OLT TAX CORNER ~ Foreign Income

OLT TAX CORNER ~ Foreign Income

OLT TAX CORNER ~ Foreign Income



OLT TAX CORNER ~ Foreign Income

Foreign Income FAQ
  1. What is the foreign income exclusion?
  2. What are the rules for out of country (foreign) income?
  3. I am a Canadian citizen living and working in the U.S. for a U.S. employer on a visa. Do I need to file both a U.S. tax return and a Canadian tax return?
  4. Are the Canada Pension Plan and Canadian Old Age Security Benefits taxable? If they are, please tell me where they should be entered on Form 1040.
  5. How do I know if the U.S. has an income tax treaty with another country?
  6. I am a U.S. citizen working for a U.S. firm in a foreign country. Is any part of my wages or expenses tax deductible?
  7. What is the foreign tax credit?


What is the foreign income exclusion?
International Taxpayer - Choosing The Foreign Income Exclusion

The foreign earned income exclusion is voluntary. You can choose the foreign earned income exclusion and the foreign housing exclusion by completing the appropriate parts of Form 2555. Your initial choice of the exclusions on Form 2555 generally must be made with:
  • a timely filed return (including any extensions),
  • a return amending a timely filed return,
  • or a late-filed return filed within 1 year from the original due date of the return (determined without regard to any extensions).
You can choose the exclusion on a return filed after the periods described above, provided you owe no federal income tax after taking into account the exclusion. If you owe federal income tax after taking into account the exclusion, you can choose the exclusion on a return filed after the periods described above, provided you file before the IRS discovers that you failed to choose the exclusion. You must type or legibly print at the top of the first page of the Form 1040 "FILED PURSUANT TO SECTION 1.911-7(a)(2)(i)(D)." If you owe federal income tax after taking the foreign earned income exclusion into account and the IRS discovers that you failed to choose the exclusion, you must request a private letter ruling under Income Tax Regulation 301.9100-3 and according to the instructions contained in the very first Revenue Procedure issued by the Internal Revenue Service every year.

Once you choose to exclude your foreign earned income or housing amount, that choice remains in effect for that year and all later years unless you revoke it.

Foreign Tax Credit

Once you choose to exclude either foreign earned income or foreign housing costs, you cannot take a foreign tax credit for taxes on income you can exclude. If you do take the credit, one or both of the choices may be considered revoked.

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What are the rules for out of country (foreign) income?
With more and more United States citizens earning money from foreign sources, the IRS reminds people that they must report all such income on their tax return unless it is exempt under federal law. U.S. citizens are taxed on their worldwide income.This applies whether a person lives inside or outside the United States. The foreign income rule also applies regardless of whether or not the person receives a Form W-2, Wage and Tax Statement, or a Form 1099 (information return).
Foreign source income includes earned income, such as wages and tips, and unearned income, such as interest, dividends, capital gains, pensions, rents and royalties.
An important point to remember is that citizens living outside the U.S. may be able to exclude up to $126,500 of their 2024 foreign source income if they meet certain requirements.
If you meet certain requirements, you may qualify for the foreign earned income and foreign housing exclusions and the foreign housing deduction. If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude from income up to $126,500 of your foreign earnings. In addition, you can exclude or deduct certain foreign housing amounts. To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income, your tax home must be in a foreign country, and you must be one of the following:
  • A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year.
  • A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
  • A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
Foreign Country
To meet the bona fide residence test or the physical presence test, you must live in or be present in a foreign country. A foreign country usually is any territory (including the air space and territorial waters) under the sovereignty of a government other than that of the United States.
The term "foreign country" includes the seabed and subsoil of those submarine areas adjacent to the territorial waters of a foreign country and over which the foreign country has exclusive rights under international law to explore and exploit the natural resources. The term "foreign country" does not include Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the Virgin Islands, or U.S. possessions such as American Samoa. For purposes of the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction, the terms "foreign," "abroad," and "overseas" refer to areas outside the United States, American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, Puerto Rico, the Virgin Islands, and the Antarctic region.
To determine whether you can claim the exclusion or deduction, please begin with question 1:
  1. Do you have foreign earned income?
    1. Yes. Go to question 2.
    2. No. You CANNOT claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction.
  2. Is your tax home in a foreign country?
    1. Yes. Go to question 3.
    2. No. You CANNOT claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction.
  3. Are you a U.S. citizen?
    1. Yes. Go to question 4.
    2. No - Are you a U.S. resident alien?
      1. Yes. Are you a citizen or national of a country with which the United States has an income tax treaty in effect?
        1. Yes. Go to question 4.
        2. No. Go to question 5.
      2. No. You CANNOT claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction.
  4. Were you a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year?
    1. Yes. You CAN claim the foreign earned income exclusion and the foreign housing exclusion or the foreign housing deduction.
    2. No. Go to question 5.
  5. Were you physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months?
    1. Yes. You CAN claim the foreign earned income exclusion and the foreign housing exclusion or the foreign housing deduction.
    2. No. You CANNOT claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction.
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I am a Canadian citizen living and working in the U.S. for a U.S. employer on a visa. Do I need to file both a U.S. tax return and a Canadian tax return?
You must comply with both U.S. and Canadian filing requirements, if any. In the United States, you generally are required to file a return if you have income from the performance of personal services within the United States. However, under certain circumstances, that income may be exempt from payment of U.S. tax pursuant to the U.S.-Canada income tax treaty. You need to determine what type of visa you have, and how that impacts your residency status in the United States. If based on the tax code and your visa status, you are treated as a U.S. resident, then your entitlement to treaty benefits will be impacted. You must contact the Canadian government to determine whether you must file a Canadian tax return and pay Canadian taxes.
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Are the Canada Pension Plan and Canadian Old Age Security Benefits taxable? If they are, please tell me where they should be entered on Form 1040.
Benefits paid under the Canada Pension Plan (CPP), Quebec Pension Plan (QPP), and Old Age Security (OAS) program to a U.S. resident are taxable, if at all, only in the United States. According to the U.S.-Canada income tax treaty, taxation of these benefits is based on residence. U.S. citizens or green card holders who reside in Canada are not subject to U.S. tax on this income.
These Canadian benefits are treated as U.S. social security benefits for U.S. tax purposes. Thus, under section 86 of the Internal Revenue Code, the portion of the benefits that is taxable will depend on your income and filing status. If your modified adjusted gross income is above certain limits, a maximum of 85% of your benefits will be subject to U.S. tax. Refer to Tax Topic 423 for information about determining the taxable amount of your benefits. Any benefit under the social security legislation of Canada that would not be subject to Canadian tax if paid to a resident of Canada is not subject to U.S. tax.
Canadian benefits that are treated as U.S. social security benefits are reported on line 5a and 5b of Form 1040, U.S. Individual Income Tax Return.
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How do I know if the U.S. has an income tax treaty with another country?
IRS Publication 901, U.S. Tax Treaties, has information regarding United States tax treaties.
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I am a U.S. citizen working for a U.S. firm in a foreign country. Is any part of my wages or expenses tax deductible?
U.S. citizens are taxed on their worldwide income, no matter where they work. Some taxpayers may qualify for the foreign earned income exclusion, foreign housing exclusion, or foreign housing deduction, if their tax home is in a foreign country and they were either a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or were physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. If the taxpayer is temporarily away from his or her tax home in the United States on business (less than a year), the taxpayer may qualify to deduct away from home expenses (for travel, meals, and lodging) but would not qualify for the foreign earned income exclusion
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What is the foreign tax credit?
The foreign tax credit is intended to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived. Generally only income taxes paid or accrued to a foreign country or a U.S. possession in lieu of an income tax, will qualify for the foreign tax credit. Qualified foreign taxes do not include taxes that are refundable to you or taxes paid to countries whose government is not recognized by the United States. You can choose to take the amount of any qualified foreign taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction. To claim the foreign tax credit, you must report this information on Form 1116 and attach it to your Form 1040.

You can claim the credit for qualified foreign taxes without filing Form 1116 if all of the following requirements are met:

  1. All of your foreign source income is passive income, such as interest and dividends,
  2. All of your foreign source income and the foreign taxes are reported to you on a payee statement, such as form 1099-INT or 1099-DIV,
  3. The total of your qualified foreign taxes is not more than $300, or $600 if you are filing a joint return.
If you claim the credit directly on Form 1040 without filing Form 1116, you cannot carry back or carry-over any unused foreign tax credit to or from this year.

If you use Form 1116 to figure the credit, your foreign tax will be the smaller of the amount of foreign tax paid or accrued, or the amount of United States tax attributable to your foreign source income. This limit is computed separately for each type of income. If you cannot use the full amount of qualified foreign taxes paid or accrued, you may be allowed a 2-year carry back and then a 5-year carry-over of the unused foreign tax. You may not take either a credit or a deduction for taxes paid or accrued on income you exclude under the foreign earned income exclusion or the foreign housing exclusion. There is no double taxation in this situation because the income is not subject to United States tax.

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