Is Foreign Income Taxable in the USA?

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If you are not a U.S. citizen or permanent resident, you are not a U.S. taxpayer and you generally don't have to pay U.S. income tax on money you earned while abroad. If you are a U.S. taxpayer, you can claim an exclusion only if your tax home was outside the US. Your tax home was outside the U.S. if you meet the bona fide residence test or the physical presence test. Although the rules are complex, if you were present in a foreign country for 12 consecutive months, including at least part of the tax year, or 330 full days during the tax year, your tax home is probably outside the U.S.

If your tax home is outside the U.S., you may exclude up to $91,500 (for the 2010 tax year) from your taxable income. This amount is prorated according to how many days you were abroad during the tax year. If, for example, you lived in Mexico for 12 consecutive months ending on March 31, 2010, and returned to the U.S. for the remainder of the year, your foreign-earned income exclusion is (90/365) X $91,500, because you spent 90 days of the year abroad. File forms 1040 and 2555 to claim the exclusion even if you don't owe the IRS any money -- otherwise the IRS may revoke the exclusion and tax your foreign-earned income.

You may deduct expenses for housing abroad if these expenses were provided by your employer. You may also deduct reasonable related expenses such as homeowner's insurance premiums. This deduction also applies to housing expenses for your spouse and dependents. Since the IRS applies complex rules concerning the extent to which you can apply both the housing deduction and the foreign-earned income exclusion, you will not be able to take full advantage of both.

The foreign tax credit allows you to subtract taxes paid to foreign governments from your total tax as reported on Form 1040. IRS rules on foreign taxation are complex, but you normally cannot deduct 100 percent of your foreign taxes. The foreign tax credit applies even if you earned the income in the U.S.If your employer is located overseas, for example, and deducts foreign payroll taxes from your paycheck, you can apply the foreign tax credit.