Exclude Me? Pt III

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In Part I and Part II of this series, I introduced you to the  Foreign Earned Income Exclusion and Housing Exclusion and Deduction,  a list of definitions, the “mechanics” of the exclusions and deduction , explained how they reduce the income tax liability of qualified taxpayers, and discussed IRS Form 2555-EZ.

Now for the heart of it all — employing the earned income exclusion and the housing exclusions/deductions, and completing and filing Form 2555.

Visa Assistance

The same caveats of not being all-inclusive and being current as of the date of writing, as explained earlier in the other parts of the article, still apply.

If you have a personal tax question regarding this topic, please contact me here  or use the similar tab just above this article.

Housing Exclusion or Deduction?

Part II ended with an unresolved question:  Can a taxpayer employ both the housing exclusion and deduction?  The answer, unfortunately, is “Probably not.”  You may receive a benefit for housing expenses, but it will most likely be one or the other.  Who decides?  In a way, you do.  I should say your means of earning the income does.

The housing exclusion is available to those who earn income as an employee for someone else.  The housing deduction is available to self-employed individuals.  Someone who earns income by both means (i.e., has a job and has a business on the side) can avail of both the exclusion and the deduction, but must allocate earned income.  The taxpayer allocates income earned from the job to the exclusion calculation, and income earned from the business to the deduction calculation.

The Heart of It All

Form 2555

Generally speaking — Form 2555 is the form used for claiming the foreign earned income exclusion and/or foreign housing exclusion or deduction. If you will claim a housing exclusion or deduction, you must use Form 2555.  The form itself is a little more involved than its “EZ-er” cousin, but then it serves a larger purpose.

It’s broken into nine parts and it handles almost every permutation or combination of exclusions and/or deduction.  Let’s go through these parts; it’s the best way to gain an understanding of the “mechanics.”

Part I — This part, General Information, collects historical and current information that supports your eligibility to claim the exclusions and/or deduction.  The questions are simple; answering them may require just a little thought and exercise of memory.

Part II & Part III — These parts will document your qualifying to claim the exclusions and/or deductions by either the Bona Fide Resident Test (Part II) or the Physical Presence Test (Part III).  You select the part — either Part II or Part III, not both — that best documents your qualification.  Answer all relevant questions, and insert “N/A” in those that do not apply to your situation.  Additionally, enter “N/A” as the answer for the first question of the part you do not use, and skip the rest of it.

Part IV — Here is where “the numbers” start.  This part documents your foreign earned income, broken down by methods of earning it.

NBMost income tax treaties (including the USA-RP income tax treaty) stipulate that the sourcing of earned income is to the location where the taxpayer earns it.  If you earn income in the Philippines then, by treaty agreement, it is “foreign earned income” for USA income tax purposes.

Earned income is not merely wages, salaries, commissions or business income.   It includes other items such as:

  • Non-cash income, in the form of lodging, meals, car or other property or facilities provided by your employer;
  • Allowances, reimbursements or expenses paid on your behalf; and
  • Other forms of earned income described in the Form 2555 instructions.

Adding all of these together provides you with your foreign earned income used to report and to calculate exclusions and deduction.

Part V — This is the easiest part of the entire form.  It merely asks if you are claiming the Housing Exclusion and/or Deduction.  If you are, you check the “Yes” box and continue to Part VI.  If you answer “No,” you skip Part VI and go directly to Part VII.

Part VI — Directed here by the answer provided in Part V, this part seeks your qualified housing expenses, where you incurred them, and over how many days in the year over which you incurred them.  Did I mention the housing exclusion and/or deduction is limited?  It is.  The IRS assigns a per diem rate (found in a table at the end of the instruction booklet) to the country or area where you incurred your expenses.  Multiply this rate by the number of days provided earlier.  So you are limited to either your actual qualified expenses or to the per diem limit, whichever is smaller.

Back in the second part of this article, I mentioned a limit to the foreign earned income for which you can claim the exclusions and deduction.  For 2009, that limit was $91,400; your total exclusions and/or deduction cannot exceed that amount.  It is here in the form’s Part VI that you calculate the housing expense portion of that limit.  The calculation is straightforward, albeit strange looking.  Multiply another per diem rate ($40.07 for 2009) by the number of days provided earlier.  If you incurred the expenses over the entire year (365 days), the amount is $14,624.  Subtract this amount from your limited expenses describer in the previous paragraph.

If the result is zero or less, you are finished with the housing parts – you can’t calculate a housing exclusion in Part VI and you can’t calculate a housing deduction in Part IX.  You do not complete the rest of Part VI and move directly to Part VII.  If the result is greater than zero, then you apportion that result to arrive at your housing exclusion.  Calculate the rate of apportionment by dividing the employer-provided earned income by your total foreign earned income calculated in Part IV.  Multiply this rate against the result of the limited expense calculation described in the last paragraph to provide the amount of housing exclusion that eligible taxpayers may claim.

Even if you are self-employed, you must complete Part VI to provide the amounts reported in the remaining parts of the form.

Part VII — Everyone completes this part – it calculates the Foreign Income Exclusion.  Again, the calculation is straightforward but strange looking.  All it really does is calculate this exclusion as equal to the limit ($91,400) or an amount apportioned to the number of qualifying days (the same number of days reported in Part VI, if you completed that part) for the exclusion that fall in the tax year (2009).

Part VIII — Another easy part, this one merely adds your foreign earned income exclusion and housing exclusion amounts together and has you subtract the deductions allocated to this total.  The result is the amount you will actually exclude from your income.  Here, the form tells you how and where to enter them on your Form 1040.

Part IX — This final part is for the self-employed – it calculated the Housing Deduction.  Again, it’s straightforward but strange looking.  The first strange looking item is a provision printed at the top of this part.  It says that you can complete this section only if you meet two calculated criteria.  If you cannot, you won’t have a housing deduction.  The criteria are:

  • Your limited housing expenses, as calculated in Part VI, are larger than the potential housing exclusion calculated in that same part; and
  • Your total foreign earned income, as calculated in Part IV, is larger than the sum of the potential foreign income exclusion and the housing exclusion, as calculated in Part VIII.

If you meet these two criteria, then you find the differences between the amounts listed for each of the criteria, and use the smaller of these two differences to calculate your housing deduction.  This is a simple calculation.  You merely add any unused housing deduction from the prior tax year (2008).  This is your housing deduction.

Lastly, this part instructs you on the how and where to enter the housing deduction in your Form 1040.  That’s it!


The Foreign Earned Income Exclusion and Housing Exclusion/Deduction are one of two tools devised to lower your U.S. income tax liability.  It does so by lowering your taxable income by amounts attributable to income earned in a foreign country.  Calculation and reporting of the exclusions/deduction occur on Form 2555, or Form 2555-EZ if you employ the foreign income exclusion alone.

The second tool, mentioned way earlier in a different part of this multi-part article, is the use of the Foreign Tax Credit, as calculated and reported on Form 1116.  Since the Foreign Earned Income Exclusion and Housing Exclusion/Deduction may not eliminate all foreign income taxable in the U.S., you can eliminate or significantly reduce the U.S. income tax on the remaining foreign earned income by applying this tax credit.  You qualify for this credit if you paid taxes on that remaining foreign earned income to a country with which the U.S. has an income tax treaty taxed it.

If you haven’t figured it out already, here’s the Bottom Line:  These are the methods available to you to prevent the double taxation of your income by two or more countries.

Some tax agency, whether the IRS or its counterpart in a foreign country, will receive income tax revenue from you.  One agency may receive all, or each will receive its apportioned part.  You will pay income taxes, however.  The wise move is to make sure you only pay them ONCE.


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.

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Paul is a CPA and a retired tax accountant, having served companies and corporations of all sizes, as well as individuals, in public accounting practices. Prior to what he refers to as his "real job," he served a 24-year career in the U.S. Navy, retiring as a Master Chief Petty Officer. It was during this career that he met and married his OFW spouse of 40+ years, Emy, while stationed in London, UK. (Though he pleaded for the assignment, Paul never received orders to the Philippines.) A "Phil-phile" from an early age, Paul remembers his first introduction to the Philippines in the primary grades of a parochial elementary school where, one week each year, children donated their pennies to purchase school supplies, food and other necessities for Filipino children in need. That love for Filipinos continues to this day. Calling Pasuquin, Ilocos Norte--in the far northwestern part of Luzon--home (just about as far away from Davao as one can be while still being on one of the major islands) Paul prefers a more relaxed provincial life style, and willingly shares a different view of the Philippines from "up north"!

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12 years ago

Hey paul,

Lots of good info here, however, Im not at this stage yet. I’m still wondering if I’m even going to have anything to retire on. To be truthful, I’m scared. The U.S. is so far in debt, Social Security may be bankrupt soon. There is only two ways out of this problem…The US can either tax their way out of it, or inflate their way out.
I don’t mean to sound like a pessimist, but I really am worried.

12 years ago
Reply to  hudson

Hi Hudson – I’d say that the trick is for a person not to run up debts like the U.S. is currently doing. The only way the U.S. is going to solve its financial imbalance is to cut its spending. Champaign tastes with beer pocketbooks always produces the worst hangover headaches. Higher tax rates or additional taxes will result in lower revenue – a lesson of the 20th Century that has yet to be learned by any government (except, perhaps, New Jersey). Printing money, if it can qualify as a form of solution, is very short-term. Debt tends to hang… Read more »

John Reyes
12 years ago

“ask some of the South American counties that inflated their currency how their debt situation is (answer: worse).”

Argentina’s economic meltdown, once one of the wealthiest nations in 1900, easily comes to mind, Paul.

Although the monthly Social Security benefit may be more than enough for some people to live comfortably in the Philippines, one should never depend on Social Security alone to finance his/her retirement, as it is the weakest source of retirement income a person could possibly have.

12 years ago
Reply to  John Reyes

Hi John – We totally agree on the same issues (as usual!). Yes, Argentina is a perfect example, with a few more hot on its tail to gain similar recognition (including Venezuela). The “security net” of Social Security has been stretched so taut to include many benefits not originally in the plan (and, as a result, not fully funded but relying heavily on the worker-to-retiree ratio) that no one should consider it the “insurance policy” it’s been sold as over the past 70-80 years. If anyone wants to rely on Social Security as their sole source of retirement income, they… Read more »

12 years ago

Paul..Nice post here…Your tax idea’s are well worth reading.As far as SS goes,every time I get My SS Check..I wonder how many more there will be…So..I enjoy each one on the premise it may be the last one, other wise, one should not plan their life around a Social Security check or on the idea that the Goverment will take care of you…I took mine at age 62 along with the 25% Penalty for going early with SS. My thinking was would rather get some of that while some is available and did not belive that the full retirment amount… Read more »

12 years ago
Reply to  Dan

Hi Dan – Thanks for the kind words and for your observations. Yes, SS is not the safety net it once was. When the baby boomers start tapping into SS “for real,” then we’ll here squeals out of Washington, DC! Those squeals will be much, much louder than the “prophetic” shouts of, “Watch out – you’re running the well dry,” that are heard today. On the note of taking SS at age 62, there’s nothing wrong with that. Unless you live past about age 87 (I don’t have the statistics immediately in front of me), the total benefits you’ll receive… Read more »

Paul Thompson
12 years ago
Reply to  Paul

The people who most take the time to vote in the U.S. are retired and or reaching retirement age. I want to meet the dumb member of the House who would dare bring up the subject of messing with SS. Or how would our Standing Military react is one of these knuckleheads tried to change Military retirements? I think I’ll be able to sleep well every night and think about important things, like the price of SMB’s.

12 years ago
Reply to  Paul Thompson

Hi Paul – Well, the “voting constituency” seems to have taken on a largess mentality when it comes to SS. Anyone could say (and prove that they could follow through) that they wanted to change SS from its current system to handing out gold bullion monthly. That constituency will only listen up to the words “change SS,” block out everything else, pick up the picket sign, and protest the removal of what they believe to be is some God-given right. In the name of receiving SS pennies, they’d forgo receiving dollars from a sounder, alternative source. I think it’s sort… Read more »

Paul Thompson
12 years ago

Hi Paul;
SS is somewhat of a right, we were forced to pay in every working day of our life, with the hope that it would supplement our retirement. The fund was quite large until members of Congress in the 60’s took the money to fight an Ill advised war, and re-wrote the law to be funded by congress every year vice the fund. Now that the costs have gone up, the law they wrote is not such a good idea anymore. It was well written in the 1930’s and should have been left alone.

12 years ago
Reply to  Paul Thompson

Hi Paul – Yes, Congress now trades government bonds for social security revenue whereas the revenue funded the benefits directly when the system was first instituted. That maakes some pundits refer to it as being like an official I.O.U. system. Still other pundits will say that, when you look at the first benefit recipients, it’s hard not to think that the whole thing started off as one legal ponzi scheme. Clock forward, now, by around 80 years, and the “investors” are starting to wonder whether they’ll have any return on investment even half as good as those first in. 😯… Read more »


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