Navigating the complex world of expatriate taxes can be daunting, especially when it comes to understanding the nuances of foreign housing exclusions and deductions. If you're a U.S. citizen or a resident alien working abroad, or if you have income earned in foreign countries, there are specific tax rules tailored for you. This guide aims to break down these rules, making them clear and accessible.
Key Takeaways:
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What can you exclude from your foreign earned income?
If you're earning income abroad, there's encouraging news for you. In addition to the foreign earned income exclusion, you might also be eligabel to exclude or deduct some of your foreign housing expenses on Form 2555 to reduce your income. But there's a catch: your tax home must be in a foreign country, and you need to qualify under either the bona fide residence test or the physical presence test.
How does the IRS foreign housing exclusion work?
The foreign housing exclusion is specifically for amounts considered paid with employer-provided funds. This means any amounts your employer pays you or incurs on your behalf that are taxable foreign earned income for that year. However, this is calculated without considering the foreign earned income exclusion.
What is the foreign housing deduction?
If you're self-employed, the housing deduction is for you. It only applies to amounts paid with self-employment earnings. So, if you're both self-employed and an employee during the tax year, you might qualify for both a foreign housing deduction and a foreign housing exclusion.
What counts as qualified housing expenses?
Housing expenses cover reasonable costs you've actually paid or incurred for housing in a foreign country for yourself and your family (if they live with you). But remember, this is only for the part of the year when you qualify for the foreign earned income exclusion.
However, not all expenses count. Lavish or extravagant expenses, the cost of buying property, furniture, accessories, and certain other expenses that increase your property's value aren't included. Also, you can't include the value of meals or employer-provided lodging that isn't part of your gross income.
What's the base housing amount?
To benefit from the foreign housing exclusion, your eligible housing expenses need to surpass 16% of the foreign earned income exclusion. For 2023, that maximum amount that can be excluded via the foreign earned income exclusion is $120,000 so 16% of this amount, $19,200, is called the base amount and is subtracted from the total housing expenses and is not excludable.
What's the maximum foreign housing exclusion for 2023?
The limitation on housing expenses is 30% of the maximum foreign earned income exclusion. Given that the maximum foreign earned income exclusion for 2023 is $120,000, the maximum foreign housing exclusion would be $36,000, which is 30% of the foreign earned income exclusion. Nevertheless, the IRS understands that some places have exceptionally high living costs so they've made exceptions for over 200 locations worldwide, allowing them to surpass the traditional 30% deduction ceiling.
Foreign Housing Exclusion Example
William Thompson, an American expatriate living in London, is an IT manager for a large public company and earned $150,000 in 2023. Living in London comes with high living costs, and John incurs significant housing expenses. Here's how he calculates his foreign housing exclusion:
Housing Expenses:
William 's monthly rent in London is $3,500.
Additional qualifying housing expenses (like utilities and renters' insurance) come to $200 per month.
Total housing expenses for the year: ($3,500 + $200) * 12 = $44,400.
Calculating the Base Housing Amount:
The IRS stipulates a base amount, typically 16% of the maximum foreign earned income exclusion, as normal living costs. For 2023, the foreign earned income exclusion is $120,000.
16% of $120,000 is approximately $19,200.
Figuring Out Qualified Housing Expenses:
William 's total housing expenses are $44,400.
He subtracts the base housing amount of $19,200.
His qualified housing expenses eligible for the exclusion are $44,400 - $19,200 = $25,200.
Applying Limitations:
For London, the IRS maximum amount is $69,500 for the year 2023 due to the high cost of living.
William's qualified expenses of $25,200 are well within this limit.
Calculating Taxable Income:
William's initial taxable income was $150,000.
He first applies the foreign earned income exclusion, reducing his taxable income to $150,000 - $120,000 = $30,000.
Next, he subtracts his qualified housing expenses of $25,200.
William's final taxable income amounts to $30,000 - $25,200 = $4,800.
By utilizing both the foreign earned income and housing exclusions, William manages to significantly reduce his U.S. tax liability, despite his high income.
Navigate Your Expat Tax Journey with Confidence!
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Article by Lewis Grunfeld, CPA
Lewis Grunfeld, CPA, is a renowned expert in international and U.S. expat taxation, with expertise spanning over ten years. He has successfully helped thousands of expats around the world navigate complex international U.S. tax regulations, and achieve significant tax savings. His work is driven by a strongly rooted passion for assisting the expat community through a wide range of tax situations, ensuring tailored solutions for each unique situation.
