Do you have to pay US Taxes on Foreign Income?
When you start working, the first question that you impose on yourself is about taxes. How much tax will I pay? What are the deductions? What relaxations can I apply for? The kind of taxes? Etc. are some of the questions that you ask yourself. Now, if you have foreign earned income, the major question is whether you will have to pay US taxes on that as well?
People who live outside of their country temporarily are called ex-pats. The income that they earn during their residence abroad falls under foreign earned income. There are different kinds of incomes. Some may fall under foreign income, while some may not. But what differentiates these incomes?
To answer this question, let us start by understanding what a foreign income is and the categories under which your foreign income may fall.
Foreign Earned Income
Foreign earned income is the income earned in a foreign country during a period when you either meet the bona fide residence test or the physical presence test. For the bona fide residence test, your residence in a country for the entirety of a tax year is tested. For the physical presence test, your residence in a foreign country for a full 330 days within one 12-month period is tested. As per the US government’s rules and regulations, every citizen living outside of the US will have to pay taxes on their foreign income. Hence, the levity on the taxes is based on citizenship and not on a person’s geographical location.
Before we learn about the foreign income categorization, let us see what income is excluded from that bracket.
Income that isn’t considered Foreign
The following are not included in the foreign earned income.
- Payment received as an employee of the US government.
- The amount included in the payment due to the employer’s contributions to a non-qualified annuity contract or non-exempt employee trust
- Payments received after the end of the year following the tax year during which one has performed the services that earned the income.
- Capital gains
- Gambling winnings
- Social security benefits
Now the Foreign income is categorized as Earned Incomes, Variable Income, and Non-Cash Income.
Let us understand these incomes in detail.
1. Earned Income
As the name suggests, this income implies the earnings made in a foreign country. This is the income that a person earns in return for providing services. Earned income includes the following incomes.
- Professional Fees
2. Variable Income
The income that depends on some factors to be considered as earned or unearned income, or both, is called variable income. The following are the incomes that come in this bracket.
- Business profits
3. Non-cash income
The benefits, like property or facilities provided to you by your employer while working in a foreign country, are considered non-cash income. This income includes the following incomes.
- Cost of living
- Cost of education
- Cost of moving
Now that we have learned about foreign income and its types, let us look at the exclusions and deductions that one can apply for their foreign earned income.
Criteria for Foreign earned income exclusion.
All American citizens have to file their taxes as per the guidelines set by the IRS. But there are few costs that one can be levied off by falling into foreign earned income exclusion criteria.
To qualify for exclusions and deductions, one must pass either the bona fide resident test or the physical presence test.
If you qualify for either of the tests, you can exclude your income from being texted up, up to a specific limit. The foreign earned income exclusion exempts you from paying US taxes on your foreign earned income.
In the year 2019, the limit for foreign earned income exclusion was $105,900. If your income is higher than this, you have to pay the taxes on the difference between these two values.
The Streamlined Foreign Offshore Procedures
If you do not fall under the category of foreign earned income exemption, you will have to file a federal tax return, as you normally would. The Streamlined Foreign Offshore Procedures is a tax amnesty program to help ex-pats who have filed their taxes late.
Deductions and Exclusions that an ex-pat may quality for
We have already seen the criteria for the applicability of deductions and exclusions in foreign earned income. Now let us look at the kind of deductions one can file for. These are the exclusions and deductions included in the United States tax code applied to citizens living in foreign countries.
The Foreign Housing Exclusion
This is the exclusion that can be applied to the employer-provided amounts. This is the amount paid by the employer to you, which is taxable foreign earned income for the given tax year. Employees are entitled to yearly foreign housing expenses. The exclusion amount is equal to the amount that is the difference between the yearly foreign housing expenses and your base housing amount. These amounts also include the reasonable expenses that are incurred in the housing of dependents and your spouse.
But these amounts do not include the expenses of a lavish lifestyle. The cost of furniture, accessories, or home-decor is also not included in this amount. The property that you may buy too does not fall under this amount. The foreign housing exclusion does not include your cost of the meals or the employer-provided lodging.
The important thing to note here is that you cannot claim less than the full housing exclusion amount once you choose this exclusion. You also cannot choose to take foreign tax credits or deductions on taxes on income that you have excluded once you choose to use foreign earned income. If this is not followed, your choice to exclude housing amounts can be revoked.
The Foreign Housing Deduction
The foreign housing deduction is the same as the foreign housing exclusion. The only difference is that the foreign housing deduction is applied to self-employed earnings.
Now we have seen what includes foreign earned income, the categories, and the criteria for the qualification into the exemption bar of foreign earned income. We hope this helps you whenever you need to look for taxation of your income.