U.S. citizens and resident aliens are generally taxed on their worldwide income, regardless of where the income is earned or received. A U.S. citizen who earns income in a foreign country may also be taxed on that income by the foreign host country, which may lead to possible double taxation. A number of provisions in the Tax Code help to mitigate to this potential inequity, including the foreign housing cost exclusion. Below is a brief summary of the special tax provisions that you may be able to use to offset your income tax liability while working overseas. As an NYC CPA firm, MEDOWS CPA, PLLC has a great deal of experience dealing with these types of returns and we are comfortable working remotely in case you are not currently based in the New York City area. Contact us for assistance.
Foreign Earned Income and Housing Exclusion
U.S. citizens and resident aliens are generally taxed on their worldwide income regardless of where the income is earned or received. A U.S. citizen who earns income in a foreign country may also be taxed on that income by a foreign host country, thus leading to double taxation. However, a number of tax provisions provide relief from this inequity, including the foreign tax credit and deduction, the foreign earned income exclusion, and the foreign housing cost exclusion. Based on a review of your prior year’s tax information, we feel it would be beneficial for you to meet with us to discuss tax planning regarding your foreign source income.
As you may know, taxes paid to a foreign country or possession of the United States can be claimed as either a credit or deduction. In most cases, it is more advantageous to claim the credit rather than the deduction. The credit, however, is limited to the amount of the U.S. tax that is in proportion to the foreign source taxable income over worldwide taxable income.
As an alternative, qualifying individuals may elect to exclude from gross income up to $99,200 in 2014 and $100,800 in 2015 of foreign earned income, as well as certain employer-provided housing costs. Individuals with self-employment income are also entitled to deduct certain non-employer-provided housing costs. In order to qualify for these exclusions and deductions, an individual’s tax home must be in a foreign country and he must meet either a residence or physical presence test. A determination of whether a taxpayer qualifies is based on all the facts and circumstances including:
- the taxpayer’s intention,
- the length of stay in a foreign country,
- the nature and duration of employment,
- the establishment of a home in the foreign country, and
- the nature, extent and reasons for temporary absences from the foreign home.
To substantiate eligibility for the foreign earned income and housing exclusion, a taxpayer must have adequate documentation. The IRS plans to improve compliance on international issues and expects to increase the use of foreign information documents and data sharing with other federal agencies. For instance, travel dates may be verified with U.S. passport information.
Taxpayers may not elect to take both the foreign-earned income and housing exclusions and the foreign tax credit. Also, if a taxpayer claims the foreign earned income exclusion, the taxpayer will not qualify for the earned income credit for that year. The choice between the foreign earned income and housing exclusions and the foreign tax credit depends on which option more effectively reduces taxes. If the taxpayer’s foreign earned income is subject to a higher foreign income tax than his U.S. income, it is more advantageous to claim the foreign tax credit.
In selecting the more appropriate option, a taxpayer must also consider factors, such as length and certainty of stay in a foreign country. If a taxpayer working in a high tax country revokes the election, he may not take the election for five years without permission from the IRS and, therefore, would be at a disadvantage if he were transferred to a low tax country. In addition, a “stacking rule” has been added to ensure that U.S. citizens living abroad are subject to the same U.S. tax rates as individuals living and working in the United States. Thus, income that is excluded from gross income is included for determining the applicable tax rate. Contact the NYC foreign tax specialists at MEDOWS CPA for more information.
Self-Employment Tax for Businesses Abroad
In addition, you need to be mindful of self-employment tax on income earned abroad.
The self-employment tax is a social security and Medicare tax which must be paid if your net earnings from self-employment are at least $400 for the tax year. For 2015 and 2016, the maximum amount of your net earnings from self-employment that are subject to the social security portion of the tax is $118,500. All of your net earnings are subject to the Medicare portion of the tax. As you may know, if you are a self-employed citizen or resident, the rules for paying self-employment tax are generally the same whether you are living in the United States or abroad.
Nonresident Aliens. Nonresident aliens are not subject to self-employment tax. However, self-employment income you receive while you are a resident alien is subject to self-employment tax even if it was paid for services you performed as a nonresident alien.
Effect of Foreign Earned Income Exclusion. You must take all of your self-employment income into account in computing your net earnings from self-employment, even income that is exempt from income tax because of the foreign earned income exclusion.
Income from U.S. Possessions. If you are a U.S. citizen or resident alien and you own and operate a business in Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, American Samoa, or the U.S. Virgin Islands, you must pay tax on your net earnings from self-employment (if they are $400 or more) from those sources. You must pay the self-employment tax whether or not the income is exempt from U.S. income taxes (or whether or not you must otherwise file a U.S. income tax return).
Services for Foreign Government or International Organizations. For U.S. citizens, the income paid for services rendered to a foreign government or international organization is reportable as self-employment income on their U.S. federal income tax returns, and is subject to self-employment tax to the extent such services are performed within the United States.
International Social Security Agreements. The United States has entered into social security agreements with foreign countries to coordinate social security coverage and taxation of workers employed for part or all of their working careers in one of the countries. Under these agreements, dual coverage and dual contributions (taxes) for the same work are eliminated. The agreements generally make sure that social security taxes (including self-employment tax) are paid only to one country.
Considering the complexity of issues regarding foreign earned income, it is important that a CPA in NYC review either your eligibility for the foreign earned income and housing exclusion, or the possibility of revoking the election in future years for the benefit of tax credits denied. In addition, a CPA in NYC can assist you in documenting your foreign travel and housing expenses. Contact us today.