The Foreign Earned Income Exclusion 2018 is $104,100. This is a nice increase, up from $102,100 in 2017. If you’re living and working abroad, the Foreign Earned Income Exclusion is your first and best defense against the IRS and the most important tool in your expat tax toolbox. Here’s how to maximize the value of the Foreign Earned Income Exclusion 2018.
The Foreign Earned Income Exclusion 2018 allows you to exclude up to $104,100 in salary or business income from your US Federal income tax return. The FEIE applies to your salary and not to passive income or capital gains.
Again, the Foreign Earned Income Exclusion 2018 doesn’t apply to investment or rental income. It ONLY covers salary or income from a business. So, when you sell real estate or stock, you will pay tax to the US.
The Foreign Tax Credit will prevent these capital gains from being double taxed, but you’ll always owe tax on your passive income.
The US capital gains rate is 20% (assuming Obamacare taxes are repealed) and the FTC gives you a dollar for dollar credit against taxes paid to a foreign country. So, if you pay 10% tax Austria, you’ll pay 10% tax to the US. If you pay 20% to Brazil you will pay 0% to the US.
Another way to look at the FTC is that you’ll pay a minimum of 20% in capital gains tax no matter where you live. If you live in Belize, with no capital gains tax, then you get the joy of paying the full 20% to Uncle Sam.
With that, let me get back to the Foreign Earned Income Exclusion 2018.
If you qualify for the exclusion in 2018, you can earn up to $104,100 in salary free of Federal income tax. If you earn more than $104,100, you’ll pay US tax on the excess (again, using the FTC to avoid double tax).
Let’s say you earn $204,100 from your job or your business. Let’s also assume you earn this money is in a tax free country such as Panama and only need to concern yourself with US taxes.
The FEIE gives you $104,100 tax free and you pay US tax on the remaining $100,000. Your Federal rate on this $100,000 will be about 33%. This is because the US tax brackets are applied to the full $204,100 earned and your taxed at the top of the bracket for your excess $100,000.
Note that I said that the Foreign Earned Income Exclusion 2018 allows you to exclude up to $104,100 of salary from Federal income tax. The FEIE applies to income tax, but not other Federal taxes.
For example, if you’re self employed, you still must pay 15% in self employment tax on 100% of your net business income. The FEIE does not reduce self employment tax.
Likewise, if you’re living abroad but operating a business through a US corporation, or getting paid from a US company, you must pay payroll taxes. The company will pay about 7.5% in payroll taxes and you’ll pay about the same, for a total of 15%.
However, if you operate through an offshore corporation, then you pay zero in payroll tax and zero in self employment tax. Salary from a foreign corporation is exempted from US SE and payroll taxes on IRS Form 2555.
Another benefit of an offshore corporation and the FEIE 2018 is that you can retain earnings tax deferred. Most foreign businesses can hold profits in the corporation and only pay taxes on when distributed as dividends.
So, if you net $500,000 a year, you might hold $400,000 in the corporation. You would pay yourself a salary of $100,000 and defer US tax on the excess until you distribute those retained earnings as a dividend.
There are two ways to qualify for the Foreign Earned Income Exclusion 2018. You can be out of the United States for 330 out of 365 days during a 12 month period or you can be a legal resident of a foreign country for a calendar year.
The easiest of these tests, at least on paper, is the 330 day test. Just be out of the US for the required number of days and you’re golden. However, in practice, most try to push their US days and end up taking significant risks.
If you miss your 330 days, even by one day, you lose the FEIE. No prorating and no exceptions… you get to pay US tax on 100% of your foreign income. Also, because you’re a US person, you lose the right to retain earnings in your offshore corporation!
The residency test is much more secure and reliable for most US expats. Become a legal resident of a foreign country, making that nation your home base, and you can spend 3 to 5 months a year in the United States. No more counting your days and no more risking the FEIE.
Also, President Trump is attempting to move to a residency based tax system. If successful, the 330 day test will likely be eliminated and residents will be allowed to exclude 100% of their income. No more US tax for residents of foreign countries in a territorial tax system.
In order to qualify for the FEIE using the resident test, you need to have a resident visa. I suggest that this residency visa come from a tax free country, but you can choose any nation. If you want to reduce your worldwide tax burden, go with a nation that won’t tax your foreign sourced profits.
While you can get residency in a number of low tax countries if you purchase real estate for $350,000 to $500,000, the lowest cost residency program is Panama. With Panama’s Friendly Nations Reforestation Visa you get residency for you and your family with an investment of $20,000. For more on this, see: Best Panama Residency by Investment Program
I hope you’ve found this article on the Foreign Earned Income Exclusion 2018 to be helpful. For more information on setting up a business offshore or getting a second residency, please contact me at firstname.lastname@example.org or call (619) 550-2743. We’ll be happy to assist you in structuring your affairs to maximize the value of the FEIE.