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What is the foreign earned income exclusion?

The foreign-earned income exclusion is a provision in the U.S. tax code that allows American expatriates to exclude a certain amount of their foreign-earned income from their U.S. taxable income. This exclusion is intended to prevent double taxation, as it excludes income that has already been taxed in a foreign country.

For Americans working abroad, the foreign-earned income exclusion provides a significant tax advantage. While they are required to report their earnings to the IRS, they have the opportunity to avoid paying federal income taxes on a portion of their income. As of 2016, the exclusion amount was just over $100,000, adjusted for inflation.

The rationale behind this exclusion is that expatriates are likely already paying taxes in the country where they are working. However, it is important to note that this is not always the case. In some situations, expatriates may not be subject to income taxes in their host country. Nevertheless, the exclusion remains available for those who do have tax obligations in a foreign jurisdiction.

Under the foreign-earned income exclusion, the first $100,000 (approximately, as of 2016) of foreign-earned income can be excluded from federal income taxes. In addition to this exclusion, expatriates may also be eligible for another exclusion for foreign housing amounts. The foreign housing exclusion allows individuals to exclude the housing costs they paid abroad with their foreign-earned income. The maximum amount for this exclusion is $30,000, although it can be higher for locations with high costs of living.

It is important to understand that any amount of foreign-earned income exceeding the exclusion limit will still be subject to federal income tax in the United States. The tax rates applicable to the remaining income will be based on the tax brackets that the individual would fall into if the entire amount of earnings were included. However, expatriates have the option to claim a tax deduction or tax credit for the taxes they have paid internationally on amounts above the exclusion limit.

The primary purpose of the foreign-earned income exclusion is to avoid double taxation. By excluding income that has already been taxed in a foreign country, American expatriates are able to reduce their overall tax liability. This provision is especially beneficial for individuals who earn a significant portion of their income abroad and have substantial tax obligations in their host country.

To qualify for the foreign-earned income exclusion, individuals must meet certain criteria. Only U.S. citizens or resident aliens are eligible to claim this exclusion. In addition, there are specific requirements related to the individual's presence in a foreign country, such as the bona fide residence test or the physical presence test. It is crucial for expatriates to understand these qualifications and ensure that they meet the necessary criteria before claiming the foreign earned income exclusion.

The foreign-earned income exclusion serves as a valuable tax benefit for American expatriates. By excluding a portion of their foreign-earned income from U.S. taxation, expatriates can reduce their overall tax liability and prevent double taxation. It is important for individuals living and working abroad to familiarize themselves with the requirements and limitations of this provision to optimize their tax planning strategies.

Summary:
Americans working abroad must report their earnings to the IRS, but they are allowed to avoid paying federal income taxes on an amount adjusted for inflation, which is just over $100,000 as of 2016.

Americans working abroad often enjoy a few tax advantages. One of which is the Foreign Earned Income Exclusion. The reasoning is that they are probably paying some form of tax in the county in which they are working, even though this is sometimes not the case.

The worker must report his or her earnings to the IRS but is allowed to exclude the first $100,000 (approximately, as of 2016) from Federal income taxes. You can also take another exclusion for foreign housing amounts, which can be up to $30,000 or even higher for places with very high costs of living.

The remaining amount will be taxed at federal income tax rates for the bracket(s) that the individual would fall into in the United States if the entire amount of earnings were included. That is unless the worker files for a tax deduction or tax credit (they have a choice) for the taxes they have paid internationally on amounts above the exclusion amount.

What are Federal Tax Brackets?
What is a Foreign Tax Deduction?
What if I Want to Retire Abroad?
What is Form 4563: Exclusion of Income for Bona-Fide Residents of American Samoa?

Disclaimers and Limitations

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