U.S. Tax Preparation Worldwide   James Maertin CPA

 
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Tax Guide, Americans Abroad
 - Foreign Earned Income


Foreign earned income    (See also foreign unearned income.)
 

Foreign earned income is income you receive for services you perform in a foreign country.  For purposes of the foreign earned income exclusion, this would be during a period your tax home is in a foreign country and during which you meet either the bona fide residence test or the physical presence test.

Earned Income

Earned income is pay for personal services performed, such as:

Earned and Unearned Income

Some types of income are not easily identified as earned or unearned income. These types of income -specifically, income from sole proprietorships, partnerships, and corporations, stock options, pensions and annuities, royalties, rents, and fringe benefits.

Income from a sole proprietorship or partnership.

Example 1. You are a U.S. citizen and meet the bona fide residence test. You invest in a partnership based in Cameroon that is engaged solely in selling merchandise outside the United States. You perform no services for the partnership. At the end of the tax year, your share of the net profits is $80,000. The entire $80,000 is unearned income. Example 2. Assume that in Example 1 you spend time operating the business. Your share of the net profits is $80,000; 30% of your share of the profits is $24,000. If the value of your services for the year is $15,000, your earned income is limited to the value of your services, $15,000.

Income from a corporation.

Example 1. You are a U.S. citizen and an officer and stockholder of a corporation in Honduras. You perform no work or service of any kind for the corporation. During the tax year you receive a $10,000 “salary” from the corporation. The $10,000 clearly is not for personal services and is unearned income. Example 2. You are a U.S. citizen and work full time as secretary-treasurer of your corporation. During the tax year you receive $100,000 as salary from the corporation. If $80,000 is a reasonable allowance as pay for the work you did, then $80,000 is earned income.

Stock options.

You may have earned income if you disposed of stock that you got by exercising a stock option granted to you under an employee stock purchase plan. If your gain on the disposition of stock you got by exercising an option is treated as capital gain, your gain is unearned income. However, if you disposed of the stock less than 2 years after you were granted the option or less than 1 year after you got the stock, part of the gain on the disposition may be earned income. It is considered received in the year you disposed of the stock and earned in the year you performed the services for which you were granted the option. Any part of the earned income that is due to work you did outside the United States is foreign earned income. See Pub. 525, Taxable and Nontaxable Income, for a discussion of the treatment of stock options.

Royalties.

Royalties received by a writer are earned income if they are received:  (1) For the transfer of property rights of the writer in the writer's product, or (2) Under a contract to write a book or series of articles.

Royalties from the leasing of oil and mineral lands and patents generally are a form of rent or dividends and are unearned income.

Rental income.

Generally, rental income is unearned income. If you perform personal services in connection with the production of rent, up to 30% of your net rental income can be considered earned income. Example. Larry Smith, a U.S. citizen living in Australia, owns and operates a rooming house in Sydney. If he is operating the rooming house as a business that requires capital and personal services, he can consider up to 30% of net rental income as earned income. On the other hand, if he just owns the rooming house and performs no personal services connected with its operation, except perhaps making minor repairs and collecting rents, none of his net income from the house is considered earned income. It is all unearned income.

Use of employer's property or facilities.

If you receive fringe benefits in the form of the right to use your employer's property or facilities, the fair market value of that right is earned income. Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being required to buy or sell, and both having reasonable knowledge of all the necessary facts. Example. You are privately employed and live in Japan all year. You are paid a salary of $6,000 a month. You live rent-free in a house provided by your employer that has a fair rental value of $3,000 a month. The house is not provided for your employer's convenience. You report on the calendar-year, cash basis. You received $72,000 salary from foreign sources plus $36,000 fair rental value of the house, or a total of $108,000 of earned income.

Do Not Include in Foreign Earned Income:

Source of Earned Income

The source of your earned income is the place where you perform the services for which you received the income. Foreign earned income is income you receive for performing personal services in a foreign country. Where or how you are paid has no effect on the source of the income. For example, income you receive for work done in France is income from a foreign source even if the income is paid directly to your bank account in the United States and your employer is located in New York City.

If you receive a specific amount for work done in the United States, you must report that amount as U.S. source income. If you cannot determine how much is for work done in the United States, or for work done partly in the United States and partly in a foreign country, determine the amount of U.S. source income using the method that most correctly shows the proper source of your income. In most cases you can make this determination on a time basis. U.S. source income is the amount that results from multiplying your total pay (including allowances, reimbursements other than for foreign moves, and noncash fringe benefits) by a fraction. The numerator (top number) is the number of days you worked within the United States. The denominator (bottom number) is the total number of days of work for which you were paid.

Example:

You are a U.S. citizen, a bona fide resident of Country A, and working as a mining engineer. Your salary is $76,800 per year. You also receive a $6,000 cost of living allowance, and a $6,000 education allowance. Your employment contract did not indicate that you were entitled to these allowances only while outside the United States.

Your total income is $88,800. You work a 5-day week, Monday through Friday. After subtracting your vacation, you have a total of 240 workdays in the year. You worked in the United States during the year for 6 weeks (30 workdays). The following shows how to figure the part for work done in the United States during the year. Number of days worked in the United States during the year (30) ÷ Number of days of work during the year for which payment was made (240) × Total income ($88,800) = $11,100.

Your U.S. source earned income is $11,100.

 

Sources: 

https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion-what-is-foreign-earned-income

https://www.irs.gov/pub/irs-pdf/p54.pdf