To claim the foreign earned income exclusion, the foreign housing
exclusion, or the foreign housing deduction, you must satisfy all
three of the following requirements.
- Your tax home must be in a foreign country.
- You must have foreign earned income.
- You must be either:
- 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. This
is fully explained at 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. 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 cannot claim the
foreign earned income exclusion, the foreign housing exclusion, or the
possession exclusion.
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. In figuring your U.S.
tax, you cannot deduct expenses allocable to income not subject to
tax.
Bona Fide Residence Test
You meet the bona fide residence test if you are a bona fide
resident of a foreign country or countries for an uninterrupted period
that includes an entire tax year. You can use the bona fide residence
test to qualify for the exclusions and the deduction only if you are
either:
- A U.S. citizen, or
- 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.
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 1 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 residence.
To meet the bona fide residence test, you must 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, England, 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 factors such as your intention,
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 either:
- Hold that you are not subject to their income tax laws as a
resident, or
- Have not made a final decision on your status.
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 arrived with your family in Lisbon, Portugal, on November 1,
1999. 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, 2000, you arrived
in the United States to meet with your employer, leaving your family
in Lisbon. You returned to Lisbon on May 1, and continued living
there. On January 1, 2001, you completed an uninterrupted period of
residence for a full tax year (2000), and you meet the bona fide
residence test.
Example 2.
Assume that in Example 1, you transferred back to the
United States on December 13, 2000. You would not meet 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 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, 1999,
through September 14, 2001. On September 15, 2001, you returned to the
United States. Since you were a bona fide resident of a foreign
country for all of 2000, you also qualify as a bona fide resident from
March 1, 1999, through the end of 1999 and from January 1, 2001,
through September 14, 2001.
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 Pakistan from October 1, 2000, through
November 30, 2001. On December 1, 2001, 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, 2001, 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 2000 or 2001,
you do not meet 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 Pakistan you were given a new
assignment to England. On December 1, 2001, you and your family
returned to the United States for a month's vacation. On January 2,
2002, you arrived in England for your new assignment. Because you did
not interrupt your bona fide residence abroad, you meet the bona fide
residence test.
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 days do not have to be consecutive. Any
U.S. citizen or resident can use the physical presence test to qualify
for the exclusions and the deduction.
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.
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 a 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.
Travel.
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 Kenya. You pass over western Africa at 11:00 p.m. on June 10
and arrive in Kenya 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 England by air at 11:00 p.m. on July 6 and arrive in
Sweden 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 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 New Zealand for a 20-month period from January 1, 2000,
through August 31, 2001, except that you spend 28 days in February
2000 and 28 days in February 2001 on vacation in the United States.
You are present in New Zealand 330 full days during each of the
following two 12-month periods: January 1, 2000 -- December 31,
2000, and September 1, 2000 -- August 31, 2001. 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 2002, the IRS will publish in the Internal Revenue
Bulletin a list of countries qualifying for the waiver for 2001 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 2001 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. Or, you can get a copy of the list
of countries by writing to:
Internal Revenue Service
International 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
To claim the foreign earned income exclusion, the foreign housing
exclusion, or the foreign housing deduction, you must have foreign
earned income.
Foreign earned income generally is income you receive for services
you perform during a period in which you meet both of the following
requirements.
- Your tax home is in a foreign country.
- You meet either the bona fide residence test or the physical
presence test.
To determine whether your tax home is in a foreign country, see
Tax Home in Foreign Country, earlier. To determine whether
you meet either the bona fide residence test or the physical presence
test, see Bona Fide Residence Test and Physical
Presence Test, earlier.
Foreign earned income does not include the following amounts.
- The value of meals and lodging that you exclude from your
income because it was furnished for the convenience of your
employer.
- Pension or annuity payments you receive, including social
security benefits (see Pensions and annuities,
later).
- Pay you receive as an employee of the U.S. Government. (See
U.S. Government Employees, later.)
- Amounts you include in your income because of your
employer's contributions to a nonexempt employee trust or to a
nonqualified annuity contract.
- Any unallowable moving expense deduction that you choose to
recapture as explained under Recapture of Moving Expense
Deduction in chapter 5).
- Payments you receive after the end of the tax year following
the tax year in which you performed the services that earned the
income.
Earned income.
This 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.
| Earned |
Unearned |
Variable |
|
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 allowances or reimbursements you receive,
such as the following amounts.
- Cost of living allowances.
- Overseas differential.
- Family allowance.
- Reimbursement for education or education allowance.
- Home leave allowance.
- Quarters allowance.
- Reimbursement for moving or moving allowance (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 working 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 Austria 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 Canada, 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)
× Number of days of work during the year for which payment was
made (240) × 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 proprietorships, partnerships, corporations, stock options,
pensions, annuities, royalties, rents, and fringe benefits--are
further explained here. Income from sole proprietorships 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.
Capital a factor.
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 Cameroon 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 work 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 stock you got by exercising an
option 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 the 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 reimbursement must be included in earned income.
These rules do not apply to the following individuals.
- Straight-commission salespersons.
- Employees who have arrangements with their employers under
which taxes are not withheld on a percentage of the commissions
because the employers consider that percentage to be attributable to
the employees' expenses.
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 generally 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, a portion of the reimbursement is considered earned
in the year of the move and a portion is considered earned in 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 2000 that you were being transferred to a foreign country.
You arrived in the foreign country on December 15, 2000, and you
qualify as a bona fide resident for the remainder of 2000 and all of
2001. Your employer reimbursed you $2,000 in January 2001 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 2000 and 2001.
You figure the part of the reimbursement for services performed in
the foreign country in 2000 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 366. The
remaining part of the reimbursement is for services performed in the
foreign country in 2001.
This computation is used only to determine when the
reimbursement is considered earned. You would report the amount you
include in income in 2001, the year you received it.
Move between foreign countries.
If you move between foreign countries, any moving expense
reimbursement that you must include in income will be considered
earned in the year of the move if you qualify under either the bona
fide residence test or the physical presence test for a period that
includes at least 120 days in the 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 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 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, 2001, 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 2001, 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 2001 and 2000.
You figure the part of the moving expense reimbursement for
services performed in the foreign country for 2001 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). The remaining part of the
includible reimbursement is for services performed in the foreign
country in 2000. You report the amount of the includible reimbursement
on your Form 1040 for 2001, the year you received it.
In this example, if you qualified under the physical presence test
for a period that included at least 120 days in 2001, the moving
expense reimbursement would be considered earned entirely in the year
of the move.
Storage expense reimbursements.
If you are reimbursed for storage expenses, the reimbursement is
for services you perform during the period of time for which the
storage expenses are incurred.
U.S. Government Employees
For purposes of the foreign earned income exclusion, the foreign
housing exclusion, and the foreign housing 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 exclusion or
deduction.
If you have questions about whether you are an employee or an
independent contractor, get Publication 15A, Employer's
Supplemental Tax Guide.
Panama Canal Commission.
U.S. employees of the Panama Canal Commission
are
employees of a U.S. Government agency. Because they are U.S.
Government employees, their foreign earned income does not include any
amounts paid to them by the Panama Canal Commission. 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.
American Institute in Taiwan.
Amounts paid by the American Institute in Taiwan are not foreign
earned income for purposes of the foreign earned income exclusion, the
foreign housing exclusion, or the foreign housing deduction. 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. Post
differentials are wages that must be included in gross income,
regardless of the Act of Congress under which they are paid.
More information.
Publication 516
has more information for U.S. Government employees
abroad.
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
- For the convenience of your employer.
- The lodging is furnished:
- On the business premises of your employer,
- For the convenience of your employer, and
- As a condition of your employment.
The terms used in this list are explained later.
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. They are considered
provided for your employer's convenience if there is a good business
reason for providing them, other than to give you more pay.
If the conditions listed earlier are met (including the convenience
of employer condition), do not include the value of the meals or
lodging in your income, even in the following situations.
- Your employer intends them as part of your pay.
- A law or your employment contract says that they are
provided as compensation.
On the other hand, if your employer provides meals or lodging to
you or your family 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 because they are not furnished for the convenience of your
employer.
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 the lodging is in a camp located in a foreign country, the camp
is considered part of your employer's business premises. 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 work, 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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