Foreign Earned Income and U.S. Tax Returns
The rules for filing a United States, U.S. tax return generally apply to you if you are a U.S. citizen or resident alien (Green Card Holder) and you live and/or work in a foreign country. When you start a free tax return on eFile.com, you do not have to think about these rules. Answer a few simple questions and the eFile.com tax app will select the correct tax forms for you based on your answers. eFile.com will also help you complete and e-File the forms.
If you lived and/or worked abroad during the Tax Year and you have gross income from worldwide sources that is at least the amount shown for your filing status, you must file a tax return. This also applies to you if you are a U.S. citizens working for the federal government (including the Foreign Service) and you are stationed abroad.
These factors generally determine whether or not you must file a tax return:
You will need to report the following items on your tax return:
Foreign earned income is income you receive for services performed in a foreign country during the period your tax home (the general area of your main place of business, employment, or post of duty where you are permanently or indefinitely engaged to work) is in a foreign country and whether you meet the bona fide residence test or physical presence test . How or where you are paid has no affect on the income’s source. For instance, income you received from work you’ve done in Brazil is income from a foreign source. This applies even if the income is directly paid to your U.S. bank account and your employer is located in Chicago.
If you received a specific amount for work you’ve done in the U.S., you must report that amount as U.S. source income. U.S. source income is the amount that results from multiplying your total pay (includes allowances, reimbursements other than foreign moves, and noncash fringe benefits) by a fraction. The numerator (top number) is the number of days you worked in the U.S., and the denominator (bottom number) is the total number of days for which you were paid.
If you can’t determine how much is for work done in the U.S., or for work done partly in that country and partly in a foreign country, you should determine the U.S. source income amount using the method that correctly shows the proper source of your income the most. You can make this determination on a time basis in most cases.
Most payments received by U.S. Government civilian employees for working overseas are taxed. These payments include pay differentials. Pay differentials are financial incentives you received for overseas employment under adverse conditions, like severe climate, or because the post location is outside of the U.S. (the area doesn’t have to be a qualified hazardous duty area) Examples of pay differentials include special incentive differentials, post differentials, and danger pay. They should be included on your W-2 Form as wages.
Here are other types of foreign income that may be taxed if you are a U.S. government civilian employee:
There are items that the IRS doesn’t include as foreign earned income, including:
There are three types of allowances from overseas services employment that are not taxed:
The allowances that foreign service employees receive for representation expenses are also tax free under the provisions above. Certain foreign areas allowances should not be added to your W-2 Form as wages by your employer.
There are some exceptions to allowance income taxability if you are a Peace Corps volunteer or volunteer leader. Some allowances are taxed and others are not. Taxable allowances are received by you when credited to your account. The expenses below must be reported as wages on your tax return (refer to your W-2 Form):
Nontaxable allowances should not be included on your W-2 since they are tax free, whether they’re paid by the U.S. government or the foreign country in which you are stationed. They include:
U.S. citizens and resident aliens earning over a certain amount of income from foreign sources may have to pay income taxes on the foreign income. You must pay U.S. taxes on income you earned abroad in the same way you pay taxes on income you earned in the United States. In other words, Social Security and Medicare taxes may apply to wages you earned for services in a foreign country for the following situations:
Generally, if you do not meet any of the exceptions above, Medicare and Social Security taxes will not be withheld from your foreign wages. If you are an employee of a U.S. company and your employer doesn’t withhold income tax or doesn’t withhold enough taxes, you may have to pay estimated tax. Though your international income is taxed regardless of where you reside, you may qualify to claim a foreign earned income exclusion.
Here are three ways to withhold taxes from your foreign income:
You may qualify for a foreign income tax exclusion from a limited amount of foreign earned income. In order to qualify for the exclusion, you must:
U.S. citizens or resident aliens supporting the U.S. Armed forces in designated combat zones overseas (specifically contractors or employees of contractors) may also qualify for the exclusion, even if their home is in the United States.
If you work and live outside the U.S. during the Tax Year, you may be able to exclude amounts paid by your employer for housing expenses. You must meet the requirements of either the Bona Fide or the Physical Presence Test in order to exclude these costs. Housing expenses that qualify for the exclusion include:
These expenses don’t qualify for the exclusion:
The amount of foreign income that you can exclude is limited to your annual maximum dollar amount limit or actual foreign wages, whichever is less. Below are the maximum amounts for foreign income tax exclusion since the 2006 Tax Year (adjusted for inflation):
To claim the foreign income tax exclusion, you must file or efile either Form 2555, Foreign Earned Income efile it (if you are also claiming foreign housing cost amount exclusion) or Form 2555-EZ, Foreign Earned Income Exclusion efile it (if you are only claiming the foreign income tax exclusion) Form 2555 or Form 2555-EZ should be filed with your timely filed Form 1040, U.S. Individual Income Tax Return efile it or Form 1040X (Amended U.S. Individual Income Tax Return).
Self-Employment Taxes For a Business in a Foreign Country or U.S. Territory
Generally, you are required to pay self-employment taxes if you are abroad and a self-employed U.S. citizen or resident alien. There is a Social Security and Medicare tax on net earnings from self-employment of $400 or more per Tax Year. Your net self-employment income is used to figure your net earnings from self-employment. Net self-employment income usually includes all business income minus all business deductions allowed for income tax purposes, while net earnings from self-employment is a portion of net self-employment income. This amount is figured on Schedule SE, Self-Employment Tax, The actual self-employment tax is figured on net earnings from self-employment. You must take all of your self-employment income into account when figuring your net earnings from self-employment, including income that’s exempt from income tax because of the foreign earned income exclusion.
If you are a U.S. citizen or resident and you own and operate a business in Guam, Puerto Rico, American Samoa, the Commonwealth of the Northern Mariana Islands, or the U.S. Virgin Islands, you must pay taxes on your net earnings from self-employment ($400 or more) from these sources. In addition, you must pay the self-employment tax regardless of whether the income is exempt from U.S. taxes or not (or whether or not you must otherwise file a tax return).
If you were a civilian who served in a combat zone or a qualified hazardous duty area in support of the U.S. Armed Forces, you can receive a deadline extension for the following:
Income taxes are forgiven for a U.S. Government civilian employee who dies as a result of injuries or wounds incurred while employed by the U.S. Government. The injuries or wounds must have been caused by military or terrorist action directed against the United States or its allies. The taxes are forgiven for the deceased employee’s Tax Years beginning with the year immediately before the year in which the injury or wounds occurred and ending with the year of death. If you and your deceased spouse filed a joint return, only your spouse’s part of the joint tax liability is forgiven.
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