In Part I of this series, I introduced you to a tax saving strategy that is very relevant to living in the Philippines – to the entrepreneurs and the wage or salary workers alike – Foreign Earned Income Exclusion and Housing Exclusion and Deduction.
Additionally, I presented the basic requirements for qualifying to use these exclusions and deduction. I also exposed you to the definitions of various terms used by the Internal Revenue Service (IRS) in explaining and calculating these exclusions and deduction.
We’ll continue our series by repeating the basic qualifications and providing you with the “mechanics” for claiming these benefits. Remember: those definitions from Part I still apply throughout this part. The forms we will visit, by the way, also rely on those definitions as they the seek information to insure you are eligible.
Again, I must remind you that this article is not an all-inclusive. As with other elements of tax calculations, your particular situation may affect your eligibility or benefits. The discussion will cover the basics, and give you an idea of how these exclusions and deductions could apply to your tax return.
NB – Information provided herein is current as of this writing. With current U.S. income tax rules and regulations in a state of flux, change may occur. I’ll include any changes as a comment to the article.
If you have a personal tax question regarding this topic, please contact me here or use the similar tab just above this article.
THE BASICS — QUALIFYING
As you may remember from Pt I: There are basic requirements that a U.S. taxpayer must meet to qualify for either of these exclusions or the deduction:
- must have a tax home in a foreign country,
- must have foreign earned income, and
- must be either:
- a U.S. citizen living in a foreign country, who meets the bona fide residence test,
- a U.S. resident alien, who is a citizen or national of a foreign country with which the U.S. has an income tax treaty in effect, is living in a foreign country, and meets the bona fide residence test, or
- a U.S. citizen or U.S. resident alien, who meets the physical presence test.
To claim the exclusions or deduction, the taxpayer must complete and file Form 2555-EZ (if eligible) or Form 2555 with their Form 1040 tax return. (Individuals filing either Form 2555-EZ or Form 2555 must file Form 1040.)
THE MECHANICS — LOWERING THE TAX BILL
In General — Most U.S. taxpayers who are residents in the Philippines and earning income here generally qualify for the either of the exclusions or the deduction. Double-check “The Basics–Qualifying” above to make sure. It’s too bad, though, that you “can’t have it all.” That is to say, you can’t use all of the different exclusions or the deduction unless your income and its sources meet certain standards. We’ll discuss this as we go along.
Regarding Form 2555-EZ
Using the Foreign Earned Income Exclusion alone — Using this exclusion alone is the simplest way to go about things. This is especially true if your foreign earned income consists of wages/salaries alone and is equal to or less than the exclusion limit. You want something simple without needing to calculate the housing exclusion and/or deduction. Instead of filing Form 2555, using Form 2555-EZ is the way to go.
In addition to the qualifying requirements above, you must meet these to file Form 2555-EZ:
- you had total foreign earned income equal to or less than the specified limit ($91,400 in tax year 2009),
- you do not have self-employment income,
- you do not have any business/moving expenses, and
- you do not claim the foreign housing exclusion or deduction.
NB: If the only earned income from work abroad is pay you received from the U.S. Government as its employee, you do not qualify for the foreign earned income exclusion, and cannot file Form 2555-EZ.
The form is straightforward, and the instructions are very easy to read and comprehend (even for an IRS instruction set!).
Using the Foreign Earned Income Exclusion and Foreign Tax Credit — Requirement-driven calculations could make some of your foreign earned income ineligible for this exclusion. (The income that cannot be excluded is the difference between lines 17 & 18 on Form 2555-EZ.) What can you do?
If you paid foreign income tax on your foreign earned income, you can claim a foreign tax credit equal to the foreign income tax you paid that was related to the income that cannot be excluded. To do this, you would complete and attach Form 1116 to your tax return. We discussed this form and strategy in that earlier article I’ve already mentioned.
I thought I could get through this topic in two parts, but it appears that three are needed. The next installment will discuss employing the housing exclusion/deduction along with the income exclusion. It’s too tall of an order to include all of that here. We’ll also explore the ins and outs of Form 2555 — the “big brother” of the “EZ” form. We’ll also uncover the mystery surrounding that “exclusion/deduction” business. Can you take both, or are you limited to one or the other, or what?
You’ll find out in the next part.
IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, I must inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.