Calculating the Foreign Earned Income Exclusion

for Self-Employed Individuals

 

 

 

  

Objectives • List the requirements for claiming IRC § 911

benefits. • Define foreign earned income from self-

employment. • Calculate the foreign earned income exclusion

(FEIE) for a self-employed individual. • Complete Form 2555. • Determine self-employment tax obligations.

   

 

 

Foreign Earned Income Exclusion (FEIE) – 4 Mandatory Requirements

1. Have foreign earned income2. Have a tax home in a foreign country (no U.S.

abode)3. Meet the bona fide resident or physical presence

test

4. Make a valid election

 

 

Foreign Earned Income – Capital Not a Material Factor

• If a business consists solely of personal services, all foreign source gross receipts are foreign earned income.

• If personal services are one part of producing income and capital investment is minimal, only the part of gross receipts for services performed in a foreign country is foreign earned income.

 

 

 

Foreign Earned Income – Capital a Material Factor

• If capital investment is an important factor, the lesser of: – 30% of individual’s share of net profits reduced

by deduction for ½ self-employment tax or – Reasonable allowance as compensation for

services performed in a foreign country

 

  

 

 

Information Required In order to compute FEIE, one must determine: • Schedule C net profit

• The deduction for ½ self-employment tax• Foreign earned income

• Foreign earned gross receipts

• Expenses definitely related to the foreignearned gross receipts

Form 2555, Part VII – Foreign Earned Income Exclusion

Maximum FEIE is the lesser of: Foreign Earned Income for the tax year minus the Foreign Housing Exclusion (if any) or Qualifying Days in the tax year divided by 365 (366, if leap year), multiplied by the Exclusion Amount for the calendar year

Form 2555, Part VIII – Exclusion Amount

Foreign earned income excluded Minus deductions allowed in figuring AGI

allocable to the excluded income Equals Form 1040, Line 21 Exclusion Amount

Example – Pike Bluegill –  U.S. citizen & bona fide resident of Zinnia –  Sole proprietor of specialty food store –  All business conducted in Zinnia

2016 Sch. C gross receipts $1,200,000 2016 Sch. C expenses $ (700,000) 2016 Sch. C net profit $ 500,000

–  SE Tax $ 28,085 –  Deduction for ½ SE Tax $ 14,043

  

 

 

Example – Foreign Earned Income • Lesser of:

- Reasonable compensation, in this example $125,000 or

- 30% of net profit minus deduction for ½ SE tax, in this case: $500,000 x 0.3 = $150,000

$150,000 - $14,043 = $135,957

• So . . . Pike’s 2016 foreign earned income is $125,000.

Foreign Housing Deduction Lesser of :

Foreign Housing Cost Amount* or Foreign earned income minus foreign earned income exclusion minus foreign housing exclusion, if any

* Foreign Housing Cost Amount = Qualified HousingExpenses – [(Maximum FEIE x 16%) x (QualifyingDays in Tax Year / Total Number of Days in Tax Year)].

Example – Expenses Allocable to Excluded Income

Sch C Expenses plus Deduction for ½ SE Tax

multiplied by the ratio of

Excluded Gross Receipts to Total Gross Receipts

($700,000 + $14,043) x ($101,300 / $1,200,000) = $60,277

 

 

 

 

Self-Employment Tax and Totalization Agreements

• Generally, a U.S. citizen or resident alien with net earningsfrom self-employment must pay self-employment tax.

• Totalization Agreements

– Avoid dual coverage and dual contributions (taxes) onthe same earnings.

– Govern whether self-employment taxes must be paid toU.S. or to foreign country.

 

 

 

Totalization AgreementsCertificate of Coverage

• If there is an Totalization Agreement in place and theindividual is exempt under the terms of the agreement:

– Attach Certificate of Coverage from foreign country (orfrom Social Security Administration) to return each year.

– Print “Exempt, see attached statement” on line for self-employment tax.

 

 

 

 

Foreign Earned Income Exclusion Effect on Credits or Deductions

• Cannot claim Earned Income Credit

• AGI must be increased by the amount of the FEIE whencomputing Child Tax Credit/Additional Child Tax Credit

• For taxable years ending after December 31, 2014, noteligible for the Additional Child Tax Credit

• Cannot claim foreign tax credit or take a deduction forforeign taxes paid on the excluded income

Resources

•  Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad

•  https://www.irs.gov/Individuals/International-Taxpayers/Foreign-Earned-Income-Exclusion

•  Practice Units at https://www.irs.gov/businesses/corporations/international-

practice-units

Questions