The most frequently discussed tax topic of concern to taxpayers residing abroad is the Foreign Earned Income Exclusion (FEI Exclusion). Confusion usually arises from the evolving regulations governing this concept. The May 2006 passage of the Tax Increase Prevention and Reconciliation Act of 2005 altered those regulations by including a retroactive tax hike on Americans living abroad through changes in the application of the Foreign Earned Income and Housing Cost Exclusion provisions.

This first major change under the new legislation is that beginning with Tax Year 2006 the FEI Exclusion will be adjusted for inflation, starting at an inflation adjusted amount of $82,400. This exclusion amount can only be used to offset earned (not passive) income from sources outside the United States, and is prorated for partial-year overseas residence periods.

The second major change established a limit on the Housing Exclusion available to offset costs (e.g. rent and utilities) related to housing outside the United States. Basically, for tax year 2006, the new legislation limits the Housing Exclusion to $11,536, calculated by subtracting the non-excludable housing cost floor of 16% of the FEI Exclusion ($13,184 for 2006) from the newly legislated upper housing cost limit of 30% of the FEI Exclusion ($24,720 for 2006). However, on October 8, 2006 the IRS issued Notice 2006-87 adjusting the 30% limitation on housing expenses for qualifying taxpayers in high cost geographic areas (including Hong Kong plus many areas in Japan and Korea). It is now necessary for taxpayers to determine if they live in high cost areas before calculating their Housing Exclusion. The new Housing Exclusion is prorated for partial-year overseas residence periods.

The third legislated change altered the calculation of graduated tax rates for all non-excluded income by including the FEI Exclusion and Housing Exclusion amounts when determining the applicable rates. As before, taxpayers with non-excluded foreign earned income will still have available the Foreign Tax Credit provisions provided in the tax treaties between the United States and other foreign countries. Those Foreign Tax Credits are generally the percentage of national and local income taxes paid to a foreign government equal to the percentage of foreign source income received in that country not excluded by the foreign earned income exclusions.

U.S. government regulations specify that each United States person with a financial interest in or signature authority (or other authority) over any financial accounts in a foreign country, which exceed $10,000 in aggregate value at any time during the calendar year, must report that relationship to the Department of the Treasury by June 30th of the following year. There are significant penalties related to these regulations.

Many taxpayers file annual U.S. tax returns to maintain their financial credit history, while others file to avoid an IRS audit and the related financial and criminal penalties. After working abroad, some individuals realize U.S. tax returns are necessary when using their accumulated wealth to acquire property in the U.S. In all cases, it is necessary to file to claim the foreign earned income exclusions.

Whatever your reasons for filing, the fully qualified licensed CPA tax professionals at Access H&R Tax Services can prepare your tax return quickly and at a reasonable cost.