Foreign Earned Income and Housing Exclusion

If a taxpayer is a U.S. citizen or resident alien, the rules for filing income tax returns and paying estimated taxes are generally the same whether he or she is in the United States or abroad. Your worldwide income is subject to U.S. income tax, regardless of where you reside. U.S. citizens who are a resident abroad are often also subject to taxation from the foreign host country which can lead to double taxation unless a tax treaty applies. Qualifying taxpayers may reduce this tax burden by utilizing the foreign earned income exclusion, the housing cost exclusion or deduction, or the foreign tax credit.

A U.S. citizen living abroad is eligible for the foreign earned income exclusion and the foreign housing costs exclusion or deduction if his or her tax home is in a foreign country and the individual is either:

  • a U.S. citizen who meets the requirements of the bona fide residence test by having been 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 who meets the requirements of the physical presence test by being present in a foreign country or countries during at least 330 full days during any period of 12 consecutive months.

Foreign earned income and exclusion. Foreign earned income includes wages, salaries, professional fees and other amounts received as compensation for personal services actually rendered, including the fair market value of any noncash remuneration. U.S. citizens and resident aliens living abroad who have a foreign tax home and satisfy the bona fide residence test or the physical presence test can elect to exclude a portion of earned income ($108,700 for 2021) attributable to their days present in a foreign country in each tax year. An individual that elects the earned income exclusion may not claim a foreign tax credit for the foreign income taxes attributable to the excluded income. The choice between the foreign earned income exclusion and the foreign tax credit depends on which option more effectively reduces taxes.

Foreign tax home. Taxpayers may have a foreign tax home if they work is in a foreign country and expect to be employed in the foreign country for an indefinite, rather than temporary, period of time. Taxpayers do not have a foreign tax home if their abode remains in the United States (where they keep closer familial, economic, and personal ties) unless the taxpayer works in a Presidentially-declared combat zone in support of the Armed Forces of the United States.

Foreign housing exclusion or deduction. In addition to the foreign earned income exclusion, a U.S. citizen or resident alien living abroad may deduct or separately elect to exclude foreign housing costs from gross income ($15,218 for 2021). The calculation of the housing cost exclusion or deduction amount is determined using the reasonable housing expenses incurred during the tax year in excess of the federal employee base housing amount. Housing expenses include rent or the fair rental value of housing provided in kind by the employer, utilities (other than telephone charges), real and personal property insurance, occupancy taxes that may not otherwise be deductible, nonrefundable fees paid for securing a leasehold, rental of furniture and accessories, household repairs, and residential parking.

Please call the Crosslin tax team to discuss your situation and to review the U.S. individual income tax filing obligations for U.S. citizens and resident aliens living or working abroad and the tax benefits including exclusions or deductions that may be available. We are here to help!

Bona Fide Residence or Physical Presence Test

A resident alien is generally taxed by the United States on worldwide income, just like a U.S. citizen. A U.S. citizen or resident alien who earns income in a foreign country may also be taxed on that income by the foreign host country, which can lead to double taxation. Several provisions are intended to help mitigate this situation, including the foreign earned income exclusion and the housing exclusion or deduction.

To qualify for these tax benefits, a taxpayer must:

  • have a tax home in a foreign country,
  • have foreign earned income, and
  • be a U.S. citizen or a resident alien who meets the bona fide residence test or the physical presence test in a foreign country.

COVID-19 Travel Disruption Relief. The IRS has provided individuals and businesses with relief related to travel disruptions arising from the COVID-19 emergency. Under this relief,  of U.S. presence that are presumed to arise from travel disruptions caused by the COVID-19 emergency will not be counted for purposes of determining U.S. tax residency and for purposes of determining whether an individual qualifies for tax treaty benefits for income from personal services performed in the United States.

Tax Home. A tax home is generally the taxpayer’s regular place of business or employment. If the individual has more than one regular place of business, then the tax home is located at his or her principal place of business or employment. If the individual has no principal place of business because of the nature of the business, or because the individual is not engaged in a trade or business, his or her tax home is at the individual’s regular place of abode. The location of the abode is based on where the taxpayer maintains their family, economic and personal ties.

Foreign country. A foreign country includes any territory under the sovereignty of a government other than that of the United States. This excludes Antarctica or U.S. territories such as Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa.

Bona Fide Residence Test. To meet this test, an individual must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year (e.g., January 1 through December 31, for calendar-year taxpayers). During the period of bona fide residence in a foreign country, the taxpayer can leave the country for brief or temporary trips back to the United States or elsewhere for vacation or business. However, to keep their status as a bona fide resident of a foreign country, they must have a clear intention of returning from such trips, without unreasonable delay, to their foreign residence or to a new bona fide residence in another foreign country.

The determination of a bona fide resident is based on all the facts and circumstances. The Courts have considered the length of stay plus additional factors such as:

  • a taxpayer’s intention,
  • establishment of a home in a foreign country,
  • participation in social and cultural activities in a foreign community,
  • nature and duration of employment, and
  • reasons for temporary absences from the foreign home.

Physical Presence Test. To meet this test, the individual taxpayer must be physically present in the foreign country for at least 330 full days during 12 consecutive months. It can begin with any day of the month. A full day is a period of 24 consecutive hours, beginning at midnight. Additionally, an individual’s physical presence in the foreign country may be for any reason such as for business purposes or vacation time, or any combination of purposes.

Certain days are excluded and do not count as days spent in the foreign country if they are:

  • spent on traveling to and from the United States over international waters (in transit),
  • to recover from an illness,
  • family emergencies,
  • war or civil unrest, or
  • under orders from superiors.

Because the foreign earned income exclusion and the housing exclusion or deduction is calculated on a daily basis, maximizing the number of days in a foreign country within the 12-month period and within the tax year maximizes your tax benefits.

Please call the Crosslin tax team to discuss your situation and to review your presence and days residing in a foreign country to determine your eligibility to qualify to take the foreign earned income exclusion and the housing exclusion or deduction, and to plan for the maximum tax benefit. We are here to help!

Determining Alien Tax Status

The distinction between a resident alien and a nonresident alien is crucial for your tax liability. Resident aliens are taxed like U.S. citizens, on their worldwide income, while a nonresident alien is generally subject to U.S. taxation only on income that is effectively connected with the conduct of a U.S. trade or business and on specified types of U.S. source income. Your status as a nonresident alien individual affords you many opportunities to take advantage of the U.S. tax laws.

We must verify your status as a nonresident alien as the first step in the tax planning process. This procedure is complicated due to the many compliance issues associated with residency. Sometimes residency is determined under an applicable tax treaty; however, if no treaty exists, you are treated as a resident only if one of the following three conditions is met:

  • You are a “lawful permanent resident” of the U.S. at any time during the calendar year (i.e., you have been issued a “green card”),
  • You meet the “substantial presence test” (i.e., you have been present in the U.S. on at least 183 days during a three-year period that includes the current year), or
  • You elect to be treated as a resident alien.

COVID-19 Travel Disruption Relief. The IRS has provided individuals and businesses with relief related to travel disruptions arising from the COVID-19 emergency. Under this relief,  of U.S. presence that are presumed to arise from travel disruptions caused by the COVID-19 emergency will not be counted for purposes of determining U.S. tax residency and for purposes of determining whether an individual qualifies for tax treaty benefits for income from personal services performed in the United States.

Lawful permanent residence test. The lawful permanent residence test, often referred to as the “green card test”, is based on an alien’s immigration status. If an individual has been granted a green card, he or she is a lawful permanent resident of the United States. As soon as the individual physically enters the United States while holding a green card, he or she is a resident alien.

Substantial presence test. This substantial presence test is based on the number of days the alien is physically present in the United States for at least 183 days during a three-year period. The counted days refers to a yearly sum that is based upon the number of nonexempt days the alien physically spends in the United States during the current tax year and the two preceding tax years.

The presence test is calculated as the days present in the United States totaling:

  • the current calendar year (at least 30 days required in the current year), and
  • the two preceding years:
  • one-third of the number of days of presence in the first preceding year, and
  • one-sixth of the number of days in the second preceding year.

Exempt days. Exempt days are not counted in the substantial presence test and include the following:

  • days commuting to work in the United States (if the taxpayer regularly commutes) from Canada or Mexico,
  • days in transit in the United States for less than 24 hours,
  • days in the United States as a crew member of a foreign vessel,
  • days suffering from a medical condition that leaves one unable to travel, and
  • days that one is an exempt individual.

Once the two tests are performed and if a test is met, the residency starting date is the earlier of either the date the green card test or the date the substantial presence test is met.

Other residency considerations. The absence of all of the preceding conditions generally indicates that you are a nonresident alien. Of course, there are exceptions to the general rules. For example, an alien individual who meets the “substantial presence test” may still be considered a nonresident alien if a “closer connection” is established with a tax home outside the United States. You may also qualify for dual status residency; if so, your tax year is divided into two separate tax periods. You are then taxed as a resident during one period and as a nonresident during the other.

There are specific rules for establishing and terminating residency, abandoning residency, and expatriating. In addition, all departing aliens (resident or nonresident) must obtain a certificate from the IRS, known as a sailing or departure permit, stating that they have complied with the U.S. income tax laws.

Contact the Crosslin tax team to discuss your situation and to review your presence and days residing in the United States to determine your residency status and reporting for U.S. federal income tax purposes. We are here to help!

BBA Partnerships Are Eligible for Amended Return Procedures

The IRS has issued procedures for eligible partnerships to file amended income tax returns and partners’ Schedule K-1s in order to receive tax benefits. Partnerships subject to the centralized partnership audit regime (BBA partnerships) that filed Form 1065 and gave partners’ Schedule K-1s for tax years beginning in 2018, 2019, or 2020 can file amended returns before October 15, 2021. Generally, BBA partnerships are prohibited from filing an amended return and are required to file an Administrative Adjustment Request (AAR).

Under the post-2017 audit regime provided by the Bipartisan Budget Act of 2015 (BBA), the IRS will audit all partnerships (domestic or foreign) and their partners and assess all taxes and penalties resulting from a partnership audit at the partnership level, unless the partnership has 100 or fewer qualifying partners and elects to opt out of the new audit regime. Specifically, under the new centralized partnership audit regime, the IRS will examine partnership-related items at the partnership level and make adjustments at the partnership level. A partnership-related item is any item or amount with respect to the partnership that is relevant in determining the income tax liability, including any imputed underpayment, interest, and penalties of any person.

This guidance allows BBA partnerships the option to file an amended return to accelerate certain tax benefits. A BBA partnership that files an amended return pursuant to this guidance is still subject to the centralized partnership audit procedures enacted by the BBA. An eligible BBA partnership may use amended returns to change its method of depreciation and/or general asset account treatment for its residential rental property or make a late election to be an electing real property trade or business.

Under this procedure, BBA partnerships have the option to amend their partnership tax return if they satisfy the eligibility requirements below for the applicable tax year beginning in 2018, 2019, or 2020:

  • have not elected out of the BBA partnership audit regime;
  • have timely filed Form 1065, U.S. Return of Partnership Income and required Schedules K-1; and
  • timely file an amended return and schedules by October 15, 2021.

Please call the Crosslin tax team at (615)320-5500 to review your partnership return to determine if you qualify to amend your 2018, 2019 or 2020 tax return to apply for certain tax benefits.  We are here to help!