Expat Tax Info from Barron HarperForeign Earned Income Exclusion and Economic Stimulus

By Barron Harper
www.taxbarron.com

Many countries in today’s international environment have enacted tax treaties designed to prevent double taxation. Beneficiaries of such treaties are typically residents who are subject to reporting and paying taxes on world-wide income to their foreign country of residence but who are subject to being taxed by one or more countries from where the income originated. American expatriates residing in a European country such as England, France, Portugal, Spain or Germany, for instance, are obliged to report all their income for foreign tax purposes. At the same time as US citizens, they must also report their world-wide income to the Internal Revenue Service (IRS).

While a tax treaty will delineate how two countries tax income flows, Americans living abroad can automatically exclude up to $85,700 in foreign earned income (FEI) on their 2007 tax return from US taxation. By reporting this income on their tax return and claiming the Foreign Earned Income Exclusion (FEIE), they are protected from the possibility of being taxed twice until their earned income exceeds the $85,700 threshold. But claiming FEIE is not automatic. There are three basic qualifications: tax home, residency and foreign income.

According to IRS, tax home is the locality where one carries on a business or employment regardless of family residence. Nowadays it is not so uncommon for an American expatriate to conduct business over the Internet from his European family home with occasional visits in the US with one or more clients. Where is his tax home? The distinction is important because the IRS can deny the American tax filer’s FEIE while Portugal or Spain taxes US source earnings. In addition, the Service can also deny any deductions the filer may claim for lodging and meals while he or she does business with clients stateside.

Americans living abroad can qualify for residency under the bona fide or physical presence tests. The former requires that the taxpayer live in one or more foreign countries for an uninterrupted period that includes an entire tax year. If the foreign tax authorities determine that you are not subject to their tax laws or you are on temporary assignment, you will not qualify as a bona fide resident. Under the physical presence test, you must have been present in one or more foreign countries for 330 days during a 12-month period.

Having met the tax home and residency requirements residing abroad, your income can therefore be considered foreign earned. Perhaps perversely, a source of this income can be the United States. The income must have been earned and includes: salaries and wages, commissions, bonuses, professional fees and tips. It can also include business profits, rental income, royalties, scholarships, fellowships and certain non-cash benefits.

American expatriates can qualify for FEIE without reporting their earnings to the foreign tax authority, but under the physical presence test. While an American expatriate may risk not reporting his earnings to that authority, his failure to report does not disqualify him. Moreover there are countries that do not tax earnings of foreign residents, presenting an unparalleled opportunity for a US citizen to avoid taxation on $85,700 of income by taking up residence in such a tax haven. But if the expatriate does not file a tax return to claim FEIE, he risks being disqualified from claiming FEIE should he be later audited.

In other words, if you have foreign earnings and do not report them on a US tax return – even if such earnings are your only source of income – the Internal Revenue Service can deny you the foreign earned income exclusion. As a result, not only would you be taxed on those earnings in the foreign country of residence but also in the United States.

Under the Economic Stimulus Act of 2008, tax filers may qualify for $300 to $1,200 from the government starting in May. There is a phaseout for Single filers with $75,000 or more of earnings and Married filers with $150,000 or more. To qualify you must have had $3,000 in earned income, which includes Social Security benefits, Railroad Retirement benefits, or certain veterans’ payments. Qualifying income is also income from wages, salaries, tips and self-employment. But foreign earned income excluded by the foreign earned income exclusion (FEIE) does not qualify with the possible exception of foreign earned income exceeding FEIE by $3,000; meaning that an expat only making foreign (i.e. non US) income would qualify earning $88,500 ($85,700 + $3,000).

Barron Harper is a member of Albo Euro-Consult (www.albo.org), a consortium of chartered accountants and legal experts on the European continent, and the National Association of Public Accountants (www.natptax.com). He specializes in US International Taxation for American expatriates. For more information please see - www.taxbarron.com.

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