If you are living and working abroad you may be entitled to the Foreign Earned Income Exclusion. Here are some important facts about the exclusion:

1. The Foreign Earned Income Exclusion: United States Citizens and resident aliens who live and work abroad may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs.

2. The General Rules: To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country, otherwise known as foreign earned income. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.

3. The Exclusion Amount: The foreign earned income exclusion is adjusted annually for inflation. For 2008, the maximum exclusion is up to $87,600 per qualifying person.

4. Claiming the Exclusion: The foreign earned income exclusion and the foreign housing exclusion or deduction are claimed using Form 2555, which should be attached to the taxpayer’s Form 1040. A shorter Form 2555-EZ is available to certain taxpayers claiming only the foreign income exclusion.

5. Taking Other Credits or Deductions: Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered revoked.

For more information about the Foreign Earned Income Exclusion get Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad and the instructions for Form 2555. Both are available on the IRS Web site at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad (PDF 348K)
• Form 2555, Foreign Earned Income
• Form 2555-EZ, Foreign Earned Income Exclusion

Source: irs.gov

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AskTaxGuru - Free Tax Resource

Hi,

As a citizen living abroad in China, I wanted to know about the state level of the foreign earned income exclusion, specifically NY and NJ. Do either of these conform to Sec 911 and allow for the foreign earned income exclusion? I believe I read that NJ does not, but NY does, although I'm having trouble finding references to support these claims. Any advice would be greatly appreciated! I'm just trying to figure out if I need to pay any state taxes given that I was out of the country for the entire year and do not have to pay federal b/c of the FEIC and the fact that I paid taxes abroad in China. If the state does conform, then I can write off such payments similar to the federal return.

Thanks!

B

The United States taxes citizens and residents on their worldwide income. Citizens and residents living and working outside the U.S. may be entitled to a foreign earned income exclusion that reduces taxable income.[1] For 2010, the maximum exclusion is $91,500 per taxpayer.[2] In addition, the taxpayer may exclude housing expenses in excess of 16% of this maximum (i.e., $40.11 per day in 2010), but with limits. The exclusion is available only for wages or self employment income earned for services performed outside the U.S. The exclusion is claimed on IRS Form 2555 on an expat tax return.
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Earl Nunes

I am a sole proprietor. I meet the test for tax home and physical presence test for foreign earned income. I am a sole proprietor operating outside the US in a South American city. My situation isn’t easily defined because I am not paid by a company in South America for my work. I maintain a home office and a full time paid assistant in South America. The work done is operating a retail internet business which targets the US market and other countries. The work is done in South America by phone, fax and e-mail where I arrange to buy merchandise and services and pay other businesses in the US to do fulfillment work in the US. I have no employees in the US. Mailbox only in the US and credit card sales paying into business checking accounts are in the US. I also manage from my South American office the importing of goods buying from a South American business for import and sale in the US. I need to be in South America to oversee the South American manufacturer. My income results from mainly US and some foreign buyers of the work I do in South America. Is it foreign earned income? Do I qualify for the tax exemption.

“As a citizen living abroad in China, I wanted to know about the state level of the foreign earned income exclusion, specifically NY and NJ.”----> Sorry. You can’t claim your FEIC or foreign tax credit paid to foreign taxing authority on your state level tax return. For example, you can claim your foreign earned income exclusion credit and foreign tax credit only on your federal tax return. Assume that you paid your LTCG tax to Chinese taxing authority, then you can claim the capital gain tax, CG tax, credit on your federal return. You can’t claim CG tax credit paid to the foreign taxing authority on your state income tax return.So the CGtax is subject to DOUBLE TAXATION on th state level tax return.

My question is similar to what michael123 has posted. I have an LLC based in the US that I manage from Europe - an online business selling to US customers. I live in Europe, and do all of my work from outside of the US. Do I qualify for the foreign earned income exclusion or foreign housing deduction?

Thanks.

“ Do I qualify for the foreign earned income exclusion or foreign housing deduction? “--->It depends on the situation; as you can see, the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction are based on foreign earned income that you earn there in a foreign country in Europe as a US citizen or a US resident under either US Tax Law or US INS Rules.UNLESS you have your earned income ,i.e., Salaries and wages, Commissions, professional fees , or etc. NOT unearned income,i.e. Dividends, Capital Gains, Alimony, or etc. overseas, you can’t claim FEIE/FHE. As long as you have no earned income in Europe and do not pay income taxes to the foreign taxing authorities, you can claim neither FEIE nor Foreign tax credit on your US returns( on both federal and state returns).
I guess you can claim foreign tax credit on your US taxes paid to the IRS on your US income( from your LLC in US) on your tax return in the foreign country.

Thanks for your reply.It's really helpful for me.

I agree with @Samatg. These 5 points are really useful for Foreign Earned Income Exclusion.