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Foreign Earned Income Exclusions and Deductions

Foreign Earned Income Exclusions and Deductions

Generally, United States citizens and resident aliens are taxed in the U.S. on their world-wide income. However, there are exceptions to this rule. A portion of your foreign earned income can be excluded from taxation in the U.S., and a deduction for foreign housing costs can offset that income if you have a tax home in a foreign country and are either: (i) a bona fide foreign resident, or (ii)physically present in the foreign country for 330 full days during any consecutive 12 month period.

For 2014, the foreign earned income exclusion allows up to $99,200 of foreign earned income to be excluded from your taxable income.

When determining whether or not you may qualify as a bona fide foreign resident, you will have to consider certain factors. What was your intention or purpose for the trip? What was the nature and length or your stay? To qualify, you must show the IRS that you were a resident in a foreign country or countries for an uninterrupted period that includes an entire tax year. These determinations are made on a case-by-case basis.

The housing exclusion applies only to amounts that were paid by your employer, which includes any amounts that were paid to you and/or paid or incurred on your behalf by your employer that are taxable foreign earned income to you for the year. The housing deduction applies only to amounts paid for with self-employment earnings.

Your housing amount is the total of your housing expenses for the year minus the base housing amount. The computation of the base housing amount is tied to the maximum foreign earned income exclusion. The amount is 16% of the maximum exclusion amount (computed on a daily basis), multiplied by the number of days in your qualifying period that fall within your tax year. Housing expenses do not include expenses that are lavish or extravagant, the cost of buying property, purchased furniture or accessories and improvements and other expenses that increase the value or appreciably prolong the life of your property.

Also, for purposes of determining the foreign housing exclusion or deduction, your housing expenses eligible to be considered in calculating the housing cost amount may not exceed a certain limit and may vary depending upon the location. Additionally, foreign housing expenses may not exceed your total foreign earned income for the taxable year.  Your foreign housing deduction cannot be more than your foreign earned income less the total of your foreign earned income exclusion, plus your housing exclusion.

It is important to note that although the foreign housing exclusion and/or deduction will reduce your regular income tax, they will not reduce your self-employment tax.

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