More and more Americans are earning a significant portion of their income in foreign countries. Individuals who earn foreign income in 5- and 6-figure (or more) amounts are often concerned about whether this income is taxable in the United States. Citizens of foreign countries who do not reside in the United States generally speaking do not owe any taxes to the U.S. on income earned outside the U.S., but U.S. citizens and resident aliens in the U.S. will owe taxes on income earned in other countries.
What is taxed?
U.S. citizens owe income taxes on the total of their earned and unearned income regardless of the source. Earned income includes wages, salaries, bonuses, commissions, tips and net earnings from self-employment. Unearned income includes income from investments and other sources unrelated to employment. A U.S. citizen who reports foreign income is entitled to the same deductions and adjustments that are available to all filers.
Foreign earned income exclusion
A U.S. citizen who meets certain requirements may be entitled to exclude a specified amount from income earned in a foreign country. The amount of the exclusion changes from year to year. In 2020, the exclusion was $107,800; in 2021, the exclusion will be $108,700. To be eligible for the foreign earned income exclusion, the tax-payer’s main place of employment must be located in the foreign country. The tax-payer must spend an entire year in the foreign country.
Foreign tax credit
Most Americans who work abroad can expect to have their income taxed in both the U.S. and the country where they live. The U.S. government has created a tax break to ease the pain of potential double taxation. It is called the foreign tax credit. The credit is a direct reduction in the amount of taxes owed to the U.S. Treasury; it is calculated after all deductions, exemptions and adjustments are subtracted from the filer’s total adjusted gross income.
This brief summary of the taxation of foreign income earned by U.S. citizens does not cover the many qualifications that apply to the calculation of the credit. Anyone who is facing the prospect of paying income tax to the United States and to a foreign government may wish to consult an tax lawyer with experience in foreign taxation for advice on eligibility for and calculation of the foreign taxes and the available exemptions and credits.