IRS Publication 593 highlights tax rules for U.S. citizens and residents going abroad

IRS has released Pub. 593, which discusses in general terms some provisions of U.S. federal income tax law that apply to U.S. citizens and resident aliens who live or work abroad (taxpayers abroad) and who expect to receive income from non- sources.

Tax treatment in general. The worldwide income of a taxpayer abroad is generally subject to U.S. income tax regardless of where he is living. He also is subject to the same income tax return filing requirements that apply to U.S. citizens or residents living in the U.S. However, a taxpayer abroad may qualify for one or more special tax breaks and may be able to:

• Exclude a limited amount of his foreign earned income.
• Either exclude or to deduct his housing amount. To claim these benefits, a taxpayer abroad must file a tax return and attach Form 2555, Foreign Earned Income. One who is only claiming the foreign earned income exclusion may be able to use the shorter Form 2555-EZ, Foreign Earned Income Exclusion.
• Claim a tax credit or an itemized deduction on his U.S. return for the foreign income taxes that he pays. Also, under tax treaties or conventions that the U.S. States has with many foreign countries, the taxpayer may be able to reduce his foreign tax liability.

Filing matters. The U.S. filing requirements for U.S. citizens and resident aliens in foreign countries generally are the same as those for citizens and residents living in the U.S.

Who must file. A taxpayer's age, filing status, gross income, and whether he can be claimed as a dependent by another taxpayer determines whether he must file a U.S. federal income tax return. In applying the gross income test, a taxpayer abroad must include all income received from the US as well as from foreign sources.

When to file. For a calendar year taxpayer living abroad, the due date for filing the income tax return for any year generally is April 15 of the following year. A taxpayer is automatically granted an extension to June 15 to file his return and pay any tax due if he is a U.S. citizen or resident alien and on the regular return due date:

• He is living outside the U.S. and Puerto Rico, and his main place of business or post of duty is outside the U.S. and Puerto Rico, or
• He is in military or naval service on duty outside the U.S. and Puerto Rico.

A taxpayer abroad must pay interest on any unpaid tax from the regular due date to the date he pays the tax.
Where to file. A taxpayer should file his return with the Internal Revenue Service Center, Austin, TX 73301-0215, if he claims either the foreign earned income exclusion or the foreign housing exclusion or deduction, uses an APO or FPO address, or lives in a foreign country or is a resident, for tax purposes, of a foreign country.

Foreign bank and financial accounts. A taxpayer who had any financial interest in, or signature or other authority over a bank account, securities account, or other financial account in a foreign country at any time during the tax year, may have to complete Treasury Department Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, and file it with the Department of the Treasury at the address listed on the form. It need not be filed if the combined assets in the account are $10,000 or less during the entire year, or if the assets are with a U.S. military banking facility operated by a U.S. financial institution.

Income earned abroad. A taxpayer may qualify for an exclusion from tax of a limited amount of income earned while working abroad. However, he must file a tax return to claim it. In general, foreign earned income is income received for services performed in a foreign country. A taxpayer also may be able to claim an exclusion or a deduction from gross income for a limited amount of his housing costs if his costs are more than a base amount. Generally, one will qualify for these benefits if his tax home is in a foreign country, or countries, throughout the period of bona fide foreign residence or physical presence and he is:

• A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,
• A U.S. resident alien who is a citizen or national of a country with which the U.S. has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
• A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

Tax home. One's tax home is the general area of his main place of business, employment, or post of duty where he is permanently or indefinitely engaged to work. A taxpayer is not considered to have a tax home in a foreign country for any period during which his abode is in the U.S. However, being temporarily present in the U.S., or maintaining a dwelling there, doesn't necessarily mean that one's abode is in the U.S..

Exclusion of foreign earned income. A taxpayer whose tax home is in a foreign country and who meets either the bona fide residence test or the physical presence test can choose to exclude from gross income a limited amount of his foreign earned income. His income must be for services performed in a foreign country during the period of foreign residence or presence, whichever applies. He cannot, however, exclude the pay he receives as an employee of the U.S. Government or its agencies.

One who claims the exclusion cannot claim any credits or deductions that are related to the excluded income. Also, for IRA purposes, the excluded income is not considered compensation and, for figuring deductible contributions when the taxpayer is covered by an employer retirement plan, the excluded income is included in his modified adjusted gross income.

A taxpayer whose tax home is in a foreign country and who qualifies under either the bona fide residence test or the physical presence test for the entire 2006 tax year can exclude up to $82,400 of his foreign earned income.

Housing amount. A taxpayer whose tax home is in a foreign country and who meets either the bona fide residence test or the physical presence test may be able to claim an exclusion or a deduction from gross income for a housing amount.

The housing amount is the excess, if any, of the individual's allowable housing expenses for the year over a base amount. The amount of allowable housing expenses is limited. Allowable housing expenses are the reasonable expenses (such as rent, utilities other than telephone charges, and real and personal property insurance) paid or incurred during the tax year by the taxpayer, or on his behalf, for his foreign housing and that of his spouse and dependents if they lived with him. The taxpayer can include the rental value of housing provided by his employer in return for his services.

A taxpayer's allowable housing expenses is limited to a percentage of the maximum foreign earned income exclusion amount (discussed above), figured on a daily basis, times the number of days during the year that he meets the bona fide residence test or the physical presence test. The percentage may vary depending on the foreign country where his tax home is located.

The base amount is 16% of the maximum foreign earned income exclusion amount, figured on a daily basis, times the number of days during the year that the taxpayer meets the bona fide residence test or the physical presence test.

A taxpayer can exclude (up to the limits) his entire housing amount from income if it is paid for with employer-provided amounts. A taxpayer who claims the exclusion cannot claim any credits or deductions related to excluded income.

A self-employed taxpayer can deduct his housing amount in arriving at adjusted gross income. However, the deduction cannot be more than his foreign earned income for the tax year minus the total of his excluded foreign earned income plus his housing exclusion. A taxpayer can carry over the unused part of his housing amount that cannot be deducted because of the limit to the following year only.

A taxpayer who claims the foreign earned income exclusion, the housing exclusion, or both, must figure the tax on his nonexcluded income using the tax rates that would have applied had he not claimed the exclusions.

Tax withholding and estimated tax. Generally, a taxpayer must pay U.S. tax on income earned abroad in the same way he pays tax on income earned in the U.S. Employees ordinarily will have tax withheld from their pay. If income tax is not withheld or if not enough tax is withheld, the taxpayer might have to pay estimated tax.

Foreign income taxes. In some cases, a taxpayer abroad can claim a credit or take a deduction for foreign income tax he pays. It is usually more advantageous to claim a credit rather than a deduction as a credit reduces U.S. tax liability, and any excess can be carried back and carried forward to other years. A deduction only reduces taxable income and can be taken only in the current year.

A credit is claimed on Form 1116 and generally cannot be more than the part of a taxpayers' U.S. income tax liability based on his taxable income from sources outside the U.S.

Tax treaty benefits. U.S. tax treaties or conventions with many foreign countries entitle U.S. residents to certain credits, deductions, exemptions, and reduced foreign tax rates. For example, most tax treaties allow U.S. residents to exempt part or all of their income for personal services from the treaty country's income tax if they are in the treaty country for a limited number of days. Treaties also generally provide U.S. students, teachers, and trainees with special exemptions from the foreign treaty country's income tax.