Everyone wants to avoid taxes and only a few people really know how. This goes double for US citizens who earn income in China. This is because the US taxes foreign income as well as income earned within the States. Even worse, the IRS requires any US person with a financial account overseas to register it with the treasury department, as long as such account has held over $10,000USD at some point during the year. This provision was meant to discourage the use of overseas tax shelters, but they equally apply to US people teaching English in China that have managed to save $10,000USD in their Bank of China account. And speaking from personal experience, the process is complicated because it involves both the IRS and the Treasury department. Luckily, the filing can be done online, even if it is not particularly simple.
For those earning a salary in a foreign country, the most important exclusions to know about are foreign earned income and foreign housing exclusions. For 2012, the foreign earned income exclusion is up to $95,100 and the foreign housing exclusion/deduction is
30% of the foreign earned income exclusion (but varies by location).
The housing exclusion applies to income received from an employer, and
the deduction applies to self-employment income. The details for
calculating the foreign housing exclusion/deduction are maddeningly
complicated and beyond the scope of this article. The foreign earned
income exclusion is more straightforward as it directly excludes the
income from taxes. Most important to these exclusions is how to
qualify for them.
First, you must be a resident alien or citizen of the United States.
Resident aliens are those who have Green Cards or who have been in the
United States for a total of 183 days over the past 3 years, only
counting 1/3 of days in the 2nd year and 1/6 of the days in the least recent year. (That is the easy math. Imagine what the housing exclusion entails.)
Second, you must have a foreign country as your tax home. This means
you have employment in that country and it is where you permanently or
temporarily work. Business trips don’t count, but moving there to
fulfill employment or contract work likely would. As a general rule, if
you expect to be working in the country for over a year, it is your tax
Third, you must be in a foreign country for a significant time,
determined by the bona fide resident test or the physical presence
test. Bona fide residence means you are living in a foreign country as a
resident would for a full tax year.
Each case is evaluated individually, but those who rent an apartment in
a foreign country, live there 7 days a week, and only leave the foreign
country for business and vacation with a clear intention to return to
the foreign country, are almost certainly residents. The physical
presence test is for those who live a long time in a foreign country but
not the January-December tax year. If you spend 330 days in a foreign
country over a consecutive 12 month period, you meet the physical
presence test. Unlike the bona fide resident test, you could live out
of your suitcase, travel through Europe to multiple countries for any
reason, and as long as you spent 330 days outside the US you can meet
Finally, you must have foreign earned income. Usually, foreign earned
income is any income earned when you have met the tax home and bona
fide residence/physical presence test. Foreign income also includes
housing and meals provided by the employer, allowances such as cost of
living or education reimbursement, and commissions earned. Money from
the US government or a pension does not count as foreign earned income.
If all four factors are met, then you can use the exclusions and can
avoid some or all US taxes on your foreign income. Of course, if you
have set up a company in a foreign country, the process is very
Posted by Frank Caruso. Chair, China Practice Team for IPG. _________