Exemptions, Deductions, and Credits

Topics

This chapter discusses:

• The rules concerning items related to excluded income,
• Exemptions,
• Contributions to a foreign charitable organization,
• Moving expenses,
• Contributions to individual retirement arrangements (IRAs),
• Taxes of foreign countries and U.S. possessions, and
• How to report deductions.

Useful Items You may want to see:

Publication

• 501   Exemptions, Standard Deduction, and Filing Information
• 514   Foreign Tax Credit for Individuals
• 521   Moving Expenses
• 523   Selling Your Home
• 590   Individual Retirement Arrangements (IRAs)
• 597   Information on the United States-Canada Income Tax Treaty

Form (and Instructions)

• 1116   Foreign Tax Credit
• 2106   Employee Business Expenses
• 2555   Foreign Earned Income
• 2555-EZ   Foreign Earned Income Exclusion
• 3903   Moving Expenses
• Schedule A (Form 1040)   Itemized Deductions
• Schedule C (Form 1040)   Profit or Loss From Business
• SS-5   Application for a Social Security Card
• W-7   Application for IRS Individual Taxpayer Identification Number

See chapter 7 for information about getting these publications and forms.

Items Related to Excluded Income

U.S. citizens and resident aliens living outside the United States generally are allowed the same deductions as citizens and residents living in the United States.

If you choose to exclude foreign earned income or housing amounts, 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 that are allocable to the excluded income. You can deduct only those expenses connected with earning includible income.

These rules apply only to items definitely related to the excluded earned income and they do not apply to other items that are not definitely related to any particular type of gross income. These rules do not apply to items such as:

• Personal exemptions,
• Qualified retirement contributions,
• Alimony payments,
• Charitable contributions,
• Medical expenses,
• Mortgage interest, or
• Real estate taxes on your personal residence.

For purposes of these rules, your housing deduction is not treated as allocable to your excluded income, but the deduction for self-
employment tax is.

If you receive foreign earned income in a tax year after the year in which you earned it, you may have to file an amended return for the earlier year to properly adjust the amounts of deductions, credits, or exclusions allocable to your foreign earned income and housing exclusions.

Example.   In 2001, you had $7,500 of deductions allocable to foreign earned income. If you excluded all of your $78,000 foreign earned income in 2001, you would not have been able to claim any of the $7,500 of deductions allocable to that excluded income. If you then receive a bonus of $10,000 in 2002 for work you did abroad in 2001, you cannot exclude it because it exceeds the foreign earned income exclusion limit in effect for 2001. (You have no housing exclusion.) But, you can file an amended return for 2001 to claim the $852 of your allocable deductions that are now allowable ($7,500 allocable deductions multiplied by $10,000 included foreign earned income over $88,000 total foreign earned income).

Exemptions

You can claim an exemption for your nonresident alien spouse on your separate return, provided your spouse has no gross income for U.S. tax purposes and is not the dependent of another U.S. taxpayer.

You can also claim exemptions for dependents who qualify under all the dependency tests. The dependent must be a U.S. citizen or national or a resident of the United States, Canada, or Mexico for some part of the calendar year in which your tax year begins.

Social security number.   You must include on your return the social security number (SSN) of each dependent for whom you claim an exemption. To get a social security number for a dependent, apply at a Social Security office or U.S. consulate outside the United States. You must provide original or certified copies of documents to verify the dependent's age, identity, and citizenship, and complete Form SS-5.

You do not need an SSN for a child who was born in 2002 and died in 2002. Attach a copy of the child's birth certificate to your tax return. Print Died in column (2) of line 6c of your Form 1040 or Form 1040A.

If your dependent is a nonresident alien who is not eligible to get a social security number, you must list the dependent's individual taxpayer identification number (ITIN) instead of an SSN. To apply for an ITIN, file Form W-7 with the IRS. It usually takes 30 days to get an ITIN. Enter your dependent's ITIN wherever an SSN is requested on your tax return.

Children.   Children usually are citizens or residents of the same country as their parents. If you were a U.S. citizen when your child was born, your child generally is a U.S. citizen. This is true even if the child's other parent is a nonresident alien, the child was born in a foreign country, and the child lives abroad with the other parent.

If you are a U.S. citizen living abroad and have a legally adopted child who is not a U.S. citizen or resident, you can claim an exemption for the child as a dependent if your home is the child's main home and the child is a member of your household for your entire tax year.

More information.   For more information about exemptions, see Publication 501.

Contributions to Foreign Charitable Organizations

If you make contributions directly to a foreign church or other foreign charitable organization, you generally cannot deduct them. Exceptions are explained under Canadian, Israeli, and Mexican organizations, later.

You can deduct contributions to a U.S. organization that transfers funds to a charitable foreign organization if the U.S. organization controls the use of the funds by the foreign organization, or if the foreign organization is just an administrative arm of the U.S. organization.

Canadian, Israeli, and Mexican organizations.   Under income tax treaties, you can deduct contributions to certain Canadian, Israeli, and Mexican charitable organizations. These organizations must meet the qualifications that a U.S. charitable organization must meet under U.S. tax law. The organization can tell you whether it qualifies. If you are unable to get this information from the organization itself, contact IRS at the address below.

You cannot deduct more than the percentage limit on charitable contributions applied to your Canadian, Israeli, or Mexican source income. If you or a member of your family is enrolled at a Canadian college or university, the limit does not apply to gifts to that school. For additional information on the deduction of contributions to Canadian charities, see Publication 597.

For more information on these treaty provisions, write to Internal Revenue Service, International Section, P.O. Box 920, Bensalem, PA 19020-8518.

Moving Expenses

If you moved to a new home in 2002 because of your job or business, you may be able to deduct the expenses of your move. Generally, to be deductible, the moving expenses must have been paid or incurred in connection with starting work at a new job location.

Requirements

You may be able to deduct moving expenses if your move meets the following requirements.

• Distance.
• Time.
• Closely related to the start of work.

Distance

The distance from your new job location to your former home must be at least 50 miles more than the distance from your old job location to your former home. If you did not have an old job location, your new job location must be at least 50 miles from your former home.

Time

You must work full time for at least 39 weeks during the first 12 months after you move. If you are self-employed, you must work full time for at least 39 weeks during the first 12 months AND for at least 78 weeks during the first 24 months after you move.

Retirees.   You can deduct your allowable moving expenses if you move to the United States when you permanently retire if your principal place of work and former home were outside the United States and its possessions. You do not have to meet the time test. The other requirements must be met.

Survivors.   You can deduct moving expenses for a move to a home in the United States if you are the spouse or dependent of a person whose principal place of work at the time of death was outside the United States and its possessions. The move must begin within 6 months after the decedent's death and must be from the decedent's former home outside the United States and its possessions in which you lived with the decedent at the time of death. You are not required to meet the time test. The other requirements must be met.

Closely Related to the Start of Work

Your move must be closely related, both in time and in place, to the start of work at your new job location.

Closely related in time.   In general, moving expenses you incur within 1 year from the date you first report to work at the new location are considered closely related in time to the start of work.

If you do not move within 1 year, you ordinarily cannot deduct the expenses unless you can show that circumstances existed that prevented the move within that time.

Example.   Your family moved more than a year after you started work at a new location. Their move was delayed because you allowed your child to complete high school. You can deduct your allowable moving expenses.

Closely related in place.   A move is generally considered closely related in place to the start of work if the distance from your new home to the new job location is not more than the distance from your former home to the new job location. A move that does not meet this requirement may qualify if you can show that:

1. A condition of employment requires you to live at your new home, or
2. You will spend less time or money commuting from your new home to your new job.

Deductible Expenses

If you meet the requirements discussed earlier and your expenses are reasonable, you can deduct certain moving expenses.

Reasonable expenses.   You can only deduct expenses that are reasonable for the circumstances of your move. The cost of traveling from your former home to your new one should be by the shortest, most direct route available by conventional transportation.

Reimbursements.   If you are reimbursed by your employer for allowable moving expenses, these reimbursements may have been excluded from your income. You cannot deduct moving expenses for which you were reimbursed by your employer unless the reimbursement was included in your income.

Deductible moving expenses.   Some of the moving expenses that you may be able to deduct include the reasonable costs of:

1. Moving household goods and personal effects (including packing, crating, in-transit storage, and insurance) of both you and members of your household. For foreign moves, costs of moving household goods and personal effects include reasonable expenses of moving the items to and from storage and storing them while your new place of work abroad is your principal place of work.
2. Transportation and lodging for yourself and members of your household for one trip from your former home to your new home (including costs of getting passports).

Members of your household.   A member of your household includes anyone who has both your former and new home as his or her home. It does not include a tenant or employee unless that person is your dependent.

Foreign moves.   A foreign move is a move in connection with the start of work at a new job location outside the United States and its possessions. A foreign move does not include a move back to the United States or its possessions.

Allocation of Moving Expenses

When your new place of work is in a foreign country, your moving expenses are directly connected with the income earned in that foreign country. If you exclude all or part of the income that you earn at the new location under the foreign earned income exclusion or the foreign housing exclusion, you cannot deduct the part of your moving expense that is allocable to the excluded income.

Also, you cannot deduct the part of the moving expense related to the excluded income if you move from a foreign country to the United States and all 3 of the following conditions apply.

• You are reimbursed for your move by your employer.
• You are able to treat the reimbursement as compensation for services performed in the foreign country.
• You choose to exclude your foreign earned income.

The moving expense is connected with earning the income (including reimbursements, as discussed in chapter 4 under Reimbursement of moving expenses) either entirely in the year of the move or in 2 years. It is connected with earning the income entirely in the year of the move if 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 the bona fide residence test or the physical presence test for at least 120 days during the year of the move, the expense is connected with earning the income in 2 years. The moving expense is connected with the year of the move and the following year if the move is from the United States to a foreign country. The moving expense is connected with the year of the move and the preceding year if the move is from a foreign country to the United States.

To figure the amount of your moving expense that is allocable to your excluded foreign earned income (and not deductible), you must multiply your total moving expense deduction by a fraction. The numerator (top number) of the fraction is the total of your excluded foreign earned income and housing amounts for both years and the denominator (bottom number) of the fraction is your total foreign earned income for both years.

Example.   You are transferred by your employer on November 1, 2001, to Monaco. Your tax home is in Monaco, and you qualify as a bona fide resident of Monaco for the entire tax year 2002. In 2001 you paid $6,000 for allowable moving expenses for your move from the United States to Monaco. You were fully reimbursed (under a nonaccountable plan) for these expenses in the same year. The reimbursement is included in your income. Your only other income consists of $14,000 wages earned in 2001 after the date of your move, and $80,000 wages earned in Monaco for 2002.

Because you did not meet the bona fide residence test for at least 120 days during 2001, the year of the move, the moving expenses are for services you performed in both 2001 and the following year, 2002. Your total foreign earned income for both years is $100,000, consisting of $14,000 wages for 2001, $80,000 wages for 2002, and $6,000 moving expense reimbursement for both years.

You exclude the maximum amount under the foreign earned income exclusion and have no housing exclusion. The total amount you can exclude is $92,822, consisting of the $80,000 full-year exclusion for 2002 and a $12,822 part-year exclusion for 2001 ($78,000 times the fraction of 60 qualifying bona fide residence days over 365 total days in the year). To find the part of your moving expenses that is not deductible, multiply your $6,000 total expenses by the fraction $92,822 over $100,000. The result, $5,569, is your nondeductible amount.

You must report the full amount of the moving expense reimbursement in the year in which you received the reimbursement. In the preceding example, this year was 2001. You attribute the reimbursement to both 2001 and 2002 only to figure the amount of foreign earned income eligible for exclusion for each year.

Move between foreign countries.   If you move between foreign countries, your moving expense is allocable to income earned in the year of the move if you qualified 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.

New place of work in U.S.   If your new place of work is in the United States, the deductible moving expenses are directly connected with the income earned in the United States. If you treat a reimbursement from your employer as foreign earned income (see the discussion in chapter 4), you must allocate deductible moving expenses to foreign earned income.

Storage expenses.   These expenses are attributable to work you do during the year in which you incur the storage expenses. You cannot deduct the amount allocable to excluded income.

Recapture of Moving Expense Deduction

If your moving expense deduction is attributable to your foreign earnings in 2 years (the year of the move and the following year), you should request an extension of time to file your return for the year of the move until after the end of the following year. By then, you should have all the information needed to properly figure the moving expense deduction. See Extensions under When To File and Pay in chapter 1.

If you do not request an extension, you should figure the part of the moving expense that you cannot deduct because it is allocable to the foreign earned income you are excluding. You do this by multiplying the moving expense by a fraction, the numerator (top number) of which is your excluded foreign earned income for the year of the move, and the denominator (bottom number) of which is your total foreign earned income for the year of the move. Once you know your foreign earnings and exclusion for the following year, you must either:

1. Adjust the moving expense deduction by filing an amended return for the year of the move, or
2. Recapture any additional unallowable amount as income on your return for the following year.

If, after you make the final computation, you have an additional amount of allowable moving expense deduction, you can claim this only on an amended return for the year of the move. You cannot claim it on the return for the second year.

Forms to file.   Report your moving expenses on Form 3903. Report your moving expense deduction on line 28 of Form 1040. If you must reduce your moving expenses by the amount allocable to excluded income (as explained later under How To Report Deductions), attach a statement to your return showing how you figured this amount.

For more information about figuring moving expenses, see Publication 521.

Previous | First | Next

Publication Index | 2002 Tax Help Archives | Tax Help Archives | Home