Employees with a tax home in a foreign country who meet either the bona fide residence test or physical presence test can choose to exclude from income a limited amount of foreign earned income. Employees can exclude the smaller of up to $103,900 (for 2018) or the excess of their foreign earned income for the tax year over their foreign housing cost exclusion. If both spouses have foreign earned income, they are each eligible for the maximum exclusion amount (up to $207,800 for 2018).
Foreign earned income is income an individual receives for services performed in a foreign country when his/her tax home is in a foreign country and either test described above is met. The source of earned income is the place where the services are performed. The location where the pay is received or how the pay is received does not affect the source of the income [ Reg. 1.911-3(a) ].
Employees who elect the foreign earned income exclusion cannot also take a foreign tax credit for any foreign income taxes incurred on the earned income excluded. If the foreign tax credit is taken on income the employee chose to exclude as foreign earned income, the choice to exclude foreign earned income may be considered revoked.
If only a part of an employee’s foreign earned income is excluded, he/she cannot deduct or take a credit for the foreign income taxes allocable to the excluded part. Taxes allocable to excluded foreign earned income are computed by multiplying the foreign taxes paid on the foreign earned income received during the tax year by a fraction, the numerator of which the employee’s excluded foreign earned income received during the tax year minus deductible expenses allocable to that income and the denominator of which is the employees total foreign earned income received during the tax year minus all deductible expenses allocable to that income.
Need assistance with tax advice? Contact our tax specialists at (469) 467-4660.