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Foreign Earned Income Exclusion Is a Boon for Expats

Aug 3rd 2015 at 11:16 PM

Affordable housing, cheaper food and lower medical costs often top the list when American expats start talking about their reasons for moving to a foreign country. What many who aspire to the expat lifestyle - or who are just beginning to live it -- may not realize is that Uncle Sam has a going-away present for you: lower taxes.

This gift that keeps on giving comes wrapped in the 72,000 pages of the US tax code, which contains a number of ways that Americans living abroad can pay less income tax, notably the foreign earned income exclusion. The foreign earned income exclusion does just what its name says: it excludes a portion of annual gross income for tax purposes, currently up to a maximum of $91,500.

This hefty tax break is available only to expats who can prove that they spent an entire tax year living outside the US. Plane tickets, overseas housing contracts and foreign tax receipts are the type of documents the IRS wants to see before granting the F.E.I. exclusion. The F.E.I. exclusion also only applies to what the IRS defines as earned income, not unearned income or variable income, two other IRS categories.

Examples of earned income are salaries, wages, commissions, bonuses, professional fees and tips. Unearned income, which is exempt from the F.E.I. exclusion, includes dividends, interest, capital gains, gambling winnings and social security benefits. Since the foreign earned income exclusion applies only to "foreign earned income" the IRS provides an unambiguous definition of this income category:

For example, income you receive for work done in Austria is income from a foreign source even if the income is paid directly to your bank account in the United States and your employer is located in New York City.

It all sounds so simple: move to a foreign country and pay less in US taxes. Many expats who claim the F.E.I. exclusion are turned down, however, too often because they simply misunderstood a key part of the rigorous qualifying criteria . Tax Planners CPA, a firm specializing in expat tax services, has a website that provides more detail about the foreign earned income exclusion and other tax policies affecting US taxpayers abroad.

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