Gone but not forgotten.
Part 2

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February 18, 2020

In Part 1 of this series, I talked about how the Foreign Tax Credit (FTC) could be used to offset your US income taxes when you earn income while living in a foreign country. (Click here to read it.)

But there are times that you may not be paying, legally, foreign taxes.

So, let’s review the Foreign Earned Income Exclusion (FEIE) which is yet another way to reduce your US taxable income. A brief recap and history of the FEIE and US taxation.

Taxation of US citizens regardless of where they lived and earned the income goes back to the 1860s off and on and was made formal in 1913 with the 16th amendment and from the outset was controversial. The more things change, the more they stay the same.

In the 1920s, you could earn an unlimited amount outside the US and it would be eligible for the FEIE. Fast forward to the 1960s, and a limit was placed on the annual amount that was eligible. The FEIE for 2019 is $105,900. It is adjusted annually for inflation.

But what is Foreign earned income? And is it subject to US taxation?

Remember that as long as you are a US citizen, your worldwide income is subject to US tax reporting. Taxation of that income is the next step.

All interest, dividends, rental income, retirement income, etc. … all UNearned income … is still taxed in the US, not subject to exclusion and taxed at the applicable rates. EARNED income is that which you receive as a result of your personal efforts, a/k/a working.

And what is FOREIGN earned income?

Contrary to what it sounds like, it is not necessarily income paid to you by a foreign employer. In fact, there are people in the US that are paid by foreign employers and that income does not qualify for the FEIE.

Foreign earned income is income that you earn while living in a foreign country, regardless of where the employer may be located. To help explain it a little better, I will give a few examples.

In the first case, the Taxpayer lives in England working for a US bank. She is a full-time resident of England and to be precise, she is paid in England by the bank’s English affiliate. Because she is living abroad, she will qualify for the FEIE (how to qualify will be explained later). Because she is having UK taxes withheld, she could also qualify for the FTC explained before. But in any case, she is earning the income while outside the US and so that is Foreign Earned Income.

Second case finds out taxpayer working remotely for a New York City based US business which pays him as a W-2 employee. He does all his work remotely and does not leave Panama at all during the year. Foreign Earned Income.

Scenario three is like number two. Except instead of being paid by the San Francisco based entity as an employee, she is paid as a subcontractor, in fact even receiving (as required by law) a 1099. All her work is also done online from her home in Colombia. FEIE applies.

And then there’s me. A CPA living in Mexico and preparing tax returns for US citizens located all over the world, including of course many located in the US. Although I do visit the US regularly to see our granddaughters, I do not earn any income while in the US. All income is earned while in Mexico. FEIE eligible.

There’s also the real estate agent referred to in the prior edition who worked for a Mexican real estate broker. She had Mexican taxes withheld and elected to claim the FTC. But she could elect to forego the credits and claim the FEIE. Whichever is advantageous.

Bottom line: If you earn the income while outside of the United States, it is foreign earned income. Then you must go through the process to see if you qualify for the FEIE.

Stay tuned for Part 3.

Have questions about your income or other US tax matters? Contact me at mgulko@gulko.com.