Understanding Form 2555 (the Foreign Earned Income Exclusion and the Foreign Housing Exclusion) is extremely important because it allows U.S. tax payers living and working abroad to exclude all or most of their foreign earned income.
Today we will go through this form as part of a series of blogs and videos aimed at giving guidance and tips to important forms relevant to U.S. Expat tax payers living abroad.
So, what is foreign earned income?
Foreign Earned Income is basically just that i.e. earned income from a foreign business or a job which you have while living abroad. This includes wages, bonus, stock options, fringe benefits, etc. This does not include employer pension contributions, or pension matches. Something to consider is that passive income, such as interest and dividends, is not able to be excluded via Form 2555.
Generally speaking, if you are making more than $10,000, you need to file taxes. And it is important you file Form 2555 to exclude that foreign earned income. The amount for 2014 is $99,200 and for 2015 it’s $100,800. This is a relatively high amount, and in many cases it can cause most expats not to pay any taxes at all. Even if you are above that $100,000 threshold, we are able to take credits and other deductions, to even get your tax liability to zero or minimize it.
So if you have the form in front of you, you are going to put this information in to part 4. This is where you put wages, salaries, commission, bonus, business income, and any non-cash income such as housing allowance, car allowance, business representation, etc.
One question we often get is, “How do I translate from a foreign currency to US dollars?” It’s really quite simple. You simply use the IRS published foreign currency exchange rates.
OK – before you get carried away filling out the form, let’s just say you are a US citizen sent out on international assignment for less than one year. In this case you may not qualify for the foreign earned income exclusion.
So, how do I qualify?
There are two ways. One is the physical presence test, and the other is the bona fide residence test. Both of these tests have very strict requirements by the IRS so it’s important you pay attention to the requirements of each.
Let’s talk about the bona fide residence test. This is part 2 of Form 2555. It requires you to stay outside the United States for an uninterrupted period of one year. And remember, that’s one taxable year i.e. January through December. The important thing to realize is that you can take visits back to the United States for business or vacation, but you have to have your residence outside the United States. What that means is that you are required to be able to show that you reside abroad by demonstrating that you are for example a member at clubs, organizations, churches, and the community in a country or location outside the U.S.
Ok, now let’s talk about the physical presence test, which is part 3 of Form 2555. This requires you to be outside the U.S. for 330 days out of a 12-month period. This is how most people qualify in their first year abroad because most people don’t move on the first day of a taxable year i.e. January 1st.
One thing to keep in mind is how you qualify. In the first year you are abroad, we normally qualify clients through the physical presence test because they haven’t been in the country for one full taxable year. In the years after that, we usually qualify through the bona fide residence test because at that point they have been in the country for a full taxable year and they are integrating into the community, and are a bona fide resident of that country.
Now that we’ve got that out of the way and that you are qualified, there’s one additional exclusion that you can get. This is the foreign housing exclusion. What this is, is an exclusion that you can get for your foreign housing expenses. This includes rent, utilities, repairs and maintenance, rental furniture, parking, etc. However, please note that telephone, television, and internet charges cannot be included.
How is this calculated? This is simply 16% of the foreign earned income exclusion. So let’s say roughly $16,000. And it’s going to be any amounts you spend above that, capped at a certain threshold based on the city you live in. Where do you find these rates? You will find them in the Form 2555 instructions, towards the end,for each individual city you live in. If you have any questions let me know and I will walk you through the calculation.
So, what happens if I don’t file Form 2555?
Now this is really important. If you don’t file Form 2555 after a series of years, in which you have been filing the form, for reasons such as you are taking out a foreign tax credit, or because your accountant advises you not to, this could be considered a revocation in the eyes of the IRS, which means you won’t be allowed to file this form or exclude foreign earned income for the next five years. So bottom line, don’t forget to fill out this form.
One last tip – keep a travel journal of where you travel, when you travel, the amount of income earned, and the number of days on business. This is important because you may need to enter this information in parts 2 or 3, depending on how you qualify.
So that’s Form 2555 in a nutshell. If you have any questions, just get in touch. We’ll be happy to help you out.
- List Of Common U.S. Tax Forms For Expats
- Watch our video playlist explaining the key US Tax forms in which we explain them in more detail for you.
- Watch our complete US Tax Services Video Series
- Official IRS website
- Form 2555
About US Tax Practice GmbH:
US Tax Practice offers U.S. tax services in Switzerland. It is the go-to tax preparation service and compliance practice for U.S. tax payers. Located in Schaffhausen, Switzerland, the company was founded by Patrick Evans, a U.S. tax accountant (CPA, CGMA) and U.S. citizen determined to work with his clients’ best interests in mind. US Tax Practice GmbH services include U.S. Income Tax Preparation, U.S. Tax Compliance, Foreign Bank Account Reporting (FBAR), Tax Planning and Optimization, and Expatriation.