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

If you choose to exclude foreign earned income, you cannot deduct, exclude, or claim a credit for any item that can be allocated to or charged against the excluded amounts. This includes any expenses, losses, and other normally deductible items allocable to the excluded income. For more information about deductions and credits, see chapter 5.

Limit on Excludable Amount

You may be able to exclude up to $78,000 of income earned in 2001. The table below shows the maximum amount excludable for other years.

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

For 2001, you cannot exclude more than the smaller of:

1. $78,000, 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 and your spouse meet either the bona fide residence test or the physical presence test, you can each choose the foreign earned income exclusion. You do not both need to meet the same test. Together, you and your spouse can exclude as much as $156,000.

Paid in year following work. Generally, you are considered to have earned income in the year in which you do the work for which you receive the income, even if you work in one year but are not paid until the following year. If you report your income on a cash basis, you report the income on your return for the year you receive it. If you work one year, but are not paid for that work until the next year, the amount you can exclude in the year you are paid is the amount you could have excluded in the year you did the work if you had been paid in that year. For an exception to this general rule, see Year-end payroll period, later.

Example. You qualify as a bona fide resident of Brazil for all of 2000 and 2001. You report your income on the cash basis. In 2000, you were paid $65,000 for work you did in Brazil during that year. You excluded all of the $65,000 from your income in 2000.

In 2001, you were paid $91,000 for your work in Brazil. $12,000 was for work you did in 2000 and $79,000 was for work you did in 2001. You can exclude $11,000 of the $12,000 from your income in 2001. This is the $76,000 maximum exclusion allowable in 2000 minus the $65,000 you actually excluded that year. You must include the remaining $1,000 in income in 2001 because you could not have excluded that income in 2000 if you had received it that year. You can exclude $78,000 of the $79,000 you were paid for work you did in 2001 from your 2001 income.

Your total foreign earned income exclusion for 2001 is $89,000 ($11,000 of the pay received in 2001 for work you did in 2000 and $78,000 of the pay you received in 2001 for work you did in 2001). You would include in your 2001 income $2,000 of the pay you received in 2001 ($1,000 of the pay received in 2001 for the work you did in 2000 and $1,000 of the pay received in 2001 for the work you did in 2001).

Year-end payroll period. There is an exception to the general rule that income is considered earned in the year you do the work for which you receive the income. If you are a cash basis taxpayer, any salary or wage payment you receive after the end of the year in which you do the work for which you receive the pay 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 (December 31 if you figure your taxes on a calendar-year basis).
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 apply it to the year in which you earned it in figuring your excludable amount for that year. For example, a bonus may be based on work you did over several years. You determine the amount of the bonus that is considered earned in a particular year in two steps.

1. Divide the bonus by the number of calendar months in the period when you did the work that resulted in the bonus.
2. Multiplying the result of step 1) by the number of months you did the work during the 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 year following the year you do the work to earn it.

Example. You qualify as a bona fide resident of Sweden for 1999, 2000, and 2001. You report your income on the cash basis. In 1999, you were paid $65,000 for work you did in Sweden that year and in 2000 you were paid $70,000 for that year's work in Sweden. You excluded $65,000 on your 1999 federal income tax return and $70,000 for your 2000 return.

In 2001, you were paid $90,000; $80,000 for your work in Sweden during 2001, and $10,000 for work you did in Sweden in 1999. You cannot exclude any of the $10,000 for work done in 1999 because you received it after the end of the year following the year in which you earned it. That is, you received it after 2000. You must include the $10,000 in income. You can exclude $78,000 of the $80,000 received for work you did in 2001.

Community income. The maximum exclusion applies separately 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 year, you must adjust the maximum limit based on the number of qualifying days in the year. The number of qualifying days is the number of days in the year within the period on which you both:

1. Have your tax home in a foreign country, and
2. Meet either the bona fide residence test or the physical presence 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 the year.

Example. You report your income on the calendar-year basis and you qualified under the bona fide residence test for 75 days in 2001. You can exclude a maximum of 75/365 of $78,000, or $16,027, of your foreign earned income for 2001. If you qualify under the bona fide residence test for all of 2002, you can exclude your foreign earned income up to the full $80,000 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 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, 2000, through September 29, 2001, except for 15 days in December 2000 when you were on vacation in the United States. You figure the maximum exclusion for 2000 as follows.

1. Beginning with June 1, 2000, count forward 330 full days. Do not count the 15 days you spent in the United States. The 330th day, May 11, 2001, is the last day of a 12-month period.
2. Count backward 12 months from May 11, 2001, to find the first day of this 12-month period, May 12, 2000. This 12-month period runs from May 12, 2000, through May 11, 2001.
3. Count the total days during 2000 that fall within this 12-month period. This is 235 days (May 11, 2000 - December 31, 2000).
4. Multiply $76,000 by the fraction 235/365 to find your maximum exclusion for 2000 ($48,932).

You figure the maximum exclusion for 2001 in the opposite manner.

1. Beginning with your last full day, September 29, 2001, count backward 330 full days. Do not count the 15 days you spent in the United States. That day, October 20, 2000, is the first day of a 12-month period.
2. Count forward 12 months from October 20, 2000, to find the last day of this 12-month period, October 19, 2001. This 12-month period runs from October 20, 2000, through October 19, 2001.
3. Count the total days during 2001 that fall within this 12-month period. This is 292 days (January 1, 2001--October 19, 2001).
4. Multiply $78,000, the maximum limit, by the fraction 292/365 to find your maximum exclusion for 2001 ($62,400).

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 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 years again wish to choose the same exclusion, you must apply for IRS approval. You do this by requesting a ruling from the IRS.

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 2001-1, which is published in Internal Revenue Bulletin No. 2001-1.

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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