For many years the  foreign earned income exclusion has been set at a maximum of  $80,000 of earned income for those working and living abroad. That  exclusion has been increased to $82,400 for 2006, and  $85,700  for 2007.  To qualify for that exclusion you must live and work abroad for a full calendar year or work abroad for a 12 month fiscal year period and not return to the US more than 35 days during that 12 month period.  This change is obviously good for everyone.  For partial tax years the exclusion is pro-rated.

The not so good part of the change involves the tax that will now be imposed on the income (foreign or from the US) that you make in excess of the foreign earned income exclusion.  Under the old law, all taxable income in excess of the exclusion on your expat tax return began to be taxed in the lowest brackets (as if you had no previous income) and then the rate increased as the amount in excess of the exclusion increased.

Under the new tax law, all income in excess of the exclusion will now be taxed at the same tax bracket as it would have been taxed if the $82,400 exclusion had also been taxed.  Therefore, for 2006 each dollar of income you make over the maximum exclusion amount will be subject to a 28% tax bracket  rate if are single whereas previously it would have only been subject to a 10% tax rate.  This will cause a lot of high earning Americans in low tax countries to pay taxes since the higher bracket may not be totally offset by the credit of  their Mexican income tax.  

The next change in the expatriate laws involves the foreign housing exclusion or foreign housing deduction.  Those expenses would be rent expense on your foreign residence plus cleaning, maintenance and utilities incurred in connection therewith.  The housing deduction or exclusion is allowed in addition to the maximum foreign earned income exclusion and therefore comes into play when you exceeded that  maximum amount.  Previously in 2005, you could deduct all of these housing expenses in excess of approximately $12,000 without any maximum limit.  Now for 2006 you can only deduct these expenses in excess of $13,184 up to a maximum of $11,536 in most of the world.  The IRS has published Notice 2006-87 which gives a higher maximum deduction to those living in countries with a higher cost of living.   Hong Kong is the highest with the maximum over $100,000. So if you are paying high rent, utilities, etc. you can no longer deduct those amounts.  If you own your foreign residence, you can still deduct all of your property taxes and mortgage interest on Schedule A but with some exceptions you cannot use the housing exclusion or deduction.
 
Remember, if you live abroad on 4/15/07, your 2006 return receives an automatic extension until June 15th, but any tax due (as it may be for the first time in 2006) is payable on April 15th to avoid imposition of interest and penalties.
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Don Nelson has been assisting expatriates living in abroad for over 31 years. He is one of the recognized world authorities on  U.S. Tax law concerning residents living abroad.  His website is located at www.TaxMeLess.com.  For the most recent news on US expatriate tax matters go to his blog at www.usexpatriate.blogspot.com .  He can be reached by email at ustax@hotmail.com or by phone at (949) 481-4094.   Watch for his articles in future editions on US reporting of foreign bank accounts, and what you need to file with the IRS if you own 10% or more of a Foreign Corporation.