Tax on Foreign Income of US Citizens or Residents
Foreign Earned Income Exclusion
Individual US citizens and residents are taxed on their worldwide income. However,
IRC Sec. 911 provides that qualified taxpayer can elect to exclude foreign earned
income up to $87,600 from taxable income. (Read IRS Pub 54 for more details.) The qualifications are:
- A citizen or resident of the US who has been a bona fide resident of a foreign country
for an entire taxable year; or
- A citizen or resident of US who is present in a foreign country during at least
330 full days during any period of 12 consecutive months.
Additionally, the excludable income must be "earned income", meaning compensation
for personal services actually performed in the foreign country when the taxpayer
qualifies for bona fid resident or physical presence test.
Qualified taxpayers can elect to take the foreign earned income election by filing
Form 2555 with their tax return. However, foreign tax paid will be allocated on
total foreign source income, any foreign tax allocated to the excluded foreign earned
income cannot qualify a tax credit again. Therefore, taxpayers should consider taking
full foreign tax credit rather than the exclusion if the foreign effective tax rate
is higher than US.
Note: Dates spent in or income from Cuba, Iraq and Libya do not qualify. (Form 2555
Foreign Tax Credit
Generally, taxes paid to foreign governments are deductible in the same manner a
US state and local taxes on Schedule A. Alternatively, taxpayers can elect to claim
foreign income tax as a credit by filling Form 1116 annually. In most instances,
foreign tax credit saves more income tax than a deduction, and also avoids triggering
AMT. One caution is that any foreign tax allocated to excluded earned income is
not eligible as either deduction or credit.