U.S. Tax Preparation Worldwide
James Maertin CPA
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
Earned income is pay for personal services performed, such as:
Self employment income for performing services
Professional fees for performing services
Income as an artist from the sale of artwork
Scholarship or fellowship grant that is paid to you for
teaching, research, or other services
Certain noncash income and allowances or reimbursements, such
as the fair market value of property or facilities provided to you by your
employer in the form of lodging, meals, or use of a car
reimbursements paid to you for the following items:
- Cost of living
- Overseas differential
- Home leave
Business profits, royalties,
rents are considered variable income and can either be earned income,
unearned income, or both some of each. See below under earned and unearned
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.
Earned Income: If you are a sole proprietor or
partner and your personal services are also an important part of producing
the income, the part of the income that represents the value of your
personal services will be treated as earned income.
Unearned Income: Income from a business in which
capital investment is an important part of producing the income may be
Capital a factor. If capital investment is an
important part of producing income, no more than 30% of your share of the
net profits of the business is earned income. If you have no net profits,
the part of your gross profit that represents a reasonable allowance for
personal services actually performed is considered earned income. Because
you do not have a net profit, the 30% limit does not apply.
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,
Income from a corporation.
The salary you receive from a
corporation is earned income only if it represents a reasonable allowance as
compensation for work you do for the corporation. Any amount over what is
considered a reasonable salary is unearned income.
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.
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
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
Royalties from the leasing of oil and mineral lands and
patents generally are a form of rent or dividends and are unearned 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
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:
- Expenses reimbursed by your employer
(unless the reimbursement was more than the expense, with a few exceptions)
- Pension or annuity payments including
social security benefits
- Pay you receive as an employee of the
- Amounts included in your income because
of your employer's contributions to a nonexempt employee trust or to a
nonqualified annuity contract
- Recaptured unallowable moving expenses
- Payments received after the end of the
tax year following the tax year in which you performed the services that
earned the income
- The value of meals and lodging provided
to you and your family by your employer at no charge if the following
conditions are met:
1. The meals are furnished: a. On the business premises of your
employer, and b. For the convenience of your employer.
2. The lodging is furnished: a. On the business premises of your
employer, b. For the convenience of your employer, and c. As a condition of
If these conditions are met, don’t include the value of the meals
or lodging in your income, even if a law or your employment contract says
that they are provided as compensation.
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.
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.