This is a huge tax break for certain self employed people who have “portable trades” or businesses. It’s also a great break for employees who have jobs that involve extended international assignments and who don’t have to spend a lot of time in the corporate offices. 

U.S. persons who work and live for at least a full year in a foreign country may exclude up to $80,000 of earned income - or self employment earnings - from U.S. taxes. (This amount will be indexed to keep pace with inflation after 2002.) To the extent that the foreign country imposes tax on income earned in the their country, this is not a way to avoid taxes entirely. The key is whether the country in which you work and live imposes substantially less taxes than what you would have to pay in the U.S. And, in a few cases, you may be able to create a job for yourself in a tax haven country where there is no tax on your earnings. 

For example, a couple who were writers and self-publishers moved to the Bahamas for two years. Their publishing business was a U.S. corporation that continued to publish and sell their books and newsletters. They each received compensation of $70,000 a year for two years while working in the Bahamas. The salaries were deductible by the corporation the same as when the couple worked in the U.S. After piling up $280,000 of tax free earnings, they returned to the U.S. For them, two years in paradise was more than enough.

The pre-97 law permitted individuals who worked and lived abroad to exclude up to $70,000 a year of earnings each year from U.S. taxes. That’s now been increased by $2,000 a year for each year from 1998 through 2002. In the year 2002, the exempt amount will be $80,000 per year. After 2002, the amount is to be indexed for inflation. 

This exclusion is an alternative to the foreign tax credit , which is often a better choice for those who work in high tax foreign countries. The exclusion is more beneficial for those who work in low tax countries. 

It isn’t necessary that you live in the same foreign country for the entire time. You can move from country to country. The test is that you must live and work abroad for at least 330 days out of each year to qualify for the full exclusion. Time spent traveling between countries is counted as time spent working in a foreign country. The exclusion is only available after the U.S. person has lived offshore for at least 330 days out of any full year. Thereafter, the exclusion is also available for portions of a year spent working offshore. 

Other income realized or earned while working abroad is still subject to U.S. tax. Any earnings in excess of the exclusion, any capital gains, interest, dividends, royalties or other income is subject to U.S. taxes. 

For those who are self employed and don’t own a corporation, the exclusion is based on self employment earnings when capital is NOT a material income producing factor. Where capital is material, only 30% of the profits will count as compensation for the exclusion. 

Vern Jacobs 
 

(C) Copyright, 2004, Vernon K. Jacobs, All rights reserved.