The United States has a special tax benefit for certain (but not all) income earned overseas. U.S. tax filers seeking to take advantage of this tax break must file a Form 2555 or 2555-EZ. Filers should learn how to plan properly for taking this foreign earned income exclusion (or housing exclusion) so they can take maximum benefit of this special tax break.
Individuals can easily find and print out Form 2555 from the IRS website. See the Resources section below for a link to the form. However, if you experience any problems with the link, there is a search box at the top of each Internal Revenue Service web page. Just search for “IRS Form 2555” to find it. You can then print it out and fill in this foreign earned income tax exclusion form. You can also find instructions for Form 2555 or 2555-EZ from the link below.
The Main Rule for Qualifying Under 2555
The thing you need to plan out when working overseas is to spend sufficient time to get the tax exclusion for foreign earned income. It is probably best to meet the physical presence test (330 days in a straight one-year period). Now, it does not actually matter when you leave because you can request a specific time extension that is directly related to your ability to qualify for the exemption under IRS Form 2555.
But the one thing you generally must do is stay for 330 days in a 365-day period. This is the basic rule for qualifying to use Form 2555 for the foreign tax exclusion (the physical presence test, which is very objective and just requires you to merely count the number of days you were in a foreign country over the qualifying one-year period). In other words, you cannot just go for a few months, quit and then come back and expect to get the exclusion. This tax break is for those who establish a tax home in another country, not someone who is taking a short trip and working for a few weeks during that trip.
If you have a job overseas for only a few days, weeks or months and quit or get fired, you are typically out of luck if you are forced to come back to the United States. However, as long as you stay in ANY foreign country or a combination of countries for 330 days in a 365-day period, then you can file Form 2555 with the IRS to get the tax exclusion.
Access the form below. Most of it is self-explanatory, so there is no need to break it down for you. However, keep in mind that there is a maximum foreign income tax exclusion. This changes slightly every year. The maximum deduction is $91,500 for 2010.
However, that amount will be divided by the number of days in your tax year (Part VII of the 2555 form). This is generally not a problem so long as you do not get paid more than what would amount to a $91,500 salary over that year. So if you were in Japan and worked from June to December, you can still deduct all of that income on your IRS 1040 form so long as you did not earn more than approximately $40,000 over that period.
Follow the simple instructions on the form to report your exclusion on your 1040 form. Make sure you use the parentheses on the Form 1040 that it is a negative amount, meaning that you subtract it from your total income. In other words, you need to report your total income in the usual place on your 1040. But you then put your excludable foreign-earned income in parentheses in the currently appropriate block to show that you are subtracting that amount from your gross income.
Note: The housing deduction is taken by some overseas filers. That is beyond the scope of this particular article. Refer to the 2555 instructions for more details on that housing deduction.
IRS Form 2555
IRS Form 2555-EZ
IRS Form 2555 Instructions
IRS Form 2555-EZ Instructions