Foreign earned income may not be excluded if you do not meet all of the requirements for the Foreign Earned Income Exclusion under Internal Revenue Code (IRC) Section 911. To qualify, you must have a tax home in a foreign country and meet either the bona fide residence test or the physical presence test. If you do not satisfy these requirements, your foreign earned income cannot be excluded.
Reasons Your Foreign Income May Not Be Excluded
Failure to meet eligibility requirements: To qualify for the foreign earned income exclusion, you must be a U.S. citizen or a resident alien with a tax home in a foreign country and meet either the bona fide residence test or the physical presence test. If you do not meet these requirements, the exclusion is not available.
Failure to meet residency or physical presence requirements: You must either be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year, or be physically present in one or more foreign countries for at least 330 full days during any 12-month period. If you do not meet either test, you cannot claim the exclusion.
Exclusion limit exceeded: The foreign earned income exclusion is limited to the maximum amount allowed by law for the tax year. If your foreign earned income exceeds the annual exclusion limit, only the amount up to the allowable limit may be excluded.
Income is not foreign earned income: Only earned income received for services performed in a foreign country qualifies for the exclusion. Income such as interest, dividends, pensions, capital gains, rental income, and other unearned income generally does not qualify for the foreign earned income exclusion.
Income earned in the United States: Income for services performed in the United States is not foreign earned income and cannot be excluded, regardless of where it is paid or where the employer is located.
Not properly claimed on Form 2555: You must file Form 2555 and properly complete all applicable sections to claim the foreign earned income exclusion. Failure to file the form or provide the required information may result in the exclusion being denied.
Income received in a different tax year than earned: Foreign earned income received in a later tax year may still qualify for exclusion if it would have been excludable in the year the services were performed. Follow the Form 2555 instructions regarding the reporting and documentation requirements for such income.
Additional Considerations
Foreign tax credit or deduction restrictions: You cannot claim a foreign tax credit or foreign tax deduction for taxes paid or accrued on income that you exclude under the foreign earned income exclusion or foreign housing exclusion. Any allowable foreign tax credit or deduction must be reduced accordingly.
Deductions allocable to excluded income: Deductions, credits, and other tax benefits that are properly allocable to excluded foreign earned income may be limited or reduced. Review Form 2555 instructions and IRS Publication 54 for guidance on allocating expenses and deductions related to excluded income.
Nonresident aliens filing Form 1040-NR: The foreign earned income exclusion generally applies only to qualifying U.S. citizens and resident aliens. Individuals filing Form 1040-NR as nonresident aliens generally are not eligible to claim the foreign earned income exclusion on Form 2555.
Source:
Disclaimer: Always verify details with the current year’s Federal or State Department of Revenue Forms and Instructions. For complex situations, consult a CPA or tax attorney.