Foreign Earned Income Exclusion is a nice exemption that allows US Expats to avoid double taxation on their foreign earned income. As a US citizen or a US expat living abroad, you are supposed to disclose your worldwide income on your US tax return. Even if you are not staying in the US, you are required to disclose your global income and file your US tax return unless you meet the minimum filing requirements.
Dislosing your global income does not mean paying tax on this income twice. There are various provisions in the Income Tax Act of India, US and the DTAA (Double Taxation Avoidance Agreement) signed between India and US which allows you to take the benefit of certain provisions and not be liable to doube taxation.
Foerign Earned Income Exclusion (FEIE) is one such deduction. This deduction can be availed by filling out Form 2555. FEIE allows you to deduct upto a certain amount of your “foreign earned” income from your US tax return. Additionally you may also qualify to deduct certain foreign housing amounts.
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You need to satisfy the following conditions in order to qualify for the FEIE:
- You should have “foreign earned” income – As the name suggests, the income must be earned outside the US and it should be “earned income”. Earned income referrs to active income like salary or income from business or profession. Any other type of income such as bank interest, rental property income etc is known as passive income and therefore does NOT qualify for Form 2555.
2. Your tax home must be in a foreign country – Tax home is generally defined as your main place of business or employment.
3. You either qualify for the bona fide residence test or the physical presence test.
What is the bona fide resident test ?
To meet this test, you must be one of the following:
a. A U.S. citizen or a resident alien who is a citizen or national of a country with which the United States 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 (January 1–December 31)
Whether you are a bona fide resident of a foreign country depends on your intention about the length and nature of your stay. Generally, if you go to a foreign country for a definite, temporary purpose and return to the United States after you accomplish it, you are not a bona fide resident of the foreign country even if you stay there for more than 1 tax year. Refer to publication 54 for more details.
What is the physical presence test ?
To meet this test, you must be a U.S. citizen or resident alien who is physically present in a foreign country, or countries, for at least 330 full days during any period of 12 months in a row.
For the tax year 2015, the 12-month period on which the physical presence test is based must include 365 days, part of which must be in 2015. The dates may begin or end in a calendar year other than 2015.
If you satisfy the tests mentioned above, you will be allowed to exclude up to $ 100,800 from your salary income or business income on your US tax return.
Application of FEIE for business income is dealt with in another article.
