2020 Tax Planning for US Individuals Living Abroad - Deloitte
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2020 Tax Planning for US Individuals Living Abroad 00
2020 Tax Planning for US Individuals Living Abroad | Contents Contents Introduction 1 Chapter 1: Filing Requirements 2 Chapter 2: Special Foreign Exclusions 5 Chapter 3: Moving and Travel Expenses 14 Chapter 4: Principal Residence 15 Chapter 5: Alternative Minimum Tax 19 Chapter 6: Foreign Tax Credit 20 Chapter 7: Tax Equalization Policies 25 Chapter 8: Payroll Taxes and Special Situations 28 Appendix A: Key Figures 32 Appendix B: Sample of the Increased Section 911 Housing Exclusions that have been published by the IRS 34 Appendix C: 2020 US Federal Rates 35 Appendix D: Decisions Checklist 37 Appendix E: Forms and Statements Location Information 38 Appendix F: US Income Tax, Estate Tax, and Social Security Treaties and Agreements 39
2020 Tax Planning for US Individuals Living Abroad | Introduction
Introduction
US citizens and resident aliens living On December 22, 2017, President • Under prior law, moving expenses
abroad must file a US tax return and, Trump signed into law U.S. tax reform were excludable from income.
with several important exceptions, legislation (P.L. 115-97, commonly However, starting in 2018, these
must use the same forms and must referred to as the 2017 Tax Reform expenses are now includable in
compute tax by referring to the same Act). This bill represented the largest gross income.
tax rules as their stateside change to the U.S. tax system in over
• Alimony payments are no longer
counterparts. The main exception is 30 years. Though initially enacted in
deductible by the payer or
special rules that allow taxpayers to 2017, updates to this legislation are
includable in income by the
exclude all or part of their foreign ongoing. This guide considers the
recipient spouse if the divorce
earned income if they meet statutory provisions of the US tax reform
agreement was executed after
foreign residence or physical presence legislation. The following summarizes
December 31, 2018. Alimony
abroad tests. While these provisions some key changes effective for tax
payments made under divorce
may allow significant tax benefits, it is years 2018-2025:
agreements executed before this
important to remember that income
• Reduction of individual tax rates date are still eligible for treatment
earned abroad is frequently subject to
and revision of tax brackets. under the former rules.
foreign income taxes. In turn, credits or
deductions for these foreign taxes may • Increase of the standard
provide an additional measure of US deduction.
tax relief.
• Repeal of Personal exemptions.
This publication combines a general
• Combined deduction for state
explanation of the rules with an
and local income taxes and real
analysis of the tax issues and decisions
estate taxes is limited to $10,000.
to consider in preparing for, and
during the course of, a foreign • Foreign real property taxes are no
assignment. It is not intended to longer deductible.
answer all questions but only as an
• Mortgage interest is deductible
introduction to the many issues facing
only up to the interest on
US taxpayers living abroad. When
$750,000 (previously $1 million) of
specific advice is necessary or
acquisition indebtedness for
appropriate, consultation with a
indebtedness incurred on or after
professional adviser who specializes in
December 15, 2017.
expatriate taxation is strongly
recommended. • Interest on home equity
indebtedness is now only
Deloitte professionals in member deductible if the loan is used to
firms throughout the world are buy, build, or substantially improve
prepared to help US taxpayers abroad the home secured by the loan.
plan for their specific US and foreign
tax issues.
12020 Tax Planning for US Individuals Living Abroad | Chapter 1: Filing Requirements
Chapter 1: Filing Requirements
Who Must File? See Appendix A for current year While no formal request for this
While residing in foreign countries, US amounts. additional time is necessary, the
citizens and aliens considered US taxpayer’s return must include a
residents must continue to follow the Joint Versus Separate Returns statement that his or her tax home
standard rules for filing US income tax A US citizen or resident alien may file a and abode were outside the United
returns. A single taxpayer must file if joint return with a spouse. If the States and Puerto Rico on the regular
his or her gross income is in excess of spouse is a nonresident alien, due date. If a joint return is filed, only
the standard deduction, and married however, the couple can elect to file a one spouse must reside outside the
taxpayers who are entitled to file a joint return only if the nonresident United States in order to obtain the
joint return must file only if their spouse agrees to be subject to US tax automatic two month extension. This
combined gross income is at least as on his or her worldwide income for postponement of the due date does
high as the value of the standard the entire year. The election to be not relieve taxpayers from paying any
deduction for a married couple. A treated as a US resident may be interest due on the unpaid portion of
child who is claimed as a dependent advantageous as long as the their ultimate tax liability. The tax
on the parents’ return must file his or nonresident alien spouse has little or liability is still due on 15 April, and
her own return if the child’s unearned no income or has foreign-source interest is calculated from such date
or investment income exceeds certain income that is taxed at a higher rate (without extension) until payment is
amounts or if the child has any earned overseas than in the United States. The received by the Internal Revenue
income. See Appendix A for the use of a standard deduction for Service (IRS).
current year amounts. In determining married individuals filing jointly may
these amounts, all compensation also make the election beneficial. This An additional automatic extension of
earned abroad is included in gross election can later be terminated by four months, to 15 October, is
income; income that is excludable for death, revocation, or separation. In available by filing Form 4868,
other reasons, such as interest on tax- considering this election, the Application for Automatic Extension of
free municipal bonds, is not included nonresident spouse should also be Time To File US Individual Income Tax
in gross income. A tax return must be aware that, as a US resident, US Return. This extension will not excuse
filed even when the taxpayer’s foreign income tax treaty benefits that might the taxpayer from interest unless he
exclusions or deductions equal or otherwise be available could be lost. or she has paid at least 100% of his or
exceed gross income or when credits, her ultimate US tax liability by the time
If the election is made, the the extension is filed.
such as the foreign tax credit,
nonresident alien spouse is taxed on
completely eliminate US tax liability.
worldwide income and may be entitled If the due date for filing a return
Tax Rates to the special foreign earned income (including the automatic extension)
There are seven tax brackets. For exclusions. falls on a Saturday, Sunday, or national
2020, the tax brackets are: 10%, 12%, holiday, the due date is the next
When to File business day. A federal return mailed
22%, 24%, 32%, 35%, and 37%.
Tax returns for individuals are due on from a foreign country will be
The brackets are applied at different the fifteenth day of the fourth month accepted as filed on time if there is an
levels of income to each of the four following the close of the tax year (15 official postmark dated on or before
categories of taxpayers: single, married April for calendar-year taxpayers); the last day for filing, including
filing jointly, married filing separately, however, taxpayers who are US citi- extensions. Tax returns filed by a
and head of household. Children under zens or residents and whose tax private mail service must reach the IRS
age eighteen at year-end are taxed on home and abode are outside the office by the required due date;
unearned income in excess of certain United States and Puerto Rico on the however, returns filed with certain
amounts at the trust and estate tax regular due date have an automatic designated delivery services will be
bracket/rate. extension of two months (to 15 June considered to have been filed when
for calendar-year taxpayers) for filing.
22020 Tax Planning for US Individuals Living Abroad | Chapter 1: Filing Requirements
they are given to the delivery service. bona fide foreign residence test or The exclusions may be elected on a
See Appendix A for a list of currently physical presence test is expected to return that has been filed by either its
designated private delivery services. be met. regular or properly extended due
date, or on a timely filed amended
If a return is mailed after its original or The extension application is filed using return. They may also be elected on a
extended due date, it is not Form 2350, Application for Extension of late return, if the return is filed within
considered filed until actually Time To File US Income Tax Return, and one year of its original due date.
received by the IRS. may be filed with the IRS Center in
Austin, TX, or with an IRS office located The exclusions may also be elected on
Interest and Penalties on Balance in a major US embassy in another a late return filed after one year of its
Due country. A copy of the approved original due date, provided one of the
A properly filed extension relieves the application should be attached to the two following conditions is met:
taxpayer from a late filing penalty on return when it is filed to help reduce
the net tax due (4.5% per month for • The taxpayer owes no federal
IRS processing delays.
late filing plus .5% per month for late income tax after taking into
payment until the payment is made; Filing a US tax return without account the exclusion and files
the combined penalties may not claiming the special foreign Form 1040 with Form 2555,
exceed 25%). It does not, however, exclusions may require payment of US Foreign Earned Income, attached
eliminate the liability for interest that taxes, particularly when the taxpayer’s before or after the IRS discovers
is charged on any unpaid tax from the compensation has not been subject to that the taxpayer failed to elect the
original due date (without extension). US tax withholding. Although all or a exclusion.
See Example 1. portion of these taxes may be • The taxpayer owes federal income
refunded at a later date, it is usually tax after taking into account the
Alternative First-Year Filing advantageous to obtain the extension exclusion and files Form 1040 with
Procedures and file the return when the special Form 2555 attached before the IRS
Taxpayers who expect to qualify for the foreign exclusions can be claimed. discovers that the taxpayer failed
special foreign exclusions but are to elect the exclusion.
required to file a return before A taxpayer who is already entitled to a
qualifying, may either obtain an refund may consider it worthwhile to Taxpayers filing a late income tax
additional extension to defer filing file by the original due date and obtain return more than one year after its
until they qualify or file the return a refund. At a later date, he or she original due date under these rules
without claiming any foreign exclusion, may file an amended return (Form must note this on page one of their
pay any tax due, and file an amended 1040X) to obtain an additional refund Form 1040.
return to apply for a refund when the because of the special foreign
requirements are met. The IRS will exclusions. This situation may occur Estimated Tax
grant an extension until thirty days when a foreign assignment begins late Estimated tax payments are required
after the date on which either the in the year. if the amount of taxes due with the
return after withholding is expected to
exceed $1,000. No estimated tax
Example 1: payments are required if there was no
Taxpayer B is living in the US as of 15 April 20X2. On 10 April 20X2, he files a valid tax liability in the preceding year. See
Form 4868 extension for his 20X1 US income tax return. He then files the return on Appendix A for a schedule of current
15 September 20X2, and there is a $1,000 balance due. year payment due dates. If there is an
underpayment of the estimated tax
Because B filed his return prior to the 15 October extended due date, there is no and none of the exceptions to the
late filing penalty assessed. He will be subject to the late payment penalty and penalty applies (i.e., payments and
interest charges, calculated as follows (assume a 3% annual interest rate): withholding are greater than or equal
Late payment penalty: 0.5% x 5 months x $1,000 = $25 to 90% of current year tax; payments
and withholding are equal to 100% of
5 months counted from 15 April to 15 September
last year’s tax if adjusted gross income
Interest: 3% x 154 days / 365 days x $1,000 = $13 on last year’s return was less than or
154 days counted from 15 April to 15 September equal to $150,000, or payments and
32020 Tax Planning for US Individuals Living Abroad | Chapter 1: Filing Requirements
withholding are equal to 110% of last Assets. Form 8938 applies to certain When required, all accounts and
year’s tax if adjusted gross income is individuals holding an interest in financial assets located outside the US
greater than $150,000), a penalty is specified foreign financial asset(s) over require disclosure on Form 8938.
imposed at the interest rate that the applicable Form 8938 reporting
applies to assessments of tax. This threshold for the underlying tax-year. US Immigration Reporting
penalty is not generally deductible for Passport applicants and green card
income tax purposes. Interest is not “Certain individuals” generally include applicants must affirm that they have
charged for the late payment of US citizens and green card holders, as properly filed required US returns.
estimated tax. well as US aliens filing a resident US Failure to file this information carries a
income tax return. These individuals penalty. The purpose of this provision
It is important to note that alternative must attach Form 8938 to their US tax is to identify US persons who fail to
minimum tax must also be paid by return when they hold an interest in file US tax returns during their period
estimates. For a complete discussion specified foreign financial assets in of foreign residence.
of alternative minimum tax, see excess of the applicable reporting
Chapter 5. threshold. A US green card holder is generally
subject to US income tax on
Foreign Bank Accounts and “Specified foreign financial assets” may worldwide income during the entire
Specified Foreign Financial Assets include: time he or she holds the green card,
Foreign Bank Account Reporting even if residing outside the US.
• any depository, custodial, or other
(FBAR). The Department of the Complex tax statutes govern
financial account maintained by a
Treasury requires that every US citizen individuals who abandon lawful
foreign (non-US) financial
or resident alien with an interest in or permanent residence status. In
institution,
signature authority over foreign bank general, revoking a green card
accounts, securities, or other financial • any stock, security, financial subjects the individual to an
accounts that exceed $10,000 in instrument or contract issued by a expatriation exit tax regime which may
aggregate value at any time during the person other than a US person serve to tax the individual on their net
calendar year must report that held outside of a financial wealth. Consultation with a
relationship. The original deadline to file institution, and, professional adviser specializing in this
the FBAR will align with that of the area is strongly recommended when
• any separate interest in a foreign
individual income tax return (that is, 15 considering potential tax
entity not held in a US institutional
April). An automatic six-month extension consequences and other legal
account
is provided for anyone who fails to meet implications associated with
the original deadline. surrendering a green card.
The table below summarizes the Form
8938 reporting threshold for each type
The report is made electronically on
of individual classified as a specified
Form 114, Report of Foreign Bank and
person and is based on the aggregate
Financial Accounts (FBAR) and is filed
total value (in US dollars) of all specified
online and separately from the income
tax return through the BSA E-Filing foreign financial assets held on either
System website. Form 114 is for the last day of the tax year, or at any
disclosure purposes only and does not time during the tax year:
impact or serve to assess any amount
of tax on the return. However, failure to
file Form 114 may result in the
imposition of civil and criminal
penalties.
Specified Foreign Financial Asset
Reporting. Additional reporting of
specified foreign financial assets may
be required as part of the individual’s
tax return by attaching Form 8938,
Statement of Specified Foreign Financial
42020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
Chapter 2: Special Foreign Exclusions
Qualifying US taxpayers with a tax • Real and personal property
Example 2:
home outside the United States are insurance
entitled to elect two exclusions to Bill and Anne Smith are US citizens
• Certain occupancy and personal
reduce their US taxable income: the who qualify for the foreign earned
property taxes
foreign earned income and the housing income exclusion for all of 20X1.
cost exclusions. The exclusions are Assume the exclusion limitation for • Nonrefundable fees paid for
available only if the taxpayer maintains 20X1 is $100,000. Anne’s 20X1 securing the leasehold
a foreign tax home and meets either foreign earned income is $110,000
• Rental of furniture and household
the bona fide residence or physical and Bill’s is $50,000. In a joint
accessories
presence requirements explained on return, the Smiths may exclude a
pages 8–10. total of $150,000: $100,000 of her • Household repairs
earnings and the full $50,000 of his
Foreign Earned Income Exclusion • Residential parking
earnings. Anne is not allowed to
A qualifying taxpayer may elect to use the unused portion of Bill’s Qualifying housing expenses exclude
exclude foreign earned income up to exclusion. If they file separately, the following:
certain thresholds. The exclusion each would report the exclusion on
amount is indexed for inflation (see a separate return. • Cost of a house purchase,
Appendix A for current year improvements, and other costs
limitations). The exclusion is allowed in considered capital expenditures
full only if the taxpayer remains Housing Cost Exclusion
Qualifying taxpayers may make an • Cost of purchased furniture or
qualified during the entire tax year.
additional election to exclude from household accessories
Otherwise, the exclusion is reduced
proportionately for the number of days their gross income an amount equal • Domestic labor expenses (maids,
during the tax year that the taxpayer to certain housing costs, as long as gardeners, etc.)
does not qualify for the exclusion (see these costs are not considered
extravagant. A taxpayer is generally • Mortgage payments (both principal
Example 3 on page 6). Also, to be
and interest)
excluded, the foreign earned income subject to US income tax on the value
must be received no later than one of accommodations, meals, and most • Depreciation expenses
year following the tax year in which it is other living expenses paid for or
• The cost of a television pay
earned. Income deferred for more than provided by the employer. However, if
subscription
one tax year may not be excluded. these items are supplied for the
convenience of the employer and • Telephone charges
In the case of married persons who several other standards are met, they
• Certain other housing-related
each earn foreign income, a full are excluded from income.
expenses claimed elsewhere on
exclusion is available for each individual
The election to exclude housing costs the return
and is computed separately against
each individual’s foreign earned is available only to those who have
received foreign earned income as an In addition, if the taxpayer’s family is
income. See Example 2. This procedure
employee. Qualifying housing required to reside in a separate abode
applies even if the income is earned in
expenses include the following: overseas because the living conditions
a foreign country that is a community
in the location where the taxpayer is
property jurisdiction. If married • Rent employed are not safe or healthy for
individuals file separately, each may
• Fair rental value of housing the family, the reasonable housing
elect to take his or her foreign earned
provided in the foreign country by expenses of maintaining the second
income exclusion on a separate return
the employer foreign household may be eligible for
(see Example 2). (Also see “Foreign
the housing cost exclusion.
Earned Income” and “Foreign-Source • Utilities (other than telephone
Income,” pages 11-13) charges)
52020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
The housing cost exclusion is equal to cost location, an individual would (1) the exclusion. The spouse claiming the
the excess of the “qualifying housing take the lower of their actual housing exclusion may aggregate the couple’s
expenses” over a “base housing expenses or the high cost amount and housing expenses and subtract his or
amount.” The maximum housing (2) subtract the base housing amount her base-housing amount. Generally,
expenses allowable are capped at 30 discussed above. Appendix B provides the joint election is more beneficial,
percent of the maximum foreign a sample of housing exclusions for since the qualified housing expenses
earned income exclusion limitation. popular foreign assignment locations are reduced by only one base housing
The base housing amount is calculated around the world. For a complete list, amount.
as 16 percent of the maximum foreign please contact a professional tax
earned income exclusion discussed advisor. These amounts will be Foreign Housing Expense
above. Thus, the maximum housing updated annually by the IRS and other Deduction
exclusion allowable is the equivalent locations may be added as cost of The foreign housing expense
to 14 percent of the foreign earned living data on those locations are deduction is roughly equivalent to the
income exclusion and will increase as evaluated by the IRS. foreign housing cost exclusion,
the foreign earned income exclusion except that its use is restricted to self-
is adjusted upward for inflation. Married Taxpayers. Spouses residing employed individuals. Under these
together and filing joint returns may circumstances, the qualifying taxpayer
If the housing expenses are incurred in elect to compute their housing cost must deduct his or her housing cost
a year in which the employee begins or exclusion separately or jointly. If they amount. If the taxpayer has earned
completes the foreign assignment, the elect to calculate the exclusion income during the year as an
base housing amount is reduced separately, they must use a separate employee and as a self-employed
proportionately. Also, assuming both base housing amount. They may individual, the housing cost amount is
exclusions have been elected, the allocate expenses to either spouse or reported as an exclusion and as a
housing cost exclusion must be divide them as they wish. Married deduction in proportion to the two
calculated first (see Example 3). persons filing separately must income sources.
compute their housing cost amounts
The IRS has provided for certain individually and file separate returns. The deduction for the housing cost
exceptions to the limitation on amount is limited to the excess of the
"qualifying housing expenses" for If they elect to compute the housing taxpayer’s foreign earned income for
taxpayers living in high cost locations. cost amount jointly, the spouses must the year over the foreign exclusion. If
Accordingly, in calculating the amount also decide which spouse is to claim part of the housing cost amount
of foreign housing exclusion in a high
Example 3:
Smith qualified for the foreign exclusions during 20X1 from 1 January through 31 May. His total foreign income earned during the
qualifying period was $45,000, and he incurred $8,000 in qualified housing expenses. The number of days in the qualifying period
during 20X1 is 151, and this number serves as the basis for the apportionment of the foreign earned income exclusion and the
base-housing amount. Assume the foreign earned income exclusion limitation for 20X1 is $100,000.
Smith’s foreign exclusions would be calculated as follows:
Qualified housing expenses $8,000
Less: proportional base housing amount (151 / 365 × (100,000 * 16%)) $(6,619)
Housing cost exclusion $1,381
Foreign earned income exclusion (151/365 × $100,000) $41,370
Total foreign exclusions $42,751
62020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
cannot be deducted due to this 2. By qualifying for the physical of countries to which this exception
limitation, it may be carried forward to presence test (PPT) by being applies is strictly limited. A special
the succeeding tax year and deducted physically present in one or more provision denies the exclusions to
up to the amount of the limitation in foreign countries for 330 full days individuals violating federal travel
that year. The expenses may be in any consecutive twelve-month restrictions.
carried forward for only one year and period
may be taken into account only if the Foreign Tax Home
foreign earned income for the In many cases, only PPT is available to A prerequisite for either BFR or PPT is
following year exceeds both the US resident aliens (“green card” that the taxpayer must establish a
exclusion and the housing expenses holders) since they are, by nature, foreign tax home. A person’s tax home
incurred in that year (see Example 4). bona fide residents of the United is generally defined as the location of
States. The IRS can waive the time his or her principal place of business,
Qualifying for the Exclusions requirement needed to quality for rather than his or her abode or
A US citizen may qualify for the foreign either of the two tests if it is residence. A tax home normally must
earned income and housing determined that the individual had to be established and maintained solely
exclusions in two ways: leave a country because of a war or for reasons of employment. If a
other adverse living conditions that person has no principal place of
1. By establishing himself or herself
existed in that country. The IRS business, his or her tax home is
as a bona fide foreign resident
publishes every year a list of countries considered to be his or her regular
(BFR) for an uninterrupted period
for which this waiver applies. The list abode.
that includes an entire calendar
year, or
Example 4:
Smith’s 20X1 foreign earned income was $112,000, $21,000 of which is considered self-employment income. His qualified housing
expenses were $35,000. Assume the foreign earned income exclusion limitation for 20X1 is $100,000. Smith’s housing cost amount
exclusion and housing cost amount deduction would be calculated as follows:
Qualified housing expenses (limited to 30% of FEIE) $30,000
Less: base housing amount (16,000)
Housing cost amount $14,000
Housing cost amount exclusion:
Employment income
× Housing cost amount = Excludable housing cost amount
Total income
$91,000
× $14,000 = $11,375
$112,000
The housing cost deduction is $2,625 (the $14,000 housing cost amount less the $11,375 exclusion). However, since Smith’s foreign
earned income is exceeded by the combination of the $100,000 exclusion and the housing cost exclusion, a portion of this housing
cost deduction will be carried forward to 20X2.
Foreign earned income $112,000
Less: housing cost exclusion (11,375)
Less: foreign earned income exclusion (100,000)
Housing cost deduction in 20X1 $625
Housing cost amount deduction carried forward to 20X2 $2,000
72020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
A taxpayer is not considered to have a If a person meets the tests for Bona Fide Foreign Residence Test
foreign tax home for any period establishing a foreign tax home and To qualify as a bona fide foreign
during which his or her abode maintains his or her principal dwelling resident, a US citizen must reside in a
remains in the United States. For abroad, merely retaining ownership of foreign country for at least an entire
example, a taxpayer who lives in the former US residence will not cause tax year—for a calendar-year
Detroit but commutes daily to work in him/her to have a US abode for taxpayer, one beginning before 1
Windsor, Ontario, would ordinarily purposes of this rule. The result is January and ending after 31
have his or her tax home in Windsor generally the same even if the December of the same year. For
(principal place of business); individual’s spouse or dependents purposes of the BFR test, it is crucial
however, because the abode continue to reside in the US house. A that the taxpayer establish foreign
continues to be located in the United final determination would depend on residence before 1 January. Being on
States, he or she would be ineligible for all other facts and circumstances. the foreign company’s payroll is not
the exclusions. The IRS considers a sufficient; residency begins only when
new tax home to have been It should be noted that once a foreign the taxpayer arrives in the foreign
established if the taxpayer actually tax home has been established, any country with a genuine intent to
stays at the new place of employment reimbursements for housing or living establish a foreign residence (see
for at least one year. expenses in that location may not be Examples 5, 6, and 7).
treated as “away from home”
Equally important as the establishment business expenses. Therefore, it is not The BFR test requires that the taxpayer
of a foreign tax home and foreign place possible to claim the exclusions for a have an intent to reside in a foreign
of employment is the taxpayer’s period of time in which housing or country, as supported by the related
demonstration that he or she has living expense reimbursements are facts and circumstances. A person
established a foreign abode. The IRS, in taking place unless these who travels abroad for a temporary
Revenue Ruling 93-86, lists three reimbursements are included in the period of time for a specific purpose is
factors for determining whether a taxable compensation of the not usually considered a BFR. Merely
taxpayer has established a foreign employee. being in a foreign country for the
abode: required length of time is not
The lack of a precise definition of sufficient; the required intent must
1. the taxpayer’s family accompanies foreign tax home makes it very exist. In determining a taxpayer’s
him or her to live in the new important that taxpayers document intent to establish a foreign residence,
home, factors in their personal situation that US courts have considered factors
2. living expenses are not being support the establishment of a foreign such as the duration and nature of the
duplicated by maintaining an old tax home. As previously mentioned, a stay; whether the taxpayer’s US house
home, and foreign tax home is absolutely was sold, leased, or abandoned in
necessary to qualify for the exclusions. favor of one in the foreign country;
3. a preponderance of business
whether the taxpayer was
contacts are now at the new Foreign Country
accompanied by his or her family; the
location. The term foreign country for purposes
type of foreign visa obtained; the
of the physical presence and bona
nature and degree of the taxpayer’s
fide foreign residence tests includes
participation in the foreign community;
any territory under the sovereignty of the taxpayer’s command of the foreign
a government other than that of the language; and the location of the
United States. It includes the territorial
taxpayer’s economic interests. The fact
waters of the foreign country, as they
that a taxpayer intends to return to the
are defined under US laws, and the air
United States when the foreign
space over the foreign country. US
assignment is over does not prevent
possessions and territories are not
his or her qualification as a BFR (see
considered foreign countries, nor are Examples 6 and 7).
international waters.
82020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
becoming BFR of a foreign country is taxpayer must have established a
Example 5:
determined under all provisions of the foreign tax home and a foreign abode
Smith, a calendar-year taxpayer, treaty, including specific provisions as of that day. The time spent on or
arrived in the United Kingdom on 19 relating to residence or privileges and over international waters is not
January 20X1. He cannot qualify as a immunities. considered when counting the days a
BFR for 20X1 because he is a UK taxpayer was physically present in a
resident for only part of 20X1. Another determining factor may be foreign country unless the points of
However if he remains a UK resident the manner in which the taxpayer departure and arrival are both foreign
for all of 20X2, the benefits of BFR presents his or her status to the countries. During such a trip, a person
status can be retroactively applied foreign tax authorities. If the taxpayer may visit the United States and,
starting from 20 January 20X1. Should gives a statement to the foreign tax provided that the US presence is for
Smith relinquish his UK residence at authorities seeking exemption from less than twenty-four hours, the day in
any time during 20X2, he will be the foreign country’s tax on the the United States will still qualify as
unable to qualify for the exclusion grounds that the taxpayer is not a one of foreign physical presence.
under the BFR test for either year. resident of the foreign country, and if
the tax authorities of the foreign The intent to establish a foreign
country agree with the claim for residence is irrelevant for purposes of
Example 6: exemption, then the taxpayer will not the physical presence test. All that is
US citizen Smith moved to the UK qualify under the BFR test. required is that the taxpayer actually
with the intention of residing/working be present on foreign soil and be
A change of foreign residence from one able to claim that his or her tax home
there for an indefinite period of time.
foreign country to another does not and abode are outside the United
He plans to return to the US after his
affect BFR status. However, even States during the time of foreign
assignment is done. He rented his
temporary residence in the United presence. An individual may qualify
home in the US and took his home
States between foreign assignments under the physical presence test re-
furnishings with him to the UK. Smith
may terminate BFR status. gardless of whether he or she is
has the intent necessary to qualify as
Consequently, a taxpayer should subject to income tax in the foreign
a BFR.
maintain his or her foreign residence country.
status until becoming a resident in a
Example 7: new foreign country. (Note, however, Time spent in a foreign country in the
that a temporary period of US employment of the US government
Brown, a US citizen, leaves the residence status does not revoke the will count toward satisfaction of the
United States to work in Belgium for election to exclude foreign earned 330-day requirement. However,
thirteen months. She leaves her income. If the taxpayer moves abroad income earned from the US
family in the United States. Brown again, the election remains in effect.) government may not be excluded.
may or may not qualify for BFR.
Additional factors must be examined. The IRS frequently determines whether A taxpayer qualifies for the exclusions
a taxpayer qualifies as a BFR on the in any twelve-month period in which
Being considered a nonresident under basis of the facts reported on Form he or she has been physically present
foreign tax laws should not preclude a 2555 Foreign Earned Income. This form outside the United States for at least
taxpayer from applying the BFR test. must be filed with each tax return for 330 full days, and the taxpayer can
Also, the possession of a tourist visa, which the foreign exclusions are select the period. The objective is to
with its implications that one is not a claimed. have as many days as possible in a tax
resident of the country under local year fall within a twelve-month
Physical Presence Test qualifying period. The foreign tax
immigration laws, does not in itself
To qualify for the special foreign home and abode need not have been
cause one to fail the BFR test.
exclusion under the physical presence established throughout the entire
An income tax exemption provided in test, a US citizen or resident alien twelve-month period, but they do
a treaty or other international must be physically present in a foreign need to have been established for
agreement will not in itself prevent a country for 330 full days within any each day of the taxpayer’s 330 foreign
person from BFR status. Whether a consecutive twelve-month period. A days within that period.
treaty prevents a person from full day is a twenty-four-hour period
beginning at midnight. Also, the
92020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
As a result, for the first year of physical
Example 8:
presence, the qualifying period and
amount of excludable earned income Brown arrives in Belgium at 11:59 p.m. on 31 March 20X1. She remains there
are maximized as follows: Count back throughout 20X1 and 20X2. The earliest possible date which Brown can qualify for
twelve months from the 330th full day the foreign earned income exclusion is 330 days from the date of arrival, or 24
of physical presence abroad. Then February 20X2:
count the number of days between
1 April 20X1 + 330 foreign days = 24 Feb 20X2
the first day of that twelve-month
period and the end of the first year of Because Brown arrived in Belgium on 31 March 20X1 and remained outside the
foreign physical presence (see U.S. for the following 330 days the physical presence qualification test is met on
Example 8). 24 Feb 20X2.
Similarly, in the year the taxpayer There are 35 days remaining (i.e., 330 of 365) in the consecutive twelve month
terminates his or her foreign qualifying period which Brown can use to claim an earlier qualifying start date
assignment, the qualifying period may than 1 April 20X1 to maximize the number of qualifying days and the excludable
be extended beyond the date of amount in 20X1:
repatriation (see Example 9).
25 Feb 20X1 1 April 20X1 24 Feb 20X2
In summary, the foreign exclusions 35 U.S. + 330 foreign 365 days
may be increased in the first and last Days days =
years of an overseas assignment in
certain situations when the physical Brown’s qualifying period during calendar-year 20X1 is 25 February 20X1 through
presence, not the BFR, rule is used. 31 December 20X1, or 310 days.
This is the only exception to the rule
The maximum amount of the 20X1 earned income exclusion available is therefore
that taxpayers must maintain a
310/365, or 85% of the total annual exclusion amount, even though Brown was
foreign tax home throughout the
physically present in Belgium only 275 days during calendar-year 20X1.
period during which they qualify for
the special foreign exclusions.
Nevertheless, the foreign tax home
must be maintained throughout the
Example 9:
time the taxpayer counts as having
been physically present outside the Brown leaves Belgium on 1 July 20X2, having been physically present there for
United States. three consecutive years. To maximize the number of qualifying days and the
excludable amount in 20X2, Brown performs the following calculation:
The date physical presence ended is 30 June 20X2. Because Brown was physically
present outside the U.S. for 330 consecutive days prior to this date, the physical
presence ending date may be deferred 35 days after Brown leaves to 4 August
20X2:
5 Aug 20X1 30 June 20X2 4 Aug 20X2
330 foreign + 35 US days = 365 days
days
Brown’s qualifying period during calendar-year 20X2 is from 1 January 20X2
through 4 August 20X2, or 216 days. The maximum amount of the 20X2 earned
income exclusion available is therefore 216/365, or 59% of the total annual
exclusion amount, even though Brown was physically present in Belgium for only
181 days during calendar-year 20X2.
102020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
Foreign Camp Exclusion Either of the elections may also be differing tax rates, and other relevant
A taxpayer is generally required to made on an amended tax return if the facts and circumstances. IRS consent
include as taxable income employer- original return was filed on time. An is obtained by filing a request for a
provided housing and meals, as well amended tax return may be filed up to private letter ruling with the IRS
as most other in-kind three years following the extended National Office of Chief Counsel.
accommodations and allowances. One due date of the original return, as
exception to this rule is that an described on pages 2 to 3. Either Foreign Earned Income
employee may exclude from gross election may also be made on a late The basis for calculating the foreign
income the value of meals and lodging return filed after one year of its original exclusion is the taxpayer’s foreign
furnished by or on behalf of his or her due date as described on page 3. A earned income for the year. Earned
employer and for the employer’s taxpayer must make separate income generally includes all typical
convenience. This exclusion applies elections for the first year he or she compensation items received by an
only if the meals are furnished on the intends to exclude foreign earned employee in providing personal
employer’s business premises. In the income or qualified housing expenses. services to the employer. It includes
case of lodging, the employee is Each election may be made regardless all types of reimbursements,
required to accept it on the business of whether the other is made. allowances, commissions, and in-kind
premise of his or her employer as a payments associated with the
condition of employment. This It may not always be to the taxpayer’s provision of services, such as:
exception applies to employees inside advantage to elect one or both of the
• Incentive payments relating to
and outside the United States. exclusions. However, once elected, the
foreign assignments
exclusions must be applied in all later
A second, more liberal exception years unless they are revoked. The • Cost-of-living and housing
applies to employees stationed taxpayer may revoke either election in allowances
overseas. This exception provides that the current tax year or use an
• Market value of employer-provided
if a taxpayer resides overseas in amended return to revoke elections
housing, automobiles, financial
employer-provided housing qualifying made in previous years. However, this
services, and so forth
as a camp, the “on the business will also revoke the exclusion claimed
premises of the employer” in any intermediate year. • Tuition and home leave
requirement for excluding the value of
• US, state, and foreign income tax
lodging and meals is waived. If the taxpayer has never previously
allowances
elected to claim the exclusions (e.g.,
There are detailed rules under which first year on assignment), and chooses When a taxpayer operates as a sole
the meals and lodging must be not to claim the exclusion, that is not proprietor or professional, separate
provided in order for this exception to considered a revocation. rules apply to determine the amount
apply. of earned income, depending on
Should the taxpayer return to the whether the income generated is the
Electing the Exclusions United States and become a US result of personal services only, or a
The exclusions for foreign earned resident and then, a number of years combination of personal services and
income and for housing costs are later, move abroad again, the other capital investments. Where both
elective by the taxpayer. These elections would remain in effect. are included, the taxpayer may
elections must be made on a tax Should he or she decide in a later year consider up to 30% of the net profits
return with Form 2555 attached that to revoke either election, the as compensation for personal services
is filed no later than one year after the revocation would be binding for that qualifying for the exclusion. If capital is
original due date. This due date will be year and at least five subsequent tax not a factor in producing the overall
determined without respect to the years. A taxpayer can, however, reelect income, the total profit may be
extension of time to file. As a result, a either exclusion within this six-year considered earned income. In all
person may elect the exclusions for period by obtaining the IRS’ consent. cases, the amount paid for personal
20X1 on a 20X1 tax return filed no In deciding whether to consent to a services for a sole proprietor or
later than 15 April 20X3. This special- reelection, the IRS considers the professional must be considered
election deadline does not extend the period of the taxpayer’s US residence, reasonable, based on all of the
return’s due date or the time period whether the individual moved from circumstances of the situation.
for other provisions in the tax law. one foreign country to another with
112020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
Professional fees will generally In the arts and sciences, distinguishing exclusion cannot be increased by
constitute earned income, even if the compensation for personal services deferring receipt of foreign earned
taxpayer employs assistants who from income and from the transfer of income to a later year.
perform part or all of the services, artistic property (for example, a
provided that the patients or clients painting, book, or copyright) has often Also, to qualify for the exclusion, the
look to the taxpayer as the person been difficult. Since 1973, the IRS has income must not be received later
responsible for the services rendered. agreed that, at least for purposes of than the end of the year following the
the foreign earned income exclusion, year in which the services were
The IRS has ruled (contrary to at least a painter’s income from the sale of his performed. Consequently, payments
one court case) that, when or her paintings is earned income for the employee’s salary, expense
determining the earned income of a eligible for the exclusion. Furthermore, reimbursements, or tax equalization
member of a foreign partnership, the the IRS has extended its analysis to will not qualify for the exclusion if paid
foreign earned income exclusion is writers who transfer the property later than one year after the year in
applied to the partner’s share of the rights to their works to a publisher, which the services were performed
partnership’s gross income, rather and to composers who transfer the (see Example 10).
than to its net income. Furthermore, if copyrights to their musical
the partner’s income partly depends compositions. Consequently, the Foreign-Source Income
upon the services of the fellow To exclude the income, not only does
income that authors and artists derive
partners and employees both inside it have to be earned income, the
from transferring their work can be
and outside the United States, the taxpayer must also establish that the
earned income for purposes of the
partner’s income qualifying for the income is from a foreign source. The
earned income exclusion.
exclusion is based on a ratio of the source of compensation for the
partnership’s earned income from As a rule, employees of the US performance of personal services is
sources outside the United States to government are not eligible for the determined on the basis of the place
its total earned income. However, if special foreign exclusions. They where the services are performed.
the partnership agreement provides usually receive other exemptions for Factors such as the place from which
that a particular partner’s share of certain cost-of-living and foreign-area payment is made, the location of the
partnership income is derived solely allowances. employer, and the employee's home
from the profits of the partnership’s base are not relevant.
foreign branch, that partner can Foreign earned income does not
include pension or annuity income, The IRS has issued regulations that
consider his or her proportionate
income received as a “nonqualified address the proper method for
share of earned income to come from
annuity,” or income received from a determining the source of
foreign sources.
nonexempt trust. compensation for personal services
“Guaranteed payments” received by a performed inside and outside the
partner for services rendered outside Earned income qualifying for the United States. Generally, the
the United States are considered exclusion is deemed to have been regulations state that the source of
separately as compensation for received, for purposes of applying the compensation should be determined
services performed outside the United limitation, in the year in which the based on either a "time" or
States. services were performed. The "geographical" basis.
Example 10
Smith, who is entitled to the foreign earned income exclusion, earned $105,000 working outside the United States during 20X1.
Smith received payment for these services over a three-year period: $60,000 in 20X1, $15,000 in 20X2, and the remaining $30,000
in 20X3. Assuming he reports on the cash basis, Smith would report the income in the year it is received. Assume the exclusion
limitation for 20X1 is $100,000.
Since it was earned in 20X1, the maximum amount that may be excluded, provided that it is received no later than 31 December
20X2, is $100,000. Smith therefore would be allowed to exclude the $60,000 received in 20X1 and the $15,000 received in 20X2,
since this total—$75,000—does not exceed the $100,000 exclusion allowed for 20X1. Smith cannot exclude any of the 20X1
income received in 20X3, even though an additional $25,000 ($100,000 - $60,000 - $15,000) could have been excluded had it been
received in either 20X1 or 20X2.
122020 Tax Planning for US Individuals Living Abroad | Chapter 2: Special Foreign Exclusions
The time basis requires all • Moving expenses — Sourced on Treaty re-sourcing provisions may be
compensation other than certain the location of the employee’s new relied on for assignees on assignment
listed fringe benefits (listed below) to principal place of work, or if more to a treaty country that has a re-
be sourced based on days worked appropriate based on specific facts, sourcing provision to ensure optimal
during the tax year. This category of then the former place of work. sourcing of compensation, in cases in
income would include, among other which such re-sourcing is applicable
Alternatively, a "facts and
items, salary, incentive compensation and the treaty provisions of the treaty
circumstances" basis may be used if it
and taxable group term life insurance. are met. The treaty provisions
can be shown to the satisfaction of
This income would be sourced based generally require that the individual is
the Commissioner that this basis is
on the ratio of foreign workdays over a US citizen who is considered
more appropriate. This may occur, for
total workdays for the year. resident in the foreign country under
example, when an employee's
the treaty.
Compensation related to prior or compensation is tied to the
multiple tax years should be sourced performance of a specific action Income Tax Calculation After
on the time basis, applied to the entire rather than earned ratably over a Considering the Exclusions
period to which the compensation is specific time period. The tax calculation with the exclusions
attributable. For example, a bonus requires the taxpayer to determine his
Some states have also published rules
received in 20X2 related to 20X1 or her taxable income after all
on sourcing which need to be
performance would be sourced based deductions and exemptions and,
considered in applying state income
on 20X1 workdays. The IRS regulations before calculating the tax liability, the
tax withholding rules and preparing
prescribe that the time basis for stock taxpayer must add back the amount
state income tax returns.
option income is the time period of the exclusions, calculate the tax,
between grant date and vesting date, Treaty Re-sourcing of and then subtract an amount of tax
rather than between the grant date Compensation calculated as if the exclusion amount
and the exercise date. Treaty re-sourcing provisions allow was the taxable income. An example
certain taxpayers to re-source US.- of the tax calculation follows:
The geographic basis sources income
source income as foreign.
received in the form of certain fringe
benefits based on the geographical
work location for which it relates. The Example 11
regulations list certain fringe benefits Married Filing Joint, No children 20X1
that should be sourced geographically, Assume for 20X1 that the foreign earned income exclusion
and set forth the following sourcing limitation is $100,000, the maximum allowable housing exclusion is
provisions: $14,000 and the standard deduction is $24,000.
• Housing — Sourced on the Gross Income Including Wages $150,000
location of the individual’s principal Foreign Earned Income Exclusion (100,000)
place of work;
Housing Exclusion ($50,000 Qualified Housing Expenses) (14,000)
• Education — Sourced on the
Adjusted Gross Income $ 36,000
location of the individual’s principal
place of work; Less:
• Local transportation — Sourced Standard/Itemized Deductions (24,000)
on the location of the individual’s Taxable Income $ 12,000
principal place of work;
Calculation of Tax
• Tax reimbursements — Sourced
Taxable Income $ 12,000
on the location of the jurisdiction
that imposed the tax; Plus: Exclusions 114,000
• Hazardous or hardship duty pay — Tax Base $126,000
Sourced based on the duty zone Tax Calculation $ 19,599
for which the fringe benefit was
Less: Tax on Exclusions 16,959
paid;
Net Tax Liability $ 2,640
132020 Tax Planning for US Individuals Living Abroad | Chapter 3: Moving and Travel Expenses
Chapter 3: Moving and Travel Expenses
Moving Expense Reimbursement exclusion in that year is based on the When a taxpayer’s employment away
Moving expense reimbursements will number of days the taxpayer resided from home is expected to last more
be included in gross income as abroad in the tax year of the move. than one year, the employment will be
compensation for services. Moving However, the moving expense treated as indefinite, as opposed to
expense reimbursements include any reimbursement is attributable entirely temporary, and the related travel
amount received, directly or indirectly, to the year of the move, as long as the expenses will be nondeductible. If the
by an employee from an employer as individual has a qualifying period of at employment away from home is
a payment for, or a reimbursement of, least 120 days in the year of the move. expected to last one year or less and
expenses for a move. during this period it is determined that
If the individual does not have a the assignment period will exceed one
Source of Moving Expense qualifying period of at least 120 days, year, the “away from home” provisions
Reimbursements. A reimbursement for he or she must attribute the moving no longer apply as soon as the intent
a move to a foreign country will expense reimbursement both to the to remain exceeds one year.
generally be considered foreign- year of the move and to the
source income and will therefore succeeding year, on the basis of the Thus, a person who works abroad but
qualify for the foreign earned income following ratio: maintains a US tax home while on a
exclusion. A reimbursement for moving temporary foreign assignment can
Number of qualifying days for
expenses incurred to return to the claim deductions for the cost of travel
year of move
United States will generally be and lodging, as well as 50% of the cost
considered US-source income, since it of meals and entertainment, related to
Total number of days in the year
is deemed to be paid for future his or her foreign (or US) business
services to be performed in the trips. By maintaining a US tax home,
Travel Expenses “Away from
United States. the person is not eligible for the
Home”
special foreign exclusions.
However, a reimbursement for the Deductions are allowed for un-
return move back to the United States reimbursed expenses of travel, lodging, If, on the other hand, the person
will be considered foreign-source and meals and entertainment, maintains a foreign tax home (and
income if it is made under a written provided that the amounts are maintains a foreign abode), he or she
agreement prepared before the move reasonable and necessary for the is eligible for the foreign exclusions
to the foreign country as an conduct of the taxpayer’s business. and can, in addition, claim similar
inducement for the move. The The expenditures cannot be “lavish or deductions for lodging, meals, and
agreement must state that the extravagant” under the circumstances. travel on business trips away from the
employer will reimburse the employee Travel and lodging expenses are foreign tax home. At times it may be
for moving expenses incurred in allowed only when the taxpayer is advantageous for a taxpayer to
returning to the United States temporarily away from his or her tax arrange his or her affairs in such a
whether or not the employee home. way that he or she continues to
continues to work for the same maintain a US tax home (and forgo
An employee’s reimbursed expenses
employer after returning to the United the foreign exclusions) to claim away
under a reimbursement or other
States. from home deductions for foreign
expense allowance arrangement with
business trips. This arrangement may
Attributing Moving Expense his or her employer should not be
be beneficial if it prevents foreign
Reimbursements. When an individual included in compensation, if the
residence status and the resulting
does not qualify for the foreign employee is required to substantiate
obligation to pay foreign income tax.
earned income exclusion for the the expenses.
entire tax year of the move, the
portion of the moving expense
reimbursement that qualifies for the
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