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Tax Help Archives > 2004 > Publications > Publication 54
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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.
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.
Your U.S. source earned income is $11,100. Earned income was defined earlier as pay for personal services performed. Some types of income are not easily identified as earned or unearned income. Some of these types of income are further explained here. Income from a 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.
Income from a 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 Honduras. 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. 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:
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.
Scholarships and fellowships.
Any portion of a scholarship or fellowship grant that is paid to you for teaching, research or other services is considered
earned income if you
must include it in your gross income. If the payer of the grant is required to provide you with a Form W-2, these amounts
will be listed as wages.
 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, 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.
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.
Accountable plan.
An accountable plan is a reimbursement or allowance arrangement that includes all three of the following rules.
Reimbursement of moving expenses.
Earned income may include reimbursement of moving expenses. You must include as earned income:
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 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.
Example. You are a U.S. citizen working in the United States. You were told in October 2003 that you were being transferred to a foreign country. You arrived in the foreign country on December 15, 2003, and you qualify as a bona fide resident for the remainder of 2003 and all of 2004. Your employer reimbursed you $2,000 in January 2004 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 2003 and 2004. You figure the part of the reimbursement for services performed in the foreign country in 2003 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 365. The remaining part of the reimbursement is for services performed in the foreign country in 2004. This computation is used only to determine when the reimbursement is considered earned. You would include the amount of the reimbursement in income in 2004, 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 for the exclusion 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 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.
Example. You are a U.S. citizen employed in a foreign country. You retired from employment with your employer on March 31, 2004, 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 2004, 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 in 2004 (the year of the move), the includible reimbursement is considered pay for services performed in the foreign country for both 2004 and 2003. You figure the part of the moving expense reimbursement for services performed in the foreign country for 2004 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 (366). The remaining part of the includible reimbursement is for services performed in the foreign country in 2003. You report the amount of the includible reimbursement on your Form 1040 for 2004, the year you received it. 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.
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 15–A, Employer's Supplemental Tax Guide. 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.
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.
Amounts you do not include in income because of these rules are not foreign earned income. 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.
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:
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 was defined earlier in this chapter. 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. You may be able to exclude up to $80,000 of income earned in 2004. The table below shows the maximum amount excludable for other years.
For 2004, you cannot exclude more than the smaller of:
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 $160,000 for 2004. 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 2003 and 2004. You report your income on the cash basis. In 2003, you were paid $69,000 for work you did in Brazil during that year. You excluded all of the $69,000 from your income in 2003. In 2004, you were paid $93,000 for your work in Brazil. $12,000 was for work you did in 2003 and $81,000 was for work you did in 2004. You can exclude $11,000 of the $12,000 from your income in 2004. This is the $80,000 maximum exclusion in 2003 minus the $69,000 actually excluded that year. You must include the remaining $1,000 in income in 2004 because you could not have excluded that income in 2003 if you had received it that year. You can exclude $80,000 of the $81,000 you were paid for work you did in 2004 from your 2004 income. Your total foreign earned income exclusion for 2004 is $91,000 ($11,000 of the pay received in 2004 for work you did in 2003 and $80,000 of the pay you received in 2004 for work you did in 2004). You would include in your 2004 income $2,000 ($1,000 of the pay received in 2004 for the work you did in 2003 and $1,000 of the pay received in 2004 for the work you did in 2004). 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.
Example. You are paid twice a month. For the normal payroll period which begins on the first of the month and ends on the fourteenth of the month, you are paid on the fifteenth day of the month. For the normal payroll period that begins on the fifteenth of the month and ends on the last day of the month, you are paid on the first day of the following month. Because all of the above conditions are met, the pay you received on January 1, 2004, is considered earned in 2003. 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.
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 2002, 2003, and 2004. You report your income on the cash basis.
In 2002, you were paid $67,000
for work you did in Sweden that year and in 2003 you were paid $72,000 for that year's work in Sweden. You excluded all the
income on your 2002 and
2003 returns.
In 2004, you were paid $90,000; $80,000 for your work in Sweden during 2004, and $10,000 for work you did in Sweden
in 2002. You cannot exclude any
of the $10,000 for work done in 2002 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 2004.
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:
Example. You report your income on the calendar-year basis and you qualified under the bona fide residence test for 75 days in 2004. You can exclude a maximum of 75/366 of $80,000, or $16,393, of your foreign earned income for 2004. If you qualify under the bona fide residence test for all of 2005, 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, 2003, through September 29, 2004, except for 15 days in December 2003 when you were on vacation in the United States. You figure the maximum exclusion for 2003 as follows.
You figure the maximum exclusion for 2004 in the opposite manner.
The foreign earned income exclusion is voluntary. You can choose the exclusion by completing the appropriate parts of Form 2555. Your initial choice of the exclusion on Form 2555 or Form 2555-EZ generally must be made with one of the following returns.
You can choose the exclusion on a return filed after the periods described above if 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 if 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 may still be able to choose the exclusion. You must request a private letter ruling under Income Tax Regulation 301.9100-3 and Revenue Procedure 2004-1. 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. The I.R.B. is available on the Internet at www.irs.gov. You can buy the C.B. containing a particular revenue procedure from the Government Printing Office (online at http://bookstore.gpo.gov or call 1-866-512-1800). Once you choose to exclude your foreign earned income, that choice remains in effect for that year and all later years unless you revoke it. Foreign tax credit or deduction.
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.
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.
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 2004-1, which is published in Internal Revenue Bulletin No. 2004-1. 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. In addition to the foreign earned income exclusion, you can also claim an exclusion or a deduction from gross income for your housing amount if your tax home is in a foreign country and you qualify under either the bona fide residence test or the physical presence test. The housing exclusion applies only to amounts considered paid for with employer-
If you are married and you and your spouse each qualifies under one of the tests, see Married Couples, later. Your housing amount is the total of your housing expenses for the year minus a base amount. Base amount.
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, 2004, the GS-14 salary was $72,381 per year; 16% of this amount is $11,581 or $31.64 per day. To figure
your base amount if you are a
calendar-year taxpayer, multiply $31.64 by the number of your qualifying days during 2004. (See Part-year exclusion under Limit on
Excludable Amount, earlier.) Subtract the result from your total housing expenses to find your housing amount.
U.S. Government allowance.
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.
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:
Second foreign household.
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:
If you do not have self-employment income, all of your earnings are employer-provided amounts and your entire housing amount is considered paid for with those employer-provided amounts. This means that you can exclude (up to the limits) your entire housing amount. Employer-provided amounts.
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:
Choosing the exclusion.
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:
Foreign tax credit or deduction.
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 do not have self-employment income, you cannot take a foreign housing deduction. How you figure your housing deduction depends on whether you have only self-employment income or both self-employment income and employer-provided income. In either case, the amount you can deduct is subject to the limit described later. Self-employed — no employer-provided amounts.
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 35 of Form 1040. On the dotted line next to line 35, enter
the amount and write “Form
2555.”
Self-employed and employer-provided amounts.
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.
Example. Your housing amount for the year is $12,000. During the year, your total foreign earned income is $80,000, of which half ($40,000) is from self-employment and half is from your services as an employee. Half of your housing amount ($12,000 ÷ 2) is considered provided by your employer. You can exclude $6,000 as a housing exclusion. You can deduct the remaining $6,000 as a housing deduction subject to the following limit. Your housing deduction cannot be more than your foreign earned income minus the total of:
Carryover.
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.
If both you and your spouse qualify for the foreign housing exclusion or the foreign housing deduction, how you figure the benefits depends on whether you maintain separate households. If you and your spouse live apart and maintain separate households, you both may be able to claim the foreign housing exclusion or the foreign housing deduction. You can both claim the exclusion or the deduction if both of the following conditions are met.
If you and your spouse live together, both of you claim a foreign housing exclusion or a foreign housing deduction, and you file a joint return, you can figure your housing amounts either separately or jointly. If you file separate returns, you must figure your housing amounts separately. In figuring your housing amounts separately, you can allocate your housing expenses between yourselves in any proportion you wish, but each spouse must use his or her full base amount. In figuring your housing amount jointly, you can combine your housing expenses and figure one base amount. If you figure your housing amount jointly, either spouse (but not both) can claim the housing exclusion or housing deduction. However, if you and your spouse have different periods of residence or presence and the one with the shorter period of residence or presence claims the exclusion or deduction, you can claim as housing expenses only the expenses for that shorter period. Example. Tom and Jane live together and file a joint return. Tom was a bona fide resident of and had his tax home in Ghana from August 17, 2004, through December 31, 2005. Jane was a bona fide resident of and had her tax home in Ghana from September 15, 2004, through December 31, 2005. During 2004, Tom received $75,000 of foreign earned income and Jane received $50,000 of foreign earned income. Tom paid $10,000 for housing expenses, of which $7,500 was for expenses incurred from September 15 through the end of the year. Jane paid $3,000 for housing expenses in 2004, all of which were incurred during her period of residence in Ghana. Tom and Jane can choose to figure their housing amount jointly. If they do so, and Tom claims the housing exclusion, their housing expenses would be $13,000 and their base amount, using Tom's period of residence (Aug. 17 – Dec. 31, 2004), would be $4,335 ($31.64 × 137 days). Tom's housing amount would be $8,665 ($13,000 – $4,335). If, instead, Jane claims the housing exclusion, their housing expenses would be limited to $10,500 ($7,500 + $3,000) and their base amount, using Jane's period of residence (Sept. 15 – Dec. 31, 2004), would be $3,417 ($31.64 × 108 days). Jane's housing amount would be $7,083 ($10,500 – $3,417). If Tom and Jane choose to figure their housing amounts separately, then Tom's separate base amount would be $4,335 and Jane's separate base amount would be $3,417. They could divide their total $13,000 housing expenses between them in any proportion. If you are claiming the foreign earned income exclusion only, you can use Form 2555. In some circumstances you can use Form 2555-EZ to claim the foreign earned income exclusion. You must file one of these forms each year you are claiming the exclusion. If you are claiming either the foreign housing exclusion or the foreign housing deduction, you must use Form 2555. You cannot use Form 2555-EZ. Form 2555 shows how you qualify for the bona fide residence test or physical presence test, how much of your earned income is excluded, and how to figure the amount of your allowable housing exclusion or deduction. Do not submit Form 2555 or Form 2555-EZ by itself. Form 2555-EZ has fewer lines than Form 2555. You can use this form if all seven of the following apply.
If you claim exclusion under the bona fide residence test, you should fill out Parts I, II, IV, and V of Form 2555. In filling out Part II, be sure to give your visa type and the period of your bona fide residence. Frequently, these items are overlooked. If you claim exclusion under the physical presence test, you should fill out Parts I, III, IV, and V of Form 2555. When filling out Part III, be sure to insert the beginning and ending dates of your 12-month period and the dates of your arrivals and departures, as requested in the travel schedule. You must fill out Part VI if you are claiming a foreign housing exclusion or deduction. Fill out Part IX if you are claiming the foreign housing deduction. If you are claiming the foreign earned income exclusion, fill out Part VII. Finally, if you are claiming the foreign earned income exclusion, the foreign housing exclusion, or both, fill out Part VIII. If you and your spouse both qualify to claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you and your spouse must file separate Forms 2555 to claim these benefits. See the discussion earlier under Separate Households. Jim and Judy Adams are married and have two dependent children. They are both U.S. citizens and they file a joint U.S. income tax return. Each one has a tax home in a foreign country and each meets the physical presence test for all of 2004. They both can exclude their foreign earned income up to the limit. Jim is a petroleum engineer. For 2004, his salary, which was entirely from foreign sources, amounted to $71,000. In addition, his employer provided him an annual housing allowance of $18,000, which he used to maintain a rented apartment at his tax home in Country X for the period he was not working at remote drilling sites. At various times during the year, Jim worked at remote oil drilling sites. While he worked at these remote sites, his employer provided him lodging and meals at nearby camps. Satisfactory housing was not available on the open market near these drilling sites, and the lodging was provided in common areas that normally accommodated 10 or more employees and were not available to the general public. The fair market value of the lodging he was provided in these camps was $2,000, and the value of the meals was $1,000. After he made an adequate accounting, Jim was reimbursed by his employer for part of his travel expenses and other employee business expenses. Jim had $2,500 of unreimbursed employee business expenses for travel, meals, and lodging that were allocable to his foreign earned income. Because of adverse conditions in Country X, Judy and the children lived in Country Y where she worked as an executive secretary with a U.S. company. Her earnings from this job were $44,000. These earnings were subject to foreign income tax. The Adams family rented an apartment in Country Y for Judy and the children. They paid $1,000 a month rent, including utilities, or $12,000 for the year. The Adamses choose to treat the expenses for the apartment as those for a qualified second foreign household. They include the $12,000 Country Y housing expenses with Jim's $18,000 Country X housing expenses. This results in a larger total housing exclusion. Jim and Judy had taxable U.S. interest income of $7,500 for the year. The Adamses had no other income for the year and do not itemize deductions. The Adamses report their income and figure their foreign earned income exclusions and foreign housing exclusion, as shown on the accompanying filled-in forms. First, they list their income on the front of Form 1040. Their combined salaries, including Jim's $18,000 housing allowance, total $133,000. They enter this on line 7. They enter their interest income of $7,500 on line 8a. At this point, Jim will complete Form 2555 and Judy will complete Form 2555-EZ to figure their foreign earned income and housing exclusions. Jim's Form 2555.
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 $11,581 on line 30 and subtracts that amount to
arrive at a total foreign housing amount of $18,419 on line 31. He figures a housing exclusion of $18,419 on line 34.
Judy's Form 2555-EZ.
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 37 is $7,500 (their investment income), which does not qualify for exclusion.
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