What is Foreign Earned Income Exclusion.

If you are living and working abroad you may be entitled to the Foreign Earned Income Exclusion.  The foreign earned income exclusion is adjusted annually for inflation.  For 2009, you can exclude from the U.S. taxes the maximum annual amount of up to $91,400 per qualifying person.  The foreign exclusion is not a simple tax matter and it’s recommended to seek professional help from an accountant, CPA or a tax adviser.  You must have documentation that you can produce to evidence your qualification for the foreign earned income exclusion.  Here are few important facts that you should know:

• If you are a U.S. citizen or a resident alien who lives and works abroad (outside the United States), you may be able to exclude all or part of your foreign salary or wages from your income.  You may also qualify to exclude compensation for your personal services or certain foreign housing costs.

• In order to qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and earned income in that foreign country.  The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.

• The Bona find residence test, is when you reside in the foreign country for an uninterrupted period that includes an entire tax year.  A tax year is January 1 through December 31.  Taking a brief vacation or short trip out of the foreign country, will not invalidate your residency test.
• Physical Presence Test is, when you physically present and reside in the foreign country for at least 330 full days in a 12-month period.   Full day is 24 hours and the count begins at midnight, so if you arrive and leave the foreign country in the same day, you will not meet the full day requirements.

• The foreign earned income exclusion and the foreign housing exclusion or deductions are claimed using Form 2555*, Foreign Earned Income, which should be attached to the taxpayer’s individual income tax return Form 1040.  A shorter Form 2555-EZ*, Foreign Earned Income Exclusion, is available to certain taxpayers claiming only the foreign income exclusion.  The IRS will decide whether you qualify on the basis of facts you report on Form 2555.

• Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered annulled.

*Links:
• Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad 
• Form 2555, Foreign Earned Income 
• Form 2555-EZ ,Foreign Earned Income Exclusion