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If You Live and Work Outside of the United States
The Foreign Earned Income Exclusion
Can Shield up to $95,100 from U.S. Tax

U.S. citizens and resident aliens who live and work outside of the United States may be eligible to shield up to $92,900 of 2011 earned income from U.S. tax.  The 2012 exclusion amount is $95,100.

Under Section 911 of the Internal Revenue Code, expatriate taxpayers who establish bona fide residence in a foreign country or who meet the requirements of what is called the physical presence test, are eligible for the foreign earned income exclusion.  To meet the physical presence test, a taxpayer must spend at least 330 days during any 365-day period working outside of the United States.

Income eligible for the foreign earned income exclusion includes salary and wages, commissions, bonuses and net income from business for the self-employed.

To claim the foreign earned income exclusion, file Form 2555 with your U.S. income tax return.

If you believe you will qualify for the foreign earned income exclusion for the current tax year, you can claim an exemption from federal income tax withholding up to the amount of your expected exclusion by filing IRS Form 673 with your employer.  You may obtain a copy of IRS Form 673 from the IRS web site..

Foreign Housing Exclusion

Taxpayers eligible for the foreign earned income exclusion may also be able to shield from tax some foreign living costs.  During 2006, Congress passed a law that effectively limits the amount of the foreign housing cost exclusion to $25,710 for taxpayers in much of the world who are eligible for the foreign earned income exclusion.  After an outcry from expats and companies with U.S. employees overseas, the IRS issued a list of "high cost localities" in which a larger housing cost exclusion will be allowed.  That list is contained in the IRS Instructions for Form 2555.

The Foreign Tax Credit Option May Save More U.S. Tax for Some Taxpayers

Taxpayers living and working overseas also have the option of claiming the foreign tax credit on their U.S. taxes for income taxes paid to a foreign country.  Using the foreign tax credit instead of the foreign earned income exclusion can sometimes help expat U.S. taxpayers benefit from other U.S. tax credits, depending on specifics of their financial situations.  For example, taxpayers living overseas who have three or more children may be able to claim a refundable, additional child tax credit if they claim the foreign tax credit rather than the foreign earned income exclusion on their tax return.

Social Security and Medicare Tax on Overseas Income

Whether an expat U.S. taxpayer is subject to U.S. Social Security and Medicare tax depends on the country in which he or she is working.  The United States generally levies Social Security and Medicare tax as well as income tax on earned income from foreign sources.  However, the United States has treaties with a number of countries, including Great Britain, Canada and Australia, that provide rules for coordinating payment of social insurance tax so that the taxpayer is only paying such tax to one country.

Extensions for Overseas Taxpayers (three options)

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