ARE you a U.S. citizen or resident working in a foreign country? Did you declare your foreign income? Did you even file a tax return? Or are you hiding from the long and lovely arms of the IRS? Can the U.S. government reach you on the other side of the globe? Unfortunately, yes.
But is there a way not to pay federal income taxes on your earned income? Fortunately, yes!
Well, perhaps, there may not be a reason to hide. Perhaps, there’s a reason to declare your foreign income and not pay federal income taxes. You see, there’s this goodie called Foreign Earned Income Exclusion that allows you to earn $$$ and not pay federal income taxes. Too good to be true? Read on and learn.
1. You may exclude $101,300 for 2016 ($102,100 for 2017) of foreign earned income. To qualify for the exclusion, your tax home must be in a foreign country and you must meet either one of the following tests:
A. The bona fide residence test: You must be a resident of a foreign country for an uninterrupted period covering a complete tax year. You must show intention to establish residence even if there are temporary absences for short trips back to the U.S.
B. Physical presence test: This test is met if you are physically present in a foreign country for at least 330 full days during any consecutive twelve-month period.
2. Both of these tests may be waived if you leave the foreign country on account of civil unrest or adverse conditions similar to the conditions in Iraq, Iran, Egypt, Afghanistan, Pakistan, or Ukraine.
3. In addition to the foreign income exclusion, you may also exclude housing amounts such as rent, fair rental value of housing provided by your employer and included in your income, insurance, rentals of furnishings, and utilities (but not telephone).
4. You may elect the exclusion by filing Form 2555 or 2555 EZ with your income tax return.
5. Is excluded Foreign Earned Income subject to self-employment tax?
Yes, it is. Private Letter Ruling 8749061 states that foreign earned income is considered income from trade or business and is therefore subject to self-employment taxes (FICA and Medicare). Since then, IRS has issued regulations that income exempt from income tax are now subject to self-employment tax.
CAVEAT: Some states, including California does not have a similar exclusion so you have to pay state income taxes on your foreign income. But here’s a TIP: claim non-residency if you are abroad for 18 consecutive months and do not intend to return to the State. Take advantage of a new Safe Harbor Rule that allows individuals domiciled in California but are outside the State on an employment-related contract, unless you have intangible income in excess of $200,000 in any taxable year when employment-related contract is in effect or the principal purpose of absence in California is to avoid tax.
TIP: If you were outside the United States on April 15 (April 18 for 2017), the due date is automatically extended to June 15 without the need to file an extension form.
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Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in Pasadena, California.
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He has 50 years of experience in defending taxpayers audited by the IRS, FTB, EDD, BOE and other governmental agencies. He is publishing a book on his expertise – “HOW TO AVOID OR SURVIVE IRS AUDITS.” Our readers may inquire about the book or email tax questions at [email protected].