As an American citizen or Green Card holder you are subject to U.S. taxation of worldwide income, no matter where you go. However, tax can generally be reduced or eliminated by:
● the foreign earned income exclusion,
● the housing exclusion, and
● the foreign tax credit.
The foreign earned income exclusion may be available if:
● You are a bona fide resident of a foreign country, or
● You are physically outside the U.S. for 330 days out of any 365 day period and your tax home is abroad.
As of tax year 2009, this entitles you to exclude up to $91,400 of earned income (i.e., income from working), per qualifying person (i.e., if you file a married joint tax return, then you are each eligible to exclude up to $91,400 of earned income). If your earned income is above $91,400, you may also be eligible for a housing exclusion (generally if you rent), and a foreign tax credit. Note: Income generated by work performed on business trips in theU.S. cannot be excluded.
My income was under $91,400, do I still need to file?
Yes. If your worldwide income is more than the standard deduction ($5,700 for single in 2010) plus personal exemption ($3,650 for single in 2010), then you are required to file a U.S. tax return.
How do I meet the bona fide resident test?
You meet the bona fide resident test if you are a bona fide resident of a foreign country (or of more than one foreign country, such as part of the year living in Country A and the other part in Country B) for an uninterrupted period that includes an entire tax year. Generally, you qualify if you have made the foreign country your home, and you pay taxes there. Other than being a resident for a full calendar year, there are no specific time restrictions. For instance, it is possible to be away from your foreign residence for months and still meet the test.
How do I meet the physical presence test?
To meet the physical presence test, you must be out of the U.S.for at least 330 days in a 365 day period and have your tax home in a foreign country. If you are out of theU.S. for 330 days between Jan. 1 and Dec. 31, you’re entitled to an exclusion of up to $91,400. However, you don’t have to use the calendar year. You could use any consecutive 365 day period (e.g.,July 1, 2009 -June 30, 2010), in which case the exclusion of $91,400 would be prorated. For instance, If you were to use the dates in the above example for the physical presence test on your 2009 tax return, you’d have 6 months in 2009 (with the rest being in 2010), and so you’d get a maximum exclusion of $45,700 in 2009 instead of $91,400. When you prepare your 2010 tax return, you are free to use a different period for the test, if you choose.
U.S. contractors working in Iraq and Afghanistan
Since you can only claim the physical presence test and many of you get extended leaves, you will have to pay special attention to the number of days you spend in theU.S. See above. To claim the full exclusion of your income (up to $91,400), please keep in mind that you can only be in theU.S.for 35 days in the tax year. To claim a prorated exclusion, you can only spend 35 days in theU.S.within any 365 day period. If you do not meet these rules, unfortunately your income cannot be excluded. Note that travel to other countries such as those inEuropeis still non-U.S. and would not jeopardize passing the test.
Generally, you will still be subject to self-employment tax (social security and Medicare taxes) even if you can exclude all of your earned income for income tax purposes. However, if there is a social security (totalization) agreement between the U.S. and the country in which you work, and you are covered by social security there on your self-employment income, you might be exempt from U.S. self-employment tax. Click here for social security agreements.
Can I contribute to a U.S. IRA Retirement Plan?
In order to contribute to an IRA, you must have earned income which is equal to or greater than your contribution. If you exclude your entire income in a tax year, and also make an IRA contribution, you have to pay an excise tax on that contribution, and the tax will be assessed again in each future tax year until the IRA contribution has been withdrawn. A way around this is to choose a 12-month period that will not give you a full exclusion of your income, and therefore leave you with enough earned income to meet the requirements to contribute to an IRA. Also, any days worked in the U.S. on your foreign assignment are not excludable, and so the income generated on those days may be enough to allow you to contribute to the IRA. This is something I can figure out for you when I do your return.
Should I file jointly with my foreign spouse?
When preparing your tax return, I will let you know if it is better to file jointly with your spouse. It often is if your income is above the $91,400 exclusion or you have substantial non-earned income. Your spouse’s foreign income (if any) would need to be reported, but he/she is also entitled to the foreign income exclusion.