IRS Changes Foreign Housing Exclusion for Some High‐Cost Locations

• Published date: 01 September 2014
• Author: Shirley Dennis‐Escoffier
• Date: 01 September 2014
• DOI: http://doi.org/10.1002/jcaf.21994

81

© 2014 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.21994

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Shirley Dennis-Escoffier

IRS Changes Foreign Housing Exclusion

for Some High-Cost Locations

The Internal Revenue Code

provides income tax exclu-

sions for a certain amount of

foreign earned income, as well

as housing benefits provided

to American employees on

long-term international assign-

ments. While an increase in the

exclusion amounts is typically

viewed as a benefit to employees

because it can reduce their tax

liability, it can also decrease the

employer’s cost of the foreign

assignment if the employer pro-

vides a tax equalization plan.

Thus, increases in the exclusion,

particularly higher limits for

excess housing costs, can provide

needed relief to businesses with

employees working in high-cost

foreign locations. When the IRS

recently announced the new

housing limits for 2014, there

were slight increases in the ceil-

ing amounts for many locations.

However, in a few locations

there were significant decreases,

such as the reduction of over

$21,000 for Tokyo, resulting in

an increase in the employer’s

cost for expatriates in that loca-

tion. Corporations should evalu-

ate the impact of these changes

on their employees and their tax

equalization plans.

BACKGROUND

The United States uses an

extraterritorial tax system in

which it taxes its citizens and

residents on their worldwide

income. This means that U.S.

citizens working in a foreign

country that imposes a tax will

pay that local tax in addition to

U.S. tax on their foreign-source

income. To provide relief from

double taxation, a foreign tax

credit can offset U.S. tax on

foreign-source income. How-

ever, due to various limitations,

the foreign tax credit does not

always eliminate double taxa-

tion. This results in a greater tax

burden for an American citizen

working overseas than for a

native of the foreign country or

for a citizen of another country

that does not use an extrater-

ritorial tax system. To enable

American companies to compete

internationally, the U.S. govern-

ment reduces the U.S. tax bur-

den on American citizens and

resident aliens working abroad

for an extended period of time

through exclusions for foreign

earned income and excess

foreign housing costs. These

exclusions allow multinational

companies to employ American

citizens and residents at foreign

assignments without having to

pay them a salary far in excess

of that paid to nationals of the

foreign country or citizens of

other countries that do not use

an extraterritorial tax system.

Internal Revenue Code

(IRC) Section 911 allows exclu-

sion for (a) a portion of foreign

earned income and (b) excess

foreign housing costs. To qualify

for this exclusion, the individual

must have a tax home in a for-

eign country and meet either the

bona fide foreign residence test

or physical presence test. The

first test requires a U.S. citizen

to be a bona fide resident of one

or more foreign countries for an

uninterrupted period of at least

one tax year (January through

December for calendar-year

individuals). To qualify under

the second test, a U.S. citiz en or

resident must be physically pres-

ent in a foreign country (or coun-

tries) for 330 full days during a

period of 12 consecutive months.

If the taxpayer elects to take

advantage of the exclusion, then

he or she cannot also claim a tax

credit for taxes paid to a foreign

country for the excluded income.