Foreign Earned Income

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Figuring the Foreign Earned Income Exclusion
Limit On Excludable Amount Indexed for Inflation Now
You may be able to exclude up to $91,500 of income earned during the tax year 2010.

Limits

For each tax year, you cannot exclude more than the smaller of:

$91,500 (or other amount determined under Section 911 of the Internal Revenue Code), or
Your foreign earned income for the tax year minus your foreign housing exclusion.
If both you and your spouse work abroad and you and your spouse meet either the bona fide residence test or the physical presence test, you can each choose the foreign earned income exclusion. You do not both need to meet the same test. Together, you and your spouse can exclude as much as $183,000 for the tax year 2010.

Paid in year following work

Generally, you are considered to have earned income in the year in which you do the work for which you receive the income, even if you work in one year but are not paid until the following year. If you report your income on a cash basis, you report the income on your return for the year you receive it. If you work one year, but are not paid for that work until the next year, the amount you can exclude in the year you are paid is the amount you could have excluded in the year you did the work if you had been paid in that year.
Example:

You qualify as a bona fide resident of Brazil for all of 2003 and 2004. You report your income on the cash basis. In 2003, you were paid $69,000 for work you did in Brazil during that year. You excluded all of the $69,000 from your income in 2003.

In 2004, you were paid $93,000 for your work in Brazil. $12,000 was for work you did in 2003 and $81,000 was for work you did in 2004. You can exclude $11,000 of the $12,000 from your income in 2004. This is the $80,000 maximum exclusion in 2003 minus the $69,000 actually excluded that year. You must include the remaining $1,000 in income in 2004 because you could not have excluded that income in 2003 if you had received it that year. You can exclude $80,000 of the $81,000 you were paid for work you did in 2004 from your 2004 income.

Your total foreign earned income exclusion for 2004 is $91,000 ($11,000 of the pay received in 2004 for work you did in 2003 and $80,000 of the pay you received in 2004 for work you did in 2004). You would include in your 2004 income $2,000 ($1,000 of the pay received in 2004 for the work you did in 2003 and $1,000 of the pay received in 2004 for the work you did in 2004).

Part Year Exclusion

Part-year exclusion. If you qualify under either the bona fide residence test or the physical presence test for only part of the year, you must adjust the maximum limit based on the number of qualifying days in the year. The number of qualifying days is the number of days in the year within the period on which you both:

Have your tax home in a foreign country, and meet either the bona fide residence test or the physical presence test. For this purpose, you can count as qualifying days all days within a period of 12 consecutive months once you are physically present and have your tax home in a foreign country for 330 full days. To figure your maximum exclusion, multiply the maximum excludable amount for the year by the number of your qualifying days in the year, and then divide the result by the number of days in the year.

Example (when limit was $80,000):

You report your income on the calendar-year basis and you qualified under the bona fide residence test for 75 days in 2004. You can exclude a maximum of 75/366 of $80,000, or $16,393, of your foreign earned income for 2004. If you qualify under the bona fide residence test for all of 2005, you can exclude your foreign earned income up to the full $80,000 limit.
Physical presence test

Under the physical presence test, a 12-month period can be any period of 12 consecutive months that includes 330 full days. If you qualify under the physical presence test for part of a year, it is important to carefully choose the 12-month period that will allow the maximum exclusion for that year.

Example (when limit was $80,000):

You are physically present and have your tax home in a foreign country for a 16-month period from June 1, 2003, through September 29, 2004, except for 15 days in December 2003 when you were on vacation in the United States. You figure the maximum exclusion for 2003 as follows.

Beginning with June 1, 2003, count forward 330 full days. Do not count the 15 days you spent in the United States. The 330th day, May 10, 2004, is the last day of a 12-month period.

Count backward 12 months from May 10, 2004, to find the first day of this 12-month period, May 11, 2003. This 12-month period runs from May 11, 2003, through May 10, 2004.

Count the total days during 2003 that fall within this 12-month period. This is 235 days (May 11, 2003 – December 31, 2003).

Multiply $80,000 by the fraction 235/365 to find your maximum exclusion for 2003 ($51,507).

You figure the maximum exclusion for 2004 in the opposite manner.

Beginning with your last full day, September 29, 2004, count backward 330 full days. Do not count the 15 days you spent in the United States. That day, October 21, 2003, is the first day of a 12-month period.

Count forward 12 months from October 21, 2003, to find the last day of this 12-month period, October 20, 2004. This 12-month period runs from October 21, 2003, through October 20, 2004.

Count the total days during 2004 that fall within this 12-month period. This is 294 days (January 1, 2004 – October 20, 2004).

Multiply $80,000, the maximum limit, by the fraction 294/366 to find your maximum exclusion for 2004 ($64,262).