the result by the number of days in your tax year.

Example. You report your income on the calendar-year basis and you qualified under the bona fide residence test for 75 days in 2000. You can exclude a maximum of 75/366 of $76,000, or $15,574, of your foreign earned income for 2000. If you qualify under the bona fide residence test for all of 2001, you can exclude your foreign earned income up to the full $78,000 limit.

Physical presence test. Under the physical presence test, a 12-month period can be any period of 12 consecutive months that includes 330 full days. If you qualify under the physical presence test for part of a tax year, it is important to carefully choose the 12-month period that will allow the maximum exclusion for that year.

Example. You are physically present and have your tax home in a foreign country for a 16-month period from June 1, 1999, through September 29, 2000, except for 15 days in December 1999 when you were on vacation in the United States. You figure the maximum exclusion for 1999 as follows:

1. Beginning with June 1, 1999, count forward 330 full days. Do not count the 15 days you spent in the United States. The 330th day, May 10, 2000, is the last day of a 12-month period.
2. Count backward 12 months from May 10, 2000, to find the first day of this 12-month period, May 11, 1999. This 12-month period runs from May 11, 1999, through May 10, 2000.
3. Count the total days during 1999 that fall within this 12-month period. This is 235 days (May 11, 1999--December 31, 1999).
4. Multiply $74,000 by the fraction 235/365 to find your maximum exclusion for 1999 ($47,644).

You figure the maximum exclusion for 2000 in the opposite manner:

1. Beginning with your last full day, September 29, 2000, count backward 330 full days. Do not count the 15 days you spent in the United States. That day, October 21, 1999, is the first day of a 12-month period.
2. Count forward 12 months from October 21, 1999, to find the last day of this 12-month period, October 20, 2000. This 12-month period runs from October 21, 1999, through October 20, 2000.
3. Count the total days during 2000 that fall within this 12-month period. This is 294 days (January 1, 2000--October 20, 2000).
4. Multiply $76,000, the maximum limit, by the fraction 294/366 to find your maximum exclusion for 2000 ($61,049).

Choosing the Exclusion

The foreign earned income exclusion is voluntary. You can separately choose the foreign earned income exclusion and the foreign housing exclusion by completing the appropriate parts of Form 2555. Your initial choice of the exclusions on Form 2555 or Form 2555-EZ generally must be made with a timely filed return (including any extensions), a return amending a timely filed return, or a late-filed return filed within 1 year from the original due date of the return (determined without regard to any extensions).

You can choose the exclusion on a return filed after the periods described above provided you owe no federal income tax after taking into account the exclusion. If you owe federal income tax after taking into account the exclusion, you can choose the exclusion on a return filed after the periods described above provided you file before IRS discovers that you failed to choose the exclusion. You must type or legibly print at the top of the first page of the Form 1040 "FILED PURSUANT TO SECTION 1.911-7(a)(2)(i)(D)." If you owe federal income tax after taking into account the foreign earned income exclusion and the IRS discovered that you failed to choose the exclusion, you must request a private letter ruling under Revenue Procedure 92-85 (as modified by Revenue Procedure 93-28).

Revenue procedures are published in the Internal Revenue Bulletin (I.R.B.) and in the Cumulative Bulletin (C.B.), which are volumes containing official matters of the Internal Revenue Service. You can buy the C.B. containing a particular revenue procedure from the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Once you choose to exclude your foreign earned income or housing amount, that choice remains in effect for that year and all later years unless you revoke it.

Revocation. You can revoke your choice for any tax year. You do this by attaching a statement that you are revoking one or more previously made choices to the return or amended return for the first year that you do not wish to claim the exclusion(s). You must specify which choice(s) you are revoking. You must revoke separately a choice to exclude foreign earned income and a choice to exclude foreign housing amounts.

If you revoked a choice and within 5 tax years again wish to choose the same exclusion, you must apply for IRS approval. You do this by requesting a ruling from the Internal Revenue Service.

Mail your request for a ruling in duplicate to: Associate Chief Counsel (International) Internal Revenue Service CC:INTL P.O. Box 7604 Ben Franklin Station Washington, DC 20044.

Because requesting a ruling can be complex, you may need professional help. Also, the IRS charges a fee for issuing these rulings. For more information, see Revenue Procedure 2000-1, which is published in Internal Revenue Bulletin No. 2000-1.

In deciding whether to give approval, the IRS will consider any facts and circumstances that may be relevant. These may include a period of residence in the United States, a move from one foreign country to another foreign country with different tax rates, a substantial change in the tax laws of the foreign country of residence or physical presence, and a change of employer.

Foreign tax credit. Once you choose to exclude either foreign earned income or foreign housing costs, you cannot take a foreign tax credit for taxes on income you can exclude. If you do take the credit, one or both of the choices may be considered revoked. See Credit for Foreign Income Taxes in chapter 5 for more information.

Earned income credit. You will not qualify for the earned income credit if you claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction for the year. For more information on this credit, see Publication 596.

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