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 under Waiver of Time Requirements, later.

See Figure 4–A and information on the following pages to determine if you are eligible to claim the exclusion or deduction.

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.

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.

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.

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.

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.

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:

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.

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.

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.

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.

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.

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.

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.

A full day is a period of 24 consecutive hours, beginning at midnight.

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.

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.

You can move about from one place to another in a foreign country or to another foreign country without losing full days. If any part of your travel is not within any foreign country and takes less than 24 hours, you are considered to be in a foreign country during that part of travel.

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.

There are four rules you should know when figuring the 12-month period.

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.

In addition to the types of earned income listed, certain noncash income and allowances or reimbursements are considered earned 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.

Earned income includes allowances or reimbursements you receive, such as the following amounts.

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.

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.

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.

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.

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.

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 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:

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.

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 you receive from the sale of paintings is earned income if you painted the pictures yourself.

If you receive fringe benefits in the form of the right to use your employer's property or facilities, the fair market value of that right is earned income. 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.

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.

An accountable plan is a reimbursement or allowance arrangement that includes all three of the following rules.

Earned income may include reimbursement of moving expenses. You must include as earned income:

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.

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 you qualify for the exclusion for a period that includes 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.

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 for the exclusion for a period that includes at least 120 days in the year of the move.

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 for the exclusion for a period that includes 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.

In this example, if you qualified under the physical presence test for a period that included at least 120 days in 2003, the moving expense reimbursement would be considered earned entirely in the year of the move.

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.

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.

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.

Publication 516 has more information for U.S. Government employees abroad.

Your family, for this purpose, includes only your spouse and your dependents.

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.

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.

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.

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.

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.

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:

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.

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.

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.

You cannot exclude income you receive after the end of the year following the year you do the work to earn it.

You qualify as a bona fide resident of Sweden for 2001, 2002, and 2003. You report your income on the cash basis. In 2001, you were paid $67,000 for work you did in Sweden that year and in 2002 you were paid $72,000 for that year's work in Sweden. You excluded all the income on your 2001 and 2002 returns.

In 2003, you were paid $90,000; $80,000 for your work in Sweden during 2003, and $10,000 for work you did in Sweden in 2001. You cannot exclude any of the $10,000 for work done in 2001 because you received it after the end of the year following the year in which you earned it. You must include the $10,000 in income. You can exclude all of the $80,000 received for work you did in 2003.

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.

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:

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.

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.

Once you choose to exclude foreign earned income, you cannot take a foreign tax credit or deduction for taxes on income you can exclude. If you do take a credit or deduction for any of those taxes, your choice to exclude foreign earned income may be considered revoked. See Publication 514 for more information.

If you claim the foreign earned income exclusion, you will not qualify for the earned income credit for the year. For more information on this credit, see Publication 596.

The base amount is 16% of the annual salary of a GS–14, step 1, U.S. Government employee, figured on a daily basis, times the number of days during the year that you meet the bona fide residence test or the physical presence test. The annual salary is determined on January 1 of the year in which your tax year begins.

On January 1, 2003, the GS–14 salary was $70,205 per year; 16% of this amount is $11,233 or $30.77 per day. To figure your base amount if you are a calendar-year taxpayer, multiply $30.77 by the number of your qualifying days during 2003. (See Part-year exclusion under Limit on Excludable Amount, earlier.) Subtract the result from your total housing expenses to find your housing amount.

You must reduce your housing amount by any U.S. Government allowance or similar nontaxable allowance intended to compensate you or your spouse for the expenses of housing during the period for which you claim a foreign housing exclusion or deduction.

Housing expenses include your reasonable expenses paid or incurred for housing in a foreign country for you and (if they live with you) for your spouse and dependents.

Consider only housing expenses for the part of the year that you qualify for the foreign earned income exclusion.

Housing expenses include:

Housing expenses do not include:

Ordinarily, if you maintain two foreign households, your reasonable foreign housing expenses include only costs for the household that bear the closer relationship (not necessarily geographic) to your tax home. However, if you maintain a second, separate household outside the United States for your spouse or dependents because living conditions near your tax home are dangerous, unhealthful, or otherwise adverse, include the expenses for the second household in your reasonable foreign housing expenses. You cannot include expenses for more than one second foreign household at the same time.

If you maintain two households and you exclude the value of one because it is provided by your employer, you can still include the expenses for the second household in figuring a foreign housing exclusion or deduction.

Adverse living conditions include:

These include any amounts paid to you or paid or incurred on your behalf by your employer that are taxable foreign earned income (without regard to the foreign earned income exclusion) to you for the year. Employer-provided amounts include:

You can choose the housing exclusion by completing the appropriate parts of Form 2555. You cannot use Form 2555–EZ to claim the housing exclusion. Otherwise, the rules about choosing the exclusion under Foreign Earned Income Exclusion also apply to the foreign housing exclusion.

Your housing exclusion is the lesser of:

If you choose the housing exclusion, you must figure it before figuring your foreign earned income exclusion. You cannot claim less than the full amount of the housing exclusion to which you are entitled.

Once you choose to exclude foreign housing amounts, you cannot take a foreign tax credit or deduction for taxes on income you can exclude. If you do take a credit or deduction for any of those taxes, your choice to exclude housing amounts may be considered revoked. See Publication 514 for more information.

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

If none of your housing amount is considered paid for with employer-provided amounts, such as when all of your income is from self-employment, you can deduct your housing amount, subject to the limit described later.

Take the deduction by including it in the total on line 34 of Form 1040. On the dotted line next to line 34, enter the amount and write “Form 2555.”

If you are both an employee and a self-employed individual during the year, you can deduct part of your housing amount and exclude part of it. To find the part that you can exclude, multiply your housing amount by the employer-provided amounts (discussed earlier) and then divide the result by your foreign earned income. This is the amount you can use to figure your foreign housing exclusion. You can deduct the balance of the housing amount, subject to the limit described later.

You can carry over to the next year any part of your housing deduction that is not allowed because of the limit. You are allowed to carry over your excess housing deduction to the next year only. If you cannot deduct it in the next year, you cannot carry it over to any other year. You deduct the carryover in figuring adjusted gross income. The amount of carryover you can deduct is limited to your foreign earned income for the year of the carryover minus the total of your foreign earned income exclusion, housing exclusion, and housing deduction for that year.

Each spouse claiming a housing exclusion must figure separately the part of the housing amount that is attributable to employer-provided amounts, based on his or her separate foreign earned income.

Each spouse claiming a housing exclusion must figure separately the part of the housing amount that is attributable to employer-provided amounts, based on his or her separate foreign earned income.

On Jim's Form 2555, Part IV, he lists his salary on line 19, his housing allowance on line 22e, and the fair market value of meals and lodging provided in camps by his employer on lines 21a and 21b. The entries on lines 21a and 21b are not shown as income on Form 1040. Jim enters the total of these two entries on line 25 of Form 2555.

Jim combines his housing expenses, $18,000, with the qualified expenses for the second household, $12,000, and enters total housing expenses of $30,000 on line 28. He puts a base amount of $11,233 on line 30 and subtracts that amount to arrive at a total foreign housing amount of $18,767 on line 31. He figures a housing exclusion of $18,767 on line 34.

Although Judy could claim a separate housing exclusion for her expenses rather than combining those expenses with Jim's housing expenses, she does not do so because she would have to reduce her expenses by a separate base housing amount. Also, her foreign earned income is less than the maximum foreign earned income exclusion, so claiming a separate housing exclusion would not result in any tax benefit.

Jim figures his foreign earned income exclusion in Part VII of Form 2555. Because his foreign earned income is more than the maximum exclusion of $80,000, he must reduce the income by the housing exclusion. The foreign earned income exclusion on line 40 is $70,233 ($89,000 – $18,767).

When Jim combines this exclusion of $70,233 with his housing exclusion of $18,767, he comes up with a total exclusion of $89,000 in Part VIII.

The Adamses cannot deduct any of Jim's unreimbursed employee business expenses because they are all allocable to excluded income. However, the Adamses are still entitled to the full standard deduction for a married couple filing jointly.

Judy completes a Form 2555–EZ to figure her foreign earned income exclusion. Her foreign earned income is less than the maximum excludable amount. On Judy's Form 2555–EZ, Part IV, she lists her salary on line 17. She figures an exclusion of $44,000 on line 18.

The Adamses enter their combined exclusions of $133,000 on line 21, Form 1040. They identify this item to the left of the entry space. Their adjusted gross income on line 35 is $7,500 (their investment income), which does not qualify for exclusion.