If you’re an independent contractor thinking about taking a gig outside of the US or you’re already overseas and are wondering how your taxes are impacted by your foreign status, this article is for you!
Most taxpayers who earn money in a foreign country are concerned about double taxation. They are concerned that they’ll have to pay taxes to the foreign country as well as to the US. To be clear, this is a very complex area of law that may involve tax treaties,
foreign tax credits, and the foreign-earned income exclusion. As for the foreign taxes, we recommend you engage a competent professional in that country. This article is going to focus on the potentially huge savings of the foreign-earned income exclusions and housing exclusion.
The United States is one of only a handful of countries that taxes all global income. So, if you are a US Citizen or Green Card Holder living and/or working in a foreign country, you still have to pay income and self-employment taxes to the US (Surprise!). That said, you may qualify for a special exclusion on your taxes called the Foreign Earned Income Exclusion (FEIE). In 2015, it allows you to exclude up to $100,800 of your taxable income for 2015 from income taxes. The exclusion amount is indexed for inflation. It is important to note that self-employment taxes do not fall under this exclusion.
How to qualify for the Foreign Earned Income Exclusion?
In order to qualify for the FEIE you must have foreign earned income, your tax home must be in a foreign country, and you need to meet one of the two tests set by the IRS:
The Physical Presence Test
This test is based on the actual days spent physically present in the foreign country. In order to meet the standards of this test, you must spend a minimum of 330 days over a 12-month period in a foreign country. These days do not need to be consecutive, phew!
The Bona Fide Resident Test
To meet the criteria of the Bona Fide Resident Test, you must be a US citizen or resident alien who is a citizen or national of a nation with which that the US has an income tax treaty in effect. Essentially, the country you are in must consider you a resident for over a year, and must be taxing your income.
What is “foreign earned income”?
So now that it’s been established that you qualify for the FEIE, we should look at what is considered as “foreign earned income”. The IRS classifies earned income as income received from performing services as an employee or an independent contractor. Forms of income include:
- -Salaries and Wages
- -Commissions
- -Bonuses
- -Professional fees
- -Tips
How it works
The Foreign earned income deduction covers an amount of taxable income up to the annual limit set by the IRS, which is $100,800 for 2015. If you are married and your spouse also receives foreign earned income, you are both able to take the FEIE, and your combined limit would be $201,600.
FEIE only excludes that income from income taxes, while your income is still subject to self-employment taxes. This exclusion is allowed to prevent double taxation on US resident’s income by the US and a foreign government.
You must elect the foreign earned income exclusion in order to benefit from it. To do so, you fill out and submit form 2555 “Foreign Earned Income” or Form 2555-EZ “Foreign Earned income Exclusion” with your tax return.
Once those forms are submitted, you are not able to take a foreign tax credit for foreign taxes paid on income you exclude. However, income that exceeds the limitation set by the IRS is eligible for a foreign tax credit for the foreign taxes paid on that income.
Because your income is still subject to the self-employment tax, as an independent contractor taking the FEI exclusion, it is highly beneficial to establish your business entity as an LLC with an S election (aka an S corporation).
By paying yourself a salary it may shield a portion of your income from self-employment taxes, by allowing you to receive your remaining income as tax efficient distributions. This may cut a large portion of your self-employment tax liability generating thousands in further tax savings!
Suppose you are an independent contractor making $150,000 per year, with an S corporation as an entity. You pay yourself $70,000 as a salary, and take the rest in distributions. That is a total of $6,000 dollars in tax savings, with or without the FEI exclusion!
Foreign Housing Exclusion or Deduction
Going right alongside the FEI exclusion the Foreign Housing Exclusion or Deduction allows you to exclude from your gross income housing costs in a foreign country. The Foreign Housing exclusion should generally be considered when your foreign earned income exceeds the FEI exclusion limit. It is important to note that the same income cannot be deducted twice.
The IRS has stated what expenses qualify for the Foreign Housing Exclusion. Those costs are:
- -The fair rental value of housing
- -Rent
- -Utilities
- -Repairs
- -Real Property and personal property insurance
- -Occupancy taxes
- -Nonrefundable security deposits or lease payments
- -Residential Parking Fees
Outside of this list, housing expenses are not included in the foreign housing exclusion or deduction.
We hope you got some useful information about the Foreign Earned Income Exclusion and Housing Exclusion for Independent Contractors. Whether you are new to the contracting world or a seasoned pro, it is always smart to have a group of professionals in your corner. Independent Contractor Tax Advisors is a CPA firm without peer in all things relating to independent contractors and their taxes. Contact us today to set a free, fast, and convenient tax consultation with one of our Tax Advisors today!
CLICK HERE FOR A FREE TAX CONSULTATION
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