Every U.S. citizen or permanent resident, regardless of whether they are living in the U.S., must file a US income tax return with the IRS to report their worldwide income. If you are an expat living outside of South Carolina, no problem.
A large segment of our client base resides or conducts business outside of South Carolina and we are comfortable communicating through phone calls, emails, or other virtual channels preferred by our clients. We use secure client portals to safely exchange tax, accounting and financial information, giving our clients immediate access to excellent service and advice, while also saving time and money.
Foreign Tax Credit
The Foreign Tax Credit is useful for any American who has paid taxes overseas. The Foreign Tax Credit does not obligate a person to prove residence in an overseas location. If a U.S. citizen works overseas or is involved in foreign investments, it is likely that he or she has paid taxes to a foreign government. If the tax rate of the foreign country is equal to or greater than the U.S. tax rate, the Foreign Tax Credit will successfully rid the expat of any U.S. tax obligation on that amount.
Simply put, by claiming the FTC the U.S. tax obligation is lowered by the amount paid to the foreign government. The qualifications are straightforward:
- Only income tax is credited.
- The credited amount cannot exceed the amount that would have been owed to the U.S. government. If the income tax paid to a foreign government far exceeds the amount of the credit (because the foreign tax rate far exceeded the US rate), the expat will forfeit that amount. The credit, however, can be carried into the future.
- Although they are foreign taxes, expats cannot claim a credit for taxes on:
- Excluded income (the Foreign Earned Income Exclusion, income from Puerto Rico and Possessions).
- Taxes Imposed By Sanctioned Countries (Cuba, Iran, Libya, North Korea, Sudan, Syria.
- Foreign mineral income.
- International boycott operations.
- S. persons controlling foreign corporations and partnerships who fail to file required information returns.
- Foreign oil/gas extraction income.
Foreign taxes that cannot be credited through Foreign Tax Credit method are still eligible to be claimed as part of itemized deductions.
Which Tax Form Do I Use to Claim the Foreign Tax Credit?
You must file the Form 1116 to claim the foreign tax credit, however, several Form 1116s may have to be filed for each year depending if you have different categories of income. The complexity of the form itself and its 23 pages of instructions can be overwhelming. Not only does the Foreign Tax Credit need to be calculated for regular tax purposes for each category of income, but also for Alternative Minimum Tax (AMT) purposes. That is why it is wise to hire an international tax expert to help you with your tax returns. But read on.
You must file the Form 1116 with your income tax return for each of the following categories of income for which you are claiming a credit unless you meet one of the exceptions.
- Passive Category Income.
- General Category Income.
- Section 901(j) Income.
- Income Re-Sourced by Treaty.
- Lump-Sum Distributions.
The exceptions include:
- Your only foreign source gross income for the tax year is passive category income. For purposes of this rule, high taxed income and export financing interest are also passive category income.
- Your qualified foreign taxes for the tax year are not more than $300 ($600 if married filing a joint return).
- All of your gross foreign income and the foreign taxes are reported to you on a payee statement (such as a Form 1099-DIV or 1099-INT).
- You elect this procedure for the tax year.
- If you are a shareholder of a controlled foreign corporation and chose to be taxed at corporate rates on the amount you must include in gross income from that corporation.
Foreign Earned Income Exclusion
Alongside the Foreign Tax Credit, the Foreign Earned Income Exclusion is the largest tax advantage available to you as an expat. If you qualify, your first $112,000 (2022) earned overseas is exempt from income tax, unless you are an employee of the U.S. government. Note that if you are a Foreign Service employee, and your spouse works in the local economy, the exemption still applies for your spouse.
To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must meet all three of the following requirements.
- Your tax home must be in a foreign country.
- You must have foreign earned income.
- You must be either:
- A U.S. citizen who is a bona fide resident of a foreign country of 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.
Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee of self-employed individual. Having a “tax home” in a given location does not necessarily mean that the given location in your residence or domicile for tax purposes.
Temporary or Indefinite Assignment
The location of your tax home often depends on whether your assignment is temporary or indefinite. If you are temporarily absent from your tax home in the United States on business, you may be able to deduct your away-from-home expenses (for travel, meals, and lodging), but you would not qualify for the foreign earned income exclusion. If your new work assignment is for an indefinite period, your new place of employment becomes your tax home and you would not be able to deduct any of the related expenses that you have in the general area of this new work assignment. If your new tax home is in a foreign country and you meet the other requirements, you earnings may qualify for the foreign earned income exclusion.
- If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise.
- If you expect it to last for more than 1 year, it is indefinite.
- If you expect it to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary (in the absence of facts and circumstances indicating otherwise) until your expectation changes. Once your expectation changes, it is indefinite.
Bona Fide Residence Test
You meet the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. Your bona fide residence is not necessarily the same as your domicile. Your domicile is your permanent home, the place to which you always return or intend to return.
Example. You could have your domicile in Cleveland, Ohio and a bona fide residence in Edinburgh, Scotland, if you intend to return eventually to Cleveland.
The fact that you go to Scotland does not automatically make Scotland your bona fide residence. If you go there as a tourist, or on a short business trip, and return to the United States, you have not established bona fide residence in Scotland. But if you go to Scotland to work for an indefinite or extended period and you set up permanent quarters there for yourself and your family, you probably have established a bona fide residence in a foreign country, even though you intend to return eventually to the United States. You are clearly not a resident of Scotland in the first instance. However, in the second, you are a resident because your stay in Scotland appears to be permanent. If your residency is not as clearly defined as either of these illustrations, it may be more difficult to decide whether you have established a bona fide residence.
Determination. Questions of bona fide residence are determined according to each individual case, taking into account factors such as your intention, the purpose of your trip, and the nature and length of your stay abroad.
Statement to Foreign Authorities
You are not considered a bona fide resident of a foreign country if you make a statement to the authorities of that country that you are not a resident of that country, and the authorities:
- Hold that you are not subject to their income tax laws as a resident, or
- Have not made a final decision on your status.
Special Agreements and Treaties
An income tax exemption provided in a treaty or other international agreement will not in itself prevent you from being a bona fide resident of a foreign country. Whether a treaty prevents you from becoming a bona fide resident of a foreign country is determined under all provisions of the treaty, including specific provisions relating to residence or privileges and immunities.
Uninterrupted Period Including Entire Tax Year
To meet the bona fide residence test, you must reside in a foreign country or countries for an uninterrupted period that includes an entire tax year. An entire tax year is from January 1 through December 31 for taxpayers who file their income tax returns on a calendar year basis. During the period of bona fide residence in a foreign country, you can leave the country for brief or temporary trips back to the United States or elsewhere for vacation or business. To keep you status as a bona fide resident of a foreign country, you must have a clear intention of returning from such trips, without unreasonable delay, to your foreign residence or to a new bona fide residence in another foreign country.
Example 1. You arrived with your family in Lisbon, Portugal, on November 1, 2006. Your assignment is indefinite, and you intend to live there with your family until your company sends you to a new post. You immediately established residence there. You spent April of 2007 at a business conference in the United States. Your family stayed in Lisbon. Immediately following the conference, you returned to Lisbon and continued living there. On January 1, 2008, you completed an uninterrupted period of residence for a full tax year (2007), and you meet the bona fide residence test.
Example 2. Assume the same facts as in Example 1, except that you transferred back to the United States on December 13, 2007. You would not meet the bona fide residence test because your bona fide residence in the foreign country, although it lasted more than a year, did not include a full tax year. You may, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction under the physical presence test (discussed later).
Bona Fide Resident For Part of a Year
Once you have established bona fide residence in a foreign country for an uninterrupted period that includes an entire tax year, you are a bona fide resident of that country for the period starting with the date you actually began the residence and ending with the date you abandon the foreign residence. Your period of bona fide residence can include an entire tax year plus parts of 2 other tax years.
Example. You were a bona fide resident of Singapore from March 1, 2006, through September 14, 2008. On September 15, 2008, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2007, you were also a bona fide resident of a foreign country from March 1, 2006, through the end of 2006 and from January 1, 2008 through September 14, 2008.
Reassignment. If you are assigned from one foreign post to another, you may or may not have a break in foreign residence between your assignments, depending on the circumstances.
Example 1. You were a resident of Pakistan from October 1, 2007, through November 30, 2008. On December 1, 2008, you and your family returned to the United States to wait for an assignment to another foreign country. Your household goods also were returned to the United States. Your foreign residence ended on November 30, 2008, and did not begin again until after you were assigned to another foreign country and physically entered that country. Since you were not a bona fide resident of a foreign country for the entire tax year of 2007 or 2008, you do not meet the bona fide residence test in either year. You may, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction under the physical presence test, discussed later.
Example 2. Assume the same facts as in Example 1, except that upon completion of your assignment in Pakistan you were given a new assignment to Turkey. On December 1, 2008, you and your family returned to the United States for a month’s vacation. On January 2, 2009, you arrived in Turkey for your new assignment. Because you did not interrupt your bona fide residence abroad, you meet the bona fide residence test.
Physical Presence Test
You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive. Any U.S. citizen or resident alien can use the physical presence to qualify for the exclusions and the deduction. The physical presence test is based only on how long you stay in a foreign country or countries. This test does not depend on the kind of residence you establish, your intentions about returning, or the nature and purpose of your stay abroad.
330 Full Days
Generally, to meet the physical presence test, you must be physically present in a foreign country or countries for at least 330 full days during a 12-month period. You can count days you spent abroad for any reason. You do not have to be in a foreign country only for employment purposes. You can be on vacation. You do not meet the physical presence test if illness, family problems, a vacation, or your employer’s orders cause you to be present for less than the required amount of time.
Exception. You can be physically present in a foreign country or countries for less than 330 full days and still meet the physical presence test if you are required to leave a country because of war or civil unrest.
A full day is a period of 24 consecutive hours, beginning at midnight.
When you leave the United States to go directly to a foreign country or when you return directly to the United States from a foreign country, the time you spend on or over international waters does not count toward the 330-day total.
Example. You leave the United States for France by air on June 10. You arrive in France at 9:00 a.m. on June 11. Your first full day of physical presence in France is June 12.
Passing Over a Foreign Country
If, in traveling from the United States to a foreign country, you pass over a foreign country before midnight of the day you leave, the first day you can count toward the 330-day total is the day following the day you leave the United States.
Example. You leave the United States by air at 9:30 a.m. on June 10 to travel to Kenya. You pass over western Africa at 11:00p.m. on June 10 and arrive in Kenya at 12:30 a.m. on June 11. Your first full day in a foreign country is June 11.
Change of Location
You can move about from one place to another in a foreign country or to another foreign country without losing full days. If any part of your travel is not within any foreign country and takes less than 24 hours, you are considered to be in a foreign country during that part of travel.
Example 1. You leave Ireland by air at 11:00 p.m. on July 6 and arrive in Sweden at 5:00 a.m. on July 7. Your trip takes less than 24 hours and you lose no full days.
Example 2. You leave Norway by ship at 10:00 p.m. on July 6 and arrive in Portugal at 6:00 a.m. on July 8. Since your travel is not within a foreign country or countries and the trip takes more than 24 hours, you lose as full days July 6, 7, and 8. If you remain in Portugal, your next full day in a foreign country is July 9.
In United States While in Transit
If you are in transit between two points outside the United States and are physically present in the United States for less than 24 hours, you are not treated as present in the United States during the transit. You are treated as traveling over areas not within any foreign country.
How to figure the 12-month period
Your 12-month period must be made up of consecutive months. Any 12-month period can be used if the 330 days in a foreign country fall within that period.
There are four rules you should know when figuring the 12-month period.
- Your 12-month period can begin with any day of the month. It ends the day before the same calendar day, 12 months later,
- You do not have to begin your 12-month period with your first full day in a foreign country or end it with the day you leave. You can choose the 12-month period that gives you the greatest exclusion.
- In determining whether the 12-month period falls within a longer stay in the foreign country, 12-month periods can overlap one another.
Example 1. You are a construction worker who works on and off in a foreign country over a 20-month period. You might pick up the 330 full days in a 12-month period only during the middle months of the time you work in the foreign country because the first fiew and last few months of the 20-month period are broken up by long visits to the United States.
Example 2. You work in New Zealand for a 20-month period from January 1, 2007, though August 31, 2008, except that you spend 28 days in February 2007 and 28 days in February 2008 on vacation in the United States. You are present in New Zealand 330 full days during each of the following two 12-month periods: January 1, 2007 – December 31, 2007 and September 1, 2007 – August 31, 2008. By overlapping the 12-month periods in this way, you meet the physical presence test for the whole 20-month period.
Foreign Housing Exclusion and Deduction
In addition to the foreign earned income exclusion, you can also claim an exclusion or a deduction from gross income for your housing amount if your tax home is in a foreign country and you qualify for the exclusions and deduction under either the bona fide residence test or the physical presence test.
The housing exclusion applies only to amounts considered paid for with employer-provided amounts. The housing deduction applies only to amounts paid for with self-employment earnings. We discuss the Foreign Housing Exclusion and Deduction in detail on a separate page of our site.