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Bona Fide Residence Test & Physical Presence Test Maximum Exclusion & Prorated Exclusion Foreign Housing Exclusion and Deduction Self-Employment & Foreign Exclusions Bona Fide Residence
and Physical Presence Tests
Bona Fide Residence Test One Full Year of Residence You are considered a "bona fide resident" of the foreign country if you reside in that country for "an uninterrupted period that includes an entire tax year." A tax year is January 1 through December 31. The qualifying period for the bona fide residence test must include one full calendar year. Trips Outside The Foreign Country Brief trips or vacations outside the foreign country will not jeopardize your status as a bona fide resident, as long as the trips are brief and you clearly intended to return to the foreign country. You can even make brief trips to the United States. Statement To Foreign Authorities You will not be considered a bona fide resident of a foreign country if you have submitted a statement to the foreign country that you are not a resident of that country, and the foreign government has determined that you are not subject to their tax laws as a resident. Tax Treaty Special treatment of income under an income tax treaty will not prevent you from meeting the bona fide residence test. Physical Presence Test You are considered physically present in a foreign country (or countries) if you reside in that country (or countries) for at least 330 full days in a 12-month period. You can live and work in any number of foreign countries, but you must be physically outside the United States for at least 330 full days. Full Day A "full day" is 24 hours. So, the day you arrive and the day you leave the country are generally not counted towards the physical presence test. 12-Month Period The qualifying period can be any consecutive 12-month period of time. You do not have to begin your qualifying period with your first day in a foreign country. You can choose a 12-month period that provides the greatest income exclusion. You can count both vacation and business days spent in the foreign country towards meeting the 330 day minimum. Travel Outside The Foreign Country Travel outside of the foreign country will not count toward your 330 day minimum. You will need to plan your travel very carefully to make sure you are physically present in your target country (or countries) for at least 330 days. Exceptions To The Time Requirements The minimum time requirements for both the bona fide and physical presence tests can be waived. The only valid reason for a waiver is that you are forced to leave the foreign country because of "war, civil unrest, or similar adverse conditions." You should be able to prove that you would have met the time requirements if adverse conditions had not prevented your stay. Prohibition On Travel to Cuba Time spent residing or working in Cuba will not qualify for the bona fide residence or physical presence tests. Foreign Earned Income Exclusion Maximum Exclusion The amount of foreign wages and salary you can exclude per year is limited to your actual foreign wages or $80,000, whichever is less. You may claim a prorated exclusion if you did not meet the time requirements for a maximum exclusion. The maximum annual exclusion will continue to be $80,000 until 2008, when the amount will begin to be adjusted annually for inflation. Carryback And Carryover Of The Foreign Tax Credit Any foreign tax credit amount in excess of the maximum limit may be carried back to a previous tax year or carried forward to a future tax year. You can carry-back the foreign tax credit to the immediately preceding tax year, or carry-forward the credit for the next 10 tax years. If you paid
foreign taxes in 2004 or previous year, a different carryover time frame
applies. For tax years 2004 and earlier, any excess foreign tax credit
may be carried back to the two previous tax years, or carried forward for
the next five tax years. The change in the carryover time frame was part
of the American Jobs Creation Act of 2004.
Prorated Exclusion If you do not meet the all the time requirements, you may claim a partial exclusion of income. You would pro-rate the exclusion based on the amount of time actually spent abroad. The pro-rated exclusion is worth a maximum of $242.42 per full day spent in a foreign country. Your pro-rated exclusion amount may not exceed the maximum allowable exclusion. Foreign Housing Exclusion And Deduction If you live and work outside the United States, you can exclude from federal taxation amounts paid by your employer for housing. This includes any amounts paid directly to you or on your behalf for housing, rent, education for your children, or tax equalization ("gross up" payments). Time Requirements For the housing exclusion, you must meet the same time requirements under the bona fide or physical presence tests. Qualifying Expenses The following expenses qualify for the foreign housing exclusion: Rent,
Non-Qualifying Expenses The following expenses do not qualify for the foreign housing exclusion: Lavish or
extravagant expenses (as determined by your circumstances),
Coordination With The Foreign Earned Income Exclusion You can claim the foreign earned income exclusion, the housing exclusion, or both. However, you cannot exclude the same income twice. Generally, you will calculate any housing exclusion if you have taxable foreign income left over after taking the maximum allowable income exclusion. Calculating The Maximum Housing Exclusion The maximum housing exclusion is calculated as follows. Add up all the housing expense amounts. Subtract any amounts already excluded under the foreign income exclusion or claimed as a moving expense deduction. Subtract any housing allowance provided by the US Government. From the remaining housing expenses, you must subtract a base amount equal to 16% of a Federal GS-14 Step 1 salary. For 2005, this base amount is equal to $12,191 annually, or $33.40 per day. Multiply this base amount times the number of days in your qualifying period. Any housing expenses in excess of this base amount are excluded. Because of the limitations in the housing exclusion, it is best to maximize your income exclusion first before calculating any housing exclusion. Independent contractors cannot claim the foreign housing exclusion. Instead, they must claim the foreign housing deduction. Self-Employment & Foreign Exclusions Self-employed persons working abroad may claim the foreign earned income exclusion and the foreign housing deduction. Foreign Earned Income Exclusion For Self-Employed People You may claim the foreign income exclusion on self-employment income. This will reduce your regular income tax, but it will not reduce your Self-Employment Tax, which is a flat 15.3% on your net income from Self-Employment. Housing Deduction For Self-Employed Persons Self-employed
persons working abroad do not qualify for the foreign housing exclusion.
Instead you can deduct your allowable housing expenses from your Self-Employment
Taxes. This will lower your Self-Employment Tax, sometimes considerably.
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