If you paid foreign income taxes, or reside outside the U.S., you may have the opportunity to reduce your U.S. tax liabilities by taking the Foreign Tax Credit and/or the Foreign Earned Income Exclusion.
Foreign Tax Credit
If you paid or accrued foreign income taxes to a foreign country or U.S. possession and are subject to U.S. tax on the same income, you may be able to take a credit for those taxes to reduce your U.S. income tax burden. Generally, the following four tests must be met for any foreign tax to qualify for the credit:
The income tax must be imposed on you directly
You must have paid or accrued the tax
The tax must be legal and an actual foreign tax liability
The tax must be an income tax (or a tax in lieu of an income tax)
File Form 1116, Foreign Tax Credit, to claim the foreign tax credit if you are an individual, estate or trust, and you paid or accrued certain foreign income taxes to a foreign country or U.S. possession. Corporation file Form 1118, Foreign Tax Credit - Corporations, to claim a foreign tax credit.
Foreign Earned Income Exclusion
If you are a U.S. citizen or a resident alien of the United States and you live abroad, the U.S. taxes you on your worldwide income. However, you may qualify to exclude from tax up to an amount of your foreign compensation or self-employment income:
$ 100,800 for 2015
$ 101,300 for 2016
$ 102,100 for 2017
$ 103,900 for 2018
$ 105,900 for 2019
In addition, you can exclude certain foreign housing amounts (see below). You may also be entitled to exclude from income the value of meals and lodging provided to you by your employer. Finally, you may be able to take a tax credit if your foreign earnings are above these amounts.
To claim the foreign earned income exclusion, the foreign housing exclusion or the foreign housing deduction, you must have foreign earned income, your tax home must be in a foreign country, and you must meet either Bona Fide Residence Test or Physical Presence Test.
Bona Fide Residence Test for Foreign Earned Income Exclusion
You meet the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire, previous tax year. The bona fide residence test has a variety of rules that must be followed. You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for one year.
Physical Presence Test for Foreign Earned Income Exclusion
You meet the physical presence test if you are physically present in a foreign country or countries for 330 full days during any period of 12 consecutive months. The 330 qualifying days do not have to be consecutive. The physical presence test applies to both U.S. citizens and U.S. resident aliens.
Day Counting Rules for Physical Presence Test -
Reason. You can count days that you spent abroad for any reason. You do not have to be in a foreign country for work or employment purposes.
Full Day. A full day is a period of 24 consecutive hours, beginning at midnight. You must spend each of the 330 full days in a foreign country. When you leave the United States to go directly to a foreign country or when you return directly to the United States from a foreign country, the time you spend on or over international waters does not count toward the 330-day total.
Passing Over a Foreign Country. If, while traveling from the United States to a foreign country, you pass over a foreign country or its territorial waters before midnight of the day you leave, the first day you can count toward the 330-day total is the day following the day you leave the United States.
In United States while in Transit. If you are in transit between two points outside the United States and are physically present in the United States for less than 24 hours, you are not treated as present in the United States during transit.
Foreign Housing Exclusion or Deduction
The housing exclusion applies only to amounts considered paid for with employer-provided amounts, which includes any amounts paid to you or paid or incurred on your behalf by your employer that are taxable foreign earned income to you for the year (without regard to the foreign earned income exclusion). 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 include your reasonable expenses actually paid or incurred for housing in a foreign country for you and (if they lived with you) for your spouse and dependents. Consider only housing expenses for the part of the year that you qualify for the foreign earned income exclusion.
Please contact Brenner & Elsea-Mandojana, LLC for assistance with qualifying for the Bona Fide Residence Test, the Physical Presence Test and/or the Foreign Housing Exclusion or Deduction.
Updated June 2019
Foreign Tax Credit and Foreign Earned Income Exclusion