Good news arrived recently for American expats regarding their U.S. income tax returns:
- The foreign earned income exclusion for 2013 was increased to USD 97,600 from the 2012 level of USD 95,100.
- Tax rates for incomes below USD 400,000 remain unchanged.
Americans living outside the USA must continue to file U.S. income tax returns, and pay U.S. tax on their worldwide income. They may use one or both of two benefits to reduce their U.S. tax:
- Foreign tax credit, and
- Foreign earned income exclusion.
A credit is allowed for foreign income taxes paid or accrued. The credit is limited to that part of U.S. tax due to foreign source income. It is not refundable, but any excess credit may be carried to other years to reduce tax.
Foreign Earned Income Exclusion
In addition, an American living and working outside the USA (expat) may exclude from taxable income his or her income earned from work outside the USA. This exclusion is in two parts. The basic exclusion is limited to USD 95,100 for the 2012 tax year, and to USD 97,600 for the 2013 tax year. These amounts are determined on a daily pro rata basis for all days on which the expat qualifies for the exclusion. In addition, the expat may exclude the amount he or she paid for housing in a foreign country in excess of 16% of the basic exclusion. This housing exclusion is limited by jurisdiction. For 2012, the housing exclusion is the amount paid in excess of USD 41.57 per day. For 2013, the amounts in excess of USD 42.78 per day may be excluded.
To qualify for the exclusion, the taxpayer must meet one of two tests: the bona fide resident test or the physical presence test. The test applies separately to each day of the tax year. To meet the bona fide resident test, the expat must be a resident of a foreign country on that day and the day must be in a period of such residence that includes a full tax year. To meet the physical presence test, he or she must be outside the USA on the day and the day must be in a 365 day period that includes 330 days outside the USA. For the latter test, there may be overlapping 365 day periods that qualify.
Example: Jerry, an American citizen, earns USD 105,000 from salary and is a resident of Zaire. Jerry has no other income. Due to the exclusion, personal exemption, and standard deduction, Jerry will have no U.S. income tax.
Congress finally acted on New Year’s Day, passing the “fiscal cliff” legislation. This law extended the existing tax rate structure for single taxpayers with taxable income of less than USD 400,000, and married taxpayers with taxable income of less than USD 450,000. For those with higher incomes, the top tax rate was increased to 39.6% These limits are determined before the foreign earned income exclusion.
Example: Mary, an American citizen, is single and lives in Bermuda. She earns a salary of $450,000. Part of Mary’s income will be subject to U.S. income tax at the 39.6% tax rate.
In addition, the exclusion is not the only good thing that increased. The income level at which each tax bracket applies was also increased for inflation.
American expats must file U.S. income tax returns by June 15 following the tax year. They can get an automatic extension of time to file their returns until October 15.
The increased foreign earned income exclusion, increased tax bracket income levels, and continuation of Bush era lower tax rates are all good news for all American expats. Tax rules for expats are complex. Get the professional help you need to file your return correctly and minimize your U.S. tax.