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The Unofficial Guide to Form 2555 Foreign Income Exclusion
The United States is one of the few governments that tries to collect taxes from its citizens regardless of where they live in the world. For years, however, Americans living abroad simply did not file returns, confident that they were under the radar and faced few consequences for not filing. All of that has come to a screeching halt recently as the government desperately gropes for more revenue and many overseas taxpayers who haven’t filed for years have received notices from the IRS reminding them they haven’t been forgotten stateside.
The silver lining to this cloud is that the US Congress has given expatriate (and reluctant) taxpayers two weapons to help fend off the greed of the IRS, Forms 2555 and 1116. For those living overseas, the 2555 is the big gun. in the armory, as it allows direct exclusion of certain incomes under certain conditions. Of course, this wouldn’t be US tax law if it were easy to understand, so I’ve included an emphatically NOT guide to IRS Form 2555 here.
How does Form 2555 help you?
Essentially, Form 2555 means that the first $91,000 of income (in 2010) that a nonresident earns while living abroad is excluded from his or her U.S. income when computing his or her taxes. For U.S. citizens living abroad who make the majority of their income through work, but are not business tycoons, professional athletes, or investment bankers, this can result in their U.S. tax returns being merely a formality, and no money is due. “So Tyler,” you ask me, “I don’t make over 91k and I’m pretty sure I don’t owe anything, why should I spend the time and money it would take to file?” I admit it seems unfair, but I have to warn you that if you don’t file, the IRS can refund you and it won’t be in your favor!
Pitfalls of failure to report
- The statute of limitations never expires! Except in cases of fraud or tax evasion, the IRS can only audit a tax return three years after it was filed. If you don’t apply, they can come back forever.
- The IRS can prepare you a return that is completely wrong or contains information that is only harmful to you. For example, they will include income without including expenses, or capital gains without showing any basis based on the sale.
- The IRS is a sneaky bastard as a debtor and can garnish Social Security benefits or pension income to pay back taxes you probably wouldn’t have owed had you just filed!
Additional benefits of Form 2555
The $91,000 is per person, so if you and your spouse both work, you both file the form. Congress also recognizes that many U.S. companies provide housing benefits to expatriate workers (which they must then include in their W-2 income), and therefore added the exclusion for housing benefits to the remaining $91,000. The trick is that the IRS determines the maximum exclusion amount based on the cost of living where you live. For example, if you live in Japan and your employer sends you to Tokyo, you will receive an allowance of $295.62 per day, for a total of $107,900 per year. On the other hand, if sent to humble little Gifu, the maximum benefit that can be excluded is $29,200. The full table is in the Form 2555 Instructions for Use and makes for fascinating reading; especially if you are posted to Moscow (Russia) and want to know how the cost of living compares to your current position in Doha (Qatar). In addition, it allows for excellent tax planning for foreigners employed by US companies; your human resources should ask for your salary as housing allowance up to the limit, and after that all salaries.
Form 1116 plays Robin to Form 2555’s Batman
If you’re a high roller and you’ve exhausted the excluded $91,000 plus potentially up to $107,900 in housing benefits, you might think you’re going to owe old Uncle Sam out of the coffers. Not so fast, if you are a tax resident of a foreign country, it goes without saying that you also have to pay taxes to the host country. This is where form 1116 comes in. Basically, it gives you a dollar for dollar tax credit for taxes paid to foreign governments. Of course, being a US tax number, there should be about ten thousand restrictions on what you actually get the credit for, so check the instructions first.
Am I eligible to file Form 2555?
To be eligible to file Form 2555, you must overcome two hurdles: first, your taxing authority is in a foreign country, and second, you must be a bona fide resident of that country or physically present in a country or countries. outside the United States
The tax authority is a foreign country
Your tax authority is the principal country or jurisdiction where you conduct your business or employment. Therefore, it would make sense that you can only have one tax jurisdiction at any given time, and to qualify for Form 2555, that tax jurisdiction must be outside the United States for at least part of the tax period you file. for.
Bona Fide Resident Test
Once you have established that your tax authority was a foreign country for at least part of the year to be filed, you then need to look further to see if you were a bona fide resident or if you meet the physical presence test. In general, if your tax residence was in a single foreign country during the entire tax period and you resided in this country permanently or indefinitely, you are considered a bona fide resident.
Some factors that may be important to becoming a bona fide resident include:
- the type of visa with which you entered the country; need we say that a tourist visa might raise some eyebrows?
- Visa limit stay? See above
- do you stay at home in the US while living abroad? if so, reveal and explain. This is not a deal breaker, but it may indicate that your intent was less than permanent or indefinite.?
Once you have qualified as a bona fide resident, you are presumed to remain a bona fide resident until you determine otherwise.
Physical presence test
If you don’t meet the criteria for being a bona fide resident of another country, check out the physical presence test. To be eligible, you must live outside the United States for at least 330 days in any consecutive 12-month period. The form (line 16) has lines that you need to fill in that show which countries you have been in and at what times. In general, the physical presence test is useful for those who moved outside the United States but did not reside in their country of bona fide residence on the first day of the tax year, and for those who resided outside the United States but in multiple locations. jurisdictions, and for those who have a job or profession that takes them abroad but do not meet the semi-permanent or indefinite term requirement. It’s important to note that you must meet the 330-day requirement not by the end of the tax year, but by the filing date, including any extensions. Also, if your period outside the United States extends to additional periods, you may receive a prorated exclusion. For example, if you move to England on 1 July 2009 and stay there until 1 July 2011, you may be entitled to half the exclusion amount for 2009, the full amount for 2010 and half for 2011. As you can imagine, it’s a lot more complicated than that, and you may not qualify for an exclusion for any of these periods. See the instructions for Form 2555 and Publication 54 for details.
Can I exclude income from my investments?
No, Form 2555 only helps with income from your employment or trade or business while meeting the above tests. If you paid tax on your foreign investments, you can credit this on form 1116.
In summary, the American living abroad has recently come under increased scrutiny from Congress and the Internal Revenue Service. However, avoiding unnecessary taxes is fairly easy for most Americans, thanks to the ability to exclude their foreign-source income on Form 2555.
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