What is the Foreign Income Exclusion?
The Foreign Income Exclusion allows U.S. citizens who are living in other countries to exclude a large portion of the income they receive from activities in those countries. For example, if a U.S. citizen is living in Russia and receiving earnings from a job in that country, he or she can exclude a certain amount of that income from taxation in the U.S. However, in order to claim this provision, the citizen must still file a U.S. tax return and notify the IRS that he or she is claiming the Foreign Income Exclusion. A citizen who simply fails to file a return will not be eligible for the exclusion.
What Income Qualifies for the Exclusion?
Along with filing a return each year, there are other qualifications that a citizen must meet in order to use the Foreign Income Exclusion. One qualification is that the income must be "earned," which means that it must arise from active employment as a company employee or from a self-employment venture. Citizens who are hired as independent contractors may also claim the Foreign Income Exclusion for their income. This provision does not apply to passive income such as investment earnings or sales of property.
Maximum Exclusion Amount
Another requirement for claiming the Foreign Income Exclusion is meeting the maximum threshold for the provision. Each year, the IRS sets a limit for how much income can be excluded from tax liability. In 2012, this amount was $95,100. So, a U.S. citizen who earned less than that amount could exclude his or her entire earned income from taxation in that year. A citizen who earned more than that amount could exclude up to $95,100 and then pay federal income tax on the amount that exceeded that limit.
Who Can Claim the Foreign Income Exclusion?
To use the Foreign Income Exclusion, individuals must also meet the citizenship requirement. This means that they must pass the "physical presence" test in regards to their residency in the foreign country. To meet the standards for the physical presence test, an individual must have lived in the foreign country for an entire tax year (January 1 through December 31) or have been in the foreign country for at least 330 days out of a consecutive 12-month period.
The Foreign Income Exclusion tax provision is a special consideration for those who are living and working outside of the U.S. Taxpayers who take advantage of this opportunity can save a significant amount on their annual tax bill.
