Internal Revenue Code (IRC) Section 911 allows U.S. citizens or residents working abroad to exclude foreign earned income from U.S. taxation and to claim an exclusion or deduction for excessive foreign housing costs. The 2012 annual foreign earned income exclusion amount is $95,100.
Individuals who incur foreign housing costs may exclude or deduct foreign costs considered to be excessive as compared to U.S. costs. The election to exclude or deduct a foreign housing cost amount applies only if the qualified individual files a U.S. federal income tax return that reports foreign earned income.
To qualify for the foreign housing exclusion or deduction, you must:
- Be a U.S. citizen or resident alien (for federal tax purposes),
- Have foreign earned income (income received for working in a foreign country),
- Have a tax home in a foreign country,
- Meet either the bona fide residence test or the physical presence test, and
- Have paid (or incurred) foreign housing expenses.
Foreign Housing Cost Amount
The foreign housing exclusion is limited to the lesser of the foreign housing costs paid for with employer-provided amounts or your foreign earned income. The housing cost amount is the total of your foreign housing expenses for the year minus a base housing amount. The base housing amount is 16% of the maximum foreign earned income exclusion for the tax year, computed on a daily basis for the number of days in the qualifying period that fall within the tax year.
The base amount is $15,216 for 2012 ($41.69 per day), and the exclusion amount is limited to $28,530 for 2012, unless housing costs are paid in a high-cost city, as discussed below.
Effective for tax years beginning on or after January 1, 2012, the U.S. Treasury Department and the IRS have issued Notice 2012-19, Determination of Housing Cost Amounts Eligible for Exclusion or Deduction for 2012. The notice provides a table of 2012 adjusted housing cost limitations based on high housing costs in certain foreign cities related to housing costs in the U.S. Limitations for high-cost cities go up to $128,000 (for example, Tokyo, Japan). Taxpayers may elect to use a limitation from the 2012 table for 2011 tax years if a particular city is higher than the 2011 amount published in Notice 2011-8.
Taxpayers should be aware that the total foreign earned income and housing exclusions are prorated if the taxpayer is not present in the foreign country for the entire year. In order to reduce U.S. taxes in excess of the exclusions, taxpayers can claim a Foreign Tax Credit for taxes paid to the foreign country.
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