The post-TIPRA foreign earned income and housing exclusions for individuals.

• Author: Godfrey, Howard
• Position: Tax Increase Prevention and Reconciliation Act of 2005

EXECUTIVE SUMMARY

* The TIPRA raised the foreign income exclusion and housing cost threshold amount, and taxes nonexcluded income at a higher rate.

* A U.S. citizen or resident working abroad may exclude a limited amount of foreign earned income and deduct housing costs under Sec. 911.

* Separate elections are required to exclude foreign earned income and housing costs.

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The Tax Increase Prevention and Reconciliation Act of 2005 will have a significant effect on the foreign earned income and housing exclusions under Sec. 911. This article explains the exclusions" benefits and requirements.

A U.S. citizen or resident working abroad may exclude a limited amount of foreign earned income under Sec. 911. In addition, such individual may exclude an employer-provided "housing cost amount" under Sec. 911 (a) or deduct nonemployer-provided housing costs under Sec. 911(c) (4). The foreign tax credit (FTC) also provides relief from double taxation when an expatriate's foreign earned income is subject to taxation by both the U.S. and a foreign country. However, the Sec. 911 foreign earned income exclusion and the housing cost exclusion/deduction go further, and provide relief from U.S. taxation even when there is little or no foreign income tax. This article explains the benefits of the elections under Sec. 911, and the requirements. (1)

TIPRA Changes

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), Section 515(a), indexes the earned income exclusion amount (limit) for inflation starting in 2006 (instead of 2008, as provided under prior law).This raises the exclusion amount from $80,000 to $82,400 for 2006.

The pre-TIPRA housing cost amount threshold (2) was 16% of the grade GS-14, step 1, U.S. government employee amount (i.e., 16% of $77,793). TIPRA Section 515(b)(1) set the 2006 threshold at 16% of the exclusion amount under Sec. 911(b) (2) (D). The housing cost amount in excess of this threshold is eligible for exclusion or deduction, subject to a new overall 30%-of-exclusion-amount limit, computed on a daily basis.

Finally, due to the TIPRA "stacking procedure," income not excluded under Sec. 911 is taxed (under the regular and alternative minimum tax (AMT)) at higher rates. The tax rates applicable to the nonexcluded income are those that would have applied had the individual not elected the Sec. 911 exclusion.

These changes are expected to raise over $2 billion in income taxes over the next 10 years. (3) The TIPRA will have the most dramatic effect on expatriates working in low-tax countries in which the benefit of the housing exclusion/ deduction has been shielding foreign earned income from U.S. income tax, especially when local housing costs are high.

Qualified Individual

Sec 911 benefits may be elected by a "qualified individual." (Exhibit 1 on p. 718 contains definitions of key terms and procedures.) A qualified individual must have a tax home in a foreign country, according to Sec. 911(d)(1). Under Sec. 911(d)(3), an individual's tax home has the same meaning as under Sec. 162(a)(2) (relating to traveling expenses while away from home). An individual's tax home is his or her regular place of employment or business, or is generally where he or she lives, if there is no regular place of business.

Exhibit 1: Key Sec. 911 terms and limits 1. Qualified individual. One who qualifies for Sec. 911 benefits. The individual must have a tax home in a foreign country (See. 911(d)(1)) and meet one of two additional tests: [] Period of residence. A citizen of the U.S. is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year (See. 911(d)(1)(A)). [] Period of presence. A citizen or resident of the U.S. is present in a foreign country or countries during at least 330 full days during any period of 12 consecutive months (Sec. 91 l(d)(1)(B)). 2. Sec. 911 benefits. [] Sec. 911(a)(1) earned income exclusion. Exclusion of income earned in foreign country; limited to the exclusion amount (see #3 below). [] Sec. 911(a)(2) foreign housing exclusion. Exclusion of a limited amount of foreign income from an employer which is used for housing costs (see # 7 below). [] Sec. 911(c)(4) foreign housing deduction. Deduction of a limited amount of foreign housing expenses that are paid from funds not provided by an employer (see #7 below). 3. Exclusion amount. This amount is $82,400 for 2006 and is adjusted annually for inflation. It is applied on a daily basis (see #6 below) (See. 91 l(b)(2)(D)). 4. Overall limit on Sec. 911 benefits. The total of the amounts excluded (foreign income and housing costs) and the amount deducted for housing costs for the tax year shall not exceed the individual's foreign earned income for such year (See. 911(d)(7)). 5. Foreign earned income. The amount received by an individual from sources within a foreign country or countries that constitute earned income attributable to services performed by such individual during the period of residence or presence (see #1 above) (See. 911(b)(1)(A)). 6. Sec. 911(a)(1) daily exclusion limit. The exclusion is limited to the amount of foreign earned income computed on a daily basis at an annual rate equal to the exclusion amount for the tax year. The 2006 daily exclusion limit is $225.75 for each day of the individual's foreign residence or presence ($82,400/365) (Sec. 911(b)(2)(A)). 7. Housing cost exclusion or deduction. The housing cost that may be excluded or deducted is the total actual amount of foreign housing costs, limited as explained in #8 and #9 below (See. 911(c)(1)). 8. "Housing cost amount" limit. This is 30% of the exclusion amount ($82,400 for 2006) (computed on a daily basis), multiplied by the number of days of foreign residence or presence in the tax year. This limit is $24,720 for 2006 ($82,400 x 0.3) (assuming foreign residence or presence on all days in the year) (See. 911(c)(2)). 9. Housing cost threshold. Housing costs up to 16% of the exclusion amount are not eligible to be included in the computation of the housing cost amount. This threshold is $13,184 for 2006 ($82,400 x 0.16). Thus, the maximum amount of 2006 housing costs considered, $24,720 (see #8 above), is reduced by $13,184, leaving a maximum housing cost amount of $11,536 for 2006 (Sec. 911(c)(1)). 10. Final limits on Sec. 911(a)(1) earned income exclusion and deduction. Because the total amounts excluded or deducted under Sec. 911 may not exceed foreign income, the Sec. 911(a)(1) earned income exclusion is limited to the lesser of the: [] Excess of (1) foreign earned income over (2) foreign housing costs excluded; or [] Sec. 911(a)(1) daily exclusion limit described in #6 above, multiplied by the number of days the residence or presence test is met (Regs. Sec. 1.911-3(d)). The housing cost deduction under Sec. 911(c)(4) (for an individual whose housing cost amount...