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Excluding offshore earnings from tax

Dear Tax Talk,
I'm writing regarding the $80,000 that U.S. citizens are allowed to earn offshore before they are taxed. If a person owns a company offshore and works for that company but does not have any income tax due in that country as an employee; or does not file and pay income tax in the foreign country even if he might owe income tax in the foreign country, does this have an effect on the U.S. foreign-earned income exclusion?

Who can you recommend for doing tax returns for people living offshore and also U.S. corporation returns? -- James

Dear James,
I usually recommend myself when it comes to accounting and tax matters. It's better for business that way. A U.S. citizen or resident can exclude up to $80,000 in wages earned in a foreign country. This means that the person actually has to live in the foreign country and earn the wages for work performed in that country. To claim the exclusion, a citizen can either be a bona fide resident of that foreign country or spend more than 330 days in 12 months outside the United States. However, U.S. residents only qualify under the 330-day rule.

If you qualify as a bona fide resident, you can spend more than 35 days in the United States, provided you maintain your residence in that foreign country. To qualify as a bona fide resident, you actually have to be living in that foreign country on a more-permanent basis, and you actually have to live there for a whole tax year to qualify. For example, if you move now, you wouldn't be a bona fide resident until tax year 2006. You could only get a partial exclusion for 2005 based on the 330-day rule. In addition, the rules state:

An individual with earned income from sources within a foreign country is not a bona fide resident of that country if:

(1) The individual claims to be a nonresident of that foreign country in a statement submitted to the authorities of that country.
(2) And the earned income of the individual is not subject, by reason of nonresidency in the foreign country, to the income tax of that country.

For example, if on the immigration forms you are asked your country of residence, you would have to say that country, not the United States. The fact that you don't pay taxes in and of itself is not detrimental to the exclusion. For example, if you say you're a resident, but you ignore your filing obligations, you could still be considered a bona fide resident.

Bankrate.com's corrections policy -- Posted: Aug. 16, 2005
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