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

For use in preparing 2002 Returns

U.S. Government Employees

For purposes of the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction, foreign earned income does not include any amounts paid by the United States or any of its agencies to its employees. Payments to employees of nonappropriated fund activities are not foreign earned income. Nonappropriated fund activities include the following employers.

1. Armed forces post exchanges.
2. Officers' and enlisted personnel clubs.
3. Post and station theaters.
4. Embassy commissaries.

Amounts paid by the United States or its agencies to persons who are not their employees may qualify for exclusion or deduction.

If you are a U.S. Government employee paid by a U.S. agency that assigned you to a foreign government to perform specific services for which the agency is reimbursed by the foreign government, your pay is from the U.S. Government and does not qualify for exclusion or deduction.

If you have questions about whether you are an employee or an independent contractor, get Publication 15-A, Employer's Supplemental Tax Guide.

Panama Canal Commission.   U.S. employees of the Panama Canal Commission are employees of a U.S. Government agency. Because they are U.S. Government employees, their foreign earned income does not include any amounts paid to them by the Panama Canal Commission. No provision of the Panama Canal Treaty or Agreement exempts their income from U.S. taxation. Employees of the Panama Canal Commission and civilian employees of the Defense Department of the United States stationed in Panama can exclude certain foreign-area and cost-of-living allowances. See Publication 516, U.S. Government Civilian Employees Stationed Abroad, for more information.

American Institute in Taiwan.   Amounts paid by the American Institute in Taiwan are not foreign earned income for purposes of the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction. If you are an employee of the American Institute in Taiwan, allowances you receive are exempt from U.S. tax up to the amount that equals tax-exempt allowances received by civilian employees of the U.S. Government.

Allowances.   Cost-of-living and foreign-area allowances paid under certain Acts of Congress to U.S. civilian officers and employees stationed in Alaska and Hawaii or elsewhere outside the 48 contiguous states and the District of Columbia can be excluded from gross income. Post differentials are wages that must be included in gross income, regardless of the Act of Congress under which they are paid.

More information.   Publication 516 has more information for U.S. Government employees abroad.

Exclusion of
Meals and Lodging

You do not include in your income the value of meals and lodging provided to you and your family by your employer at no charge if the following conditions are met.

1. The meals are furnished:
   1. On the business premises of your employer, and
   2. For the convenience of your employer.
2. The lodging is furnished:
   1. On the business premises of your employer,
   2. For the convenience of your employer, and
   3. As a condition of your employment.

Some of the terms used in this list are explained below.

Amounts you do not include in income because of these rules are not foreign earned income.

Family.   Your family, for this purpose, includes only your spouse and your dependents.

Lodging.   The value of lodging includes the cost of heat, electricity, gas, water, sewer service, and similar items needed to make the lodging fit to live in.

Business premises of employer.   Generally, the business premises of your employer is wherever you work. For example, if you work as a housekeeper, meals and lodging provided in your employer's home are provided on the business premises of your employer. Similarly, meals provided to cowhands while herding cattle on land leased or owned by their employer are considered provided on the premises of their employer.

Convenience of employer.   Whether meals or lodging are provided for your employer's convenience must be determined from all the facts. They are considered provided for your employer's convenience if there is a good business reason for providing them, other than to give you more pay.

If the conditions listed earlier are met (including the convenience of employer condition), do not include the value of the meals or lodging in your income, even in the following situations.

1. Your employer intends them as part of your pay.
2. A law or your employment contract says that they are provided as compensation.

On the other hand, if your employer provides meals or lodging to you or your family as a means of giving you more pay, and there is no other business reason for providing them, their value is extra income to you because they are not furnished for the convenience of your employer.

Condition of employment.   Lodging is provided as a condition of employment if you must accept the lodging to properly carry out the duties of your job. You must accept lodging to properly carry out your duties if, for example, you must be available for duty at all times.

Foreign camps.   If the lodging is in a camp located in a foreign country, the camp is considered part of your employer's business premises. A camp is lodging that is:

1. Provided for your employer's convenience because the place where you work is in a remote area where satisfactory housing is not available to you on the open market within a reasonable commuting distance,
2. Located as close as reasonably possible in the area where you work, and
3. Provided in a common area or enclave that is not available to the general public for lodging or accommodations and that normally houses at least ten employees.

Foreign Earned
Income Exclusion

If your tax home is in a foreign country and you meet the bona fide residence test or the physical presence test, you can choose to exclude from your income a limited amount of your foreign earned income. Foreign earned income was defined earlier in this chapter.

You can also choose to exclude from your income a foreign housing amount. This is explained later under Foreign Housing Exclusion. If you choose to exclude a foreign housing amount, you must figure the foreign housing exclusion before you figure the foreign earned income exclusion. Your foreign earned income exclusion is limited to your foreign earned income minus your foreign housing exclusion.

If you choose to exclude foreign earned income, you cannot deduct, exclude, or claim a credit for any item that can be allocated to or charged against the excluded amounts. This includes any expenses, losses, and other normally deductible items allocable to the excluded income. For more information about deductions and credits, see chapter 5.

Limit on Excludable Amount

You may be able to exclude up to $80,000 of income earned in 2002. The table below shows the maximum amount excludable for other years.

For 2002, you cannot exclude more than the smaller of:

1. $80,000, or
2. Your foreign earned income (discussed earlier) for the tax year minus your foreign housing exclusion (discussed later).

If both you and your spouse work abroad and you and your spouse meet either the bona fide residence test or the physical presence test, you can each choose the foreign earned income exclusion. You do not both need to meet the same test. Together, you and your spouse can exclude as much as $160,000 for 2002.

Paid in year following work.   Generally, you are considered to have earned income in the year in which you do the work for which you receive the income, even if you work in one year but are not paid until the following year. If you report your income on a cash basis, you report the income on your return for the year you receive it. If you work one year, but are not paid for that work until the next year, the amount you can exclude in the year you are paid is the amount you could have excluded in the year you did the work if you had been paid in that year. For an exception to this general rule, see Year-end payroll period, later.

Example.   You qualify as a bona fide resident of Brazil for all of 2001 and 2002. You report your income on the cash basis. In 2001, you were paid $67,000 for work you did in Brazil during that year. You excluded all of the $67,000 from your income in 2001.

Your total foreign earned income exclusion for 2002 is $91,000 ($11,000 of the pay received in 2002 for work you did in 2001 and $80,000 of the pay you received in 2002 for work you did in 2002). You would include in your 2002 income $2,000 of the pay you received in 2002 ($1,000 of the pay received in 2002 for the work you did in 2001 and $1,000 of the pay received in 2002 for the work you did in 2002).

Year-end payroll period.   There is an exception to the general rule that income is considered earned in the year you do the work for which you receive the income. If you are a cash-basis taxpayer, any salary or wage payment you receive after the end of the year in which you do the work for which you receive the pay is considered earned entirely in the year you receive it if all four of the following apply.

1. The period for which the payment is made is a normal payroll period of your employer that regularly applies to you.
2. The payroll period includes the last day of your tax year (December 31 if you figure your taxes on a calendar-year basis).
3. The payroll period is not longer than 16 days.
4. The payday comes at the same time in relation to the payroll period that it would normally come and it comes before the end of the next payroll period.

Income earned over more than 1 year.   Regardless of when you actually receive income, you must apply it to the year in which you earned it in figuring your excludable amount for that year. For example, a bonus may be based on work you did over several years. You determine the amount of the bonus that is considered earned in a particular year in two steps.

1. Divide the bonus by the number of calendar months in the period when you did the work that resulted in the bonus.
2. Multiply the result of (1) by the number of months you did the work during the year. This is the amount that is subject to the exclusion limit for that tax year.

Income received more than 1 year after it was earned.   You cannot exclude income you receive after the end of the year following the year you do the work to earn it.

Example.   You qualify as a bona fide resident of Sweden for 2000, 2001, and 2002. You report your income on the cash basis. In 2000, you were paid $65,000 for work you did in Sweden that year and in 2001 you were paid $70,000 for that year's work in Sweden. You excluded $65,000 on your 2000 federal income tax return and $70,000 for your 2001 return.

In 2002, you were paid $90,000; $80,000 for your work in Sweden during 2002, and $10,000 for work you did in Sweden in 2000. You cannot exclude any of the $10,000 for work done in 2000 because you received it after the end of the year following the year in which you earned it. That is, you received it after 2001. You must include the $10,000 in income. You can exclude all of the $80,000 received for work you did in 2002.

Community income.   The maximum exclusion applies separately to the earnings of a husband and wife. Ignore any community property laws when you figure your limit on the foreign earned income exclusion.

Part-year exclusion.   If you qualify under either the bona fide residence test or the physical presence test for only part of the year, you must adjust the maximum limit based on the number of qualifying days in the year. The number of qualifying days is the number of days in the year within the period on which you both:

1. Have your tax home in a foreign country, and
2. Meet either the bona fide residence test or the physical presence test.

For this purpose, you can count as qualifying days all days within a period of 12 consecutive months once you are physically present and have your tax home in a foreign country for 330 full days. To figure your maximum exclusion, multiply the maximum excludable amount for the year by the number of your qualifying days in the year, and then divide the result by the number of days in the year.

Example.   You report your income on the calendar-year basis and you qualified under the bona fide residence test for 75 days in 2002. You can exclude a maximum of 75/365 of $80,000, or $16,438, of your foreign earned income for 2002. If you qualify under the bona fide residence test for all of 2003, you can exclude your foreign earned income up to the full $80,000 limit.

Physical presence test.   Under the physical presence test, a 12-month period can be any period of 12 consecutive months that includes 330 full days. If you qualify under the physical presence test for part of a year, it is important to carefully choose the 12-month period that will allow the maximum exclusion for that year.

Example.   You are physically present and have your tax home in a foreign country for a 16-month period from June 1, 2001, through September 29, 2002, except for 15 days in December 2001 when you were on vacation in the United States. You figure the maximum exclusion for 2001 as follows.

1. Beginning with June 1, 2001, count forward 330 full days. Do not count the 15 days you spent in the United States. The 330th day, May 11, 2002, is the last day of a 12-month period.
2. Count backward 12 months from May 11, 2002, to find the first day of this 12-month period, May 12, 2001. This 12-month period runs from May 12, 2001, through May 11, 2002.
3. Count the total days during 2001 that fall within this 12-month period. This is 234 days (May 12, 2001 - December 31, 2001).
4. Multiply $78,000 by the fraction 234/365 to find your maximum exclusion for 2001 ($50,005).

1. Beginning with your last full day, September 29, 2002, count backward 330 full days. Do not count the 15 days you spent in the United States. That day, October 20, 2001, is the first day of a 12-month period.
2. Count forward 12 months from October 20, 2001, to find the last day of this 12-month period, October 19, 2002. This 12-month period runs from October 20, 2001, through October 19, 2002.
3. Count the total days during 2002 that fall within this 12-month period. This is 292 days (January 1, 2002 - October 19, 2002).
4. Multiply $80,000, the maximum limit, by the fraction 292/365 to find your maximum exclusion for 2002 ($64,000).

Choosing the Exclusion

The foreign earned income exclusion is voluntary. You can separately choose the foreign earned income exclusion and the foreign housing exclusion by completing the appropriate parts of Form 2555. Your initial choice of the exclusions on Form 2555 or Form 2555-EZ generally must be made with a timely-filed return (including any extensions), a return amending a timely-filed return, or a late-filed return filed within 1 year from the original due date of the return (determined without regard to any extensions).

You can choose the exclusion on a return filed after the periods described above provided you owe no federal income tax after taking into account the exclusion. If you owe federal income tax after taking into account the exclusion, you can choose the exclusion on a return filed after the periods described above provided you file before IRS discovers that you failed to choose the exclusion. You must type or legibly print at the top of the first page of the Form 1040 Filed pursuant to section 1.911-7(a)(2)(i)(D). If you owe federal income tax after taking into account the foreign earned income exclusion and the IRS discovered that you failed to choose the exclusion, you must request a private letter ruling under Income Tax Regulation 301.9100-3 and Revenue Procedure 2002-1.

Revenue procedures are published in the Internal Revenue Bulletin (I.R.B.) and in the Cumulative Bulletin (C.B.), which are volumes containing official matters of the Internal Revenue Service. The I.R.B. is available on the Internet at www.irs.gov. You can buy the C.B. containing a particular revenue procedure from the Superintendent of Documents, P.O. Box 371954, Pittsburgh, PA 15250-7954 (or online at
http://bookstore.gpo.gov/irs).

Once you choose to exclude your foreign earned income or housing amount, that choice remains in effect for that year and all later years unless you revoke it.

Revocation.   You can revoke your choice for any year. You do this by attaching a statement that you are revoking one or more previously made choices to the return or amended return for the first year that you do not wish to claim the exclusion(s). You must specify which choice(s) you are revoking. You must revoke separately a choice to exclude foreign earned income and a choice to exclude foreign housing amounts.

If you revoked a choice and within 5 years again wish to choose the same exclusion, you must apply for IRS approval. You do this by requesting a ruling from the IRS.

Mail your request for a ruling, in duplicate, to:
 

Associate Chief Counsel (International)
Internal Revenue Service
Attn: CC:PA:T
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044.

Because requesting a ruling can be complex, you may need professional help. Also, the IRS charges a fee for issuing these rulings. For more information, see Revenue Procedure 2002-1, which is published in Internal Revenue Bulletin No. 2002-1.

In deciding whether to give approval, the IRS will consider any facts and circumstances that may be relevant. These may include a period of residence in the United States, a move from one foreign country to another foreign country with different tax rates, a substantial change in the tax laws of the foreign country of residence or physical presence, and a change of employer.

Foreign tax credit.   Once you choose to exclude either foreign earned income or foreign housing costs, you cannot take a foreign tax credit for taxes on income you can exclude. If you do take the credit, one or both of the choices may be considered revoked. See Credit for Foreign Income Taxes in chapter 5 for more information.

Earned income credit.   You will not qualify for the earned income credit if you claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction for the year. For more information on this credit, see Publication 596.

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