Part 2 US Expat Tax Preparation and the Foreign Earned Income Exclusion – The Deductions

In Part 1 we covered

For a US Expat to qualify for foreign earned income exclusion during the US expat tax preparation, you must meet the following criteria in your expat tax preparation:

1. Work fulltime in a foreign country for a full calendar year known as the Bona Fide Resident Test

2. Work outside the US for a minimum of 330 days of any 365 days referred to as the Physical Presence Test

If either of these conditions are met by a person when the expat tax preparation occurs you will be able to deduct a maximum of $91,500 ,or if you are filing a joint claim you are able to deduct a maximum of $183,000 from your US expat taxes in 2010.

When doing your expat tax preparation the calculations for the foreign earned income exclusion depends completely on earned foreign income. Interest, rental income, dividends, etc. are not considered earned income and thus are not included in the calculation.

Expat Tax Preparation Deduction Problems

When it comes to expat tax preparation, the foreign earned income exclusion has some catches. For example, if you own a business you have to pay self-employment tax in the United States, and it will not be considered as part of your foreign earned income exclusion. Once you pay the self-employment tax you may still be allowed to exclude those earnings in your expat tax preparation.

Another good example is when you are self-employed and as a US Expat you move to a country where the US has a Social Security treaty in place, as is the case in the UK. The US/UK treaty permits you to opt out of US Social Security and then enroll in the UK National Insurance Plan. There is an annual savings of approx. 15% on your US expat taxes when you opt out of US Social Security.

In some cases with expat tax preparation, an expat can be taxed inside the US, even when they are a resident in a foreign country, and they have worked under 35 days within the United States. For example, let’s say you jet set off to LA to visit family for two weeks. You work daily from your hotel thanks to an employer. Then tax time comes along and during your US expat tax preparation you discover that you are required to pay US taxes the income you earned during those two weeks of working from your hotel room while visiting in the United State, even though your employer is located in a foreign country. Likely this would then be counteracted on your local country taxes.

Not all US expats can take advantage of the foreign earned income exclusion during expat tax preparation. If you are employed by the US Government and paid by the US Government you will not be allowed to use the foreign earned income exclusion to minimize the US expat taxes you owe. This includes those individual in the military. Professional help with your expat tax preparation is always a good idea.