Category: International tax

Foreign earned income exclusion

The Foreign Earned Income Exclusion

What is the foreign earned income exclusion?

Foreign earned income exclusion
Beating the double dip

If you are a U.S. citizen (or U.S. resident alien) who living in or planning to relocate to a foreign country you may qualify for what is known as the “Foreign Earned Income Exclusion”. The foreign earned income exclusion is an exception to the general rule that US citizens and resident aliens are taxed on their worldwide gross income, that is, you must pay US taxes on all of your income from everywhere, even if you live outside the US or have never been here. While the foreign earned income exclusion doesn’t help you when it comes to being taxed in the foreign country, it does mean that, if you qualify, you can exclude some of that income from what is taxed by Uncle Sam.

Are you a “qualified individual” for purposes of the foreign earned income exclusion?

There are a couple of tests you must pass in order to qualify for the Foreign Earned Income Exclusion.

Tax home

(1)  You must have a “tax home” in a foreign country. An individual’s tax home is considered to be his regular or principal (if there is more than one regular) place of business. If the individual has no regular or principal place of business because of the nature of the business, or because he is not engaged in carrying on a trade or business, his tax home is his regular place of abode. In other words, you must either be conducting business abroad or have your home there. Additional rules apply to resident aliens claiming to have a tax home in their country of origin.

Bona fide resident and physical presence tests

(2)  You must either be (i) a “bona fide foreign resident” of that country (only US citizens and US resident aliens who come from countries with which the US has a tax treaty can use this test) for an uninterrupted period that includes an entire “tax year”; or (ii) physically present in the foreign country for 330 full days during any consecutive 12 month period (in which case you are a “qualified individual”). Both US citizens and resident aliens can use this test.

Whether you are a “bona fide resident” of a foreign country depends on the facts and circumstances of why you are there. Part (though not all) of the analysis depends on where you are “domiciled”. Selling your home in Des Moines, for example, and purchasing a scenic villa in Punta Del Este, Uruguay, where you stay all year round and join the community, suggest that you could be a bona fide resident of Uruguay for purposes of the Foreign Earned Income Exclusion. The duration of your stay is also relevant. If it is clear that you have moved for an indefinite period of time and made yourself part of the community in the foreign country, you move closer to being a bona fide resident.

If, however, you are abroad for a limited purpose, say, if you are a contractor in country solely for a particular assignment, with the expectation that you will return to the US when it is done, this would weigh against your being a bona fide resident. The physical presence test is more straightforward than the residence test, but more rigid. It doesn’t matter why you are in the foreign country (or countries – so long as they’re not the US) so long as you are physically abroad for the 330 twenty-four hour periods. So, unlike the residence test you don’t have to worry about why you’re there, but you can’t come and go for more than 35 days (with no more than 30 being in any single month).

Calculating the foreign earned income exclusion on your taxes

Assuming you qualify under the tests described above, calculating your foreign earned income tax exclusion is unfortunately not as simple as hacking the yearly exemption amount ($100,800.00 for 2015) off the top of your gross income. Rather, you must first determine for how many days of the year in which you earned the foreign income you were a “qualified individual” (as described by the tests above). Second you then take that fraction and apply it to the maximum exclusion amount.

For example, assume that U.S. citizen Sarah’s tax home is in France where she meets the bona fide residence test for 2015. Sarah is a qualified individual for 181 days and receives $100,000 that is attributable to services she performs in France. Sarah can exclude $49,986 of foreign earned income, the lesser of $100,000 or $49,986 ($100,800 x 181/ 365). Sarah would then factor that excluded amount into her other income to come up with the amount of tax she owes.

A couple caveats about the foreign earned income exclusion. First, the calculations for determining the amount of tax due at the end of the day are very complex. Second, the character of the income (i.e. wage income versus capital gains) is relevant in some cases. Third, there are different rules that may apply if you are running a business abroad and have what would otherwise be deductible business expenses, versus serving abroad as an employee.  It is very important to consult an international tax professional to understand how any foreign tax credit and/or the foreign housing cost exclusion (covered later) would apply and how you might benefit from this important way around being taxed twice by two different countries.

Contact an international tax lawyer now

Ari Good, Esq.

(786) 235-8371

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Tax Considerations For Inbound Investors in US Property

Flags of the world
Come one come all

Tax Considerations for Inbound Investors in US Property

Foreign Investments In US Real Estate

The United States has enjoyed a resurgence in foreign money coming to our shores to invest in stocks, businesses and, perhaps most of all, real estate.  Whether this is to scoop up real estate deals or simply find a safe place your money a key first step is proper tax planning.  The tax code provisions dealing with such “inbound” investments are very complicated and there’s always a lot of variables at play.  Key considerations include the type of property you want, for how long you want to hold it, and what type of income you expect it to produce.  While there is no substitute for professional advice here are some key concepts to keep in mind.

Regulations for Regulations

Be prepared to answer a number of questions dealing with who you are, where you’re from and where you got your money, especially if you are borrowing from any “financial institution” as part of the deal.  The United States government, particularly the IRS, has for years tightening the noose on international banking and trade.  Opening bank accounts or forming companies in many cases require you to complete “know your customer” style questionnaires asking about all manner of things including who will be the beneficial owners of your investments.  Unfair as it may be this is even more difficult if you come from a country that shows up on certain lists, such as the OECD “gray list” of countries deemed uncooperative in sharing bank account and tax information, or the Financial Action Task Force (FATF) “black list”, a list of countries deemed not to be doing enough to combat money laundering.  In the end, however, you can still achieve a measure of asset protection and anonymity by selecting the right entity and tax structure that will protect you while still keeping you in compliance with the thicket of regulations.

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Moving your money

Withholding Your Money

The Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) was designed to prevent foreign investors in US real property from selling and taking their proceeds abroad without paying tax.  At the time there was no way at the time for the IRS to collect tax from people who did not have a presence in the US other than the property they sold.  FIRPTA changed this by putting the burden on the buyer (or other transferee) to withhold part of the proceeds of the sale (10% as to individuals) to put against any tax liability the foreign buyer may have.  Typically it is the settlement officer / escrow agent who would bear this burden.  The burden is even higher (35%) for a foreign corporation that sells a US property and then sends the proceeds to the corporation’s shareholders.  Again, though, fortunately, going about both the buying and the selling the right way can reduce or even eliminate FIRPTA obligations.

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Your silent partner

Your United States Tax Return

I would be hard pressed to think of one of my foreign investor clients who wants to get into the messy business of filing a US tax return.  There are options, however.  Even if you have to file a US tax return that doesn’t mean that you have to do so individually, rather, there are corporate structures that allow you to limit what “you” have to report to the business of that entity.  Second, in real estate it sometimes makes sense to consider yourself to be “effectively connected” to the United States and file a US return.  These are just words that mean that in the eyes of the law you are, in summary, doing business here and agree to file a US tax return.  The upside of this is that you are then able to fully deduct your expenses like property maintenance, interest expense, taxes and fees from your gross rents or spec properties.

Contact Us For Help

No matter what path you follow it is essential that you do it right the first time.  This requires careful attention to all of the filing and election requirements.  Failing to do this correctly could cost you some or all of your profits on the deal.  I am here to help.

Ari Good, Esq.

(786) 235-8371