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Bankrate's 2010 Tax Guide
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Taxpayers abroad can limit US taxes

TAX TIP No. 45

You took that great job in London and it has done wonders for your career as well as your bank account. It could also be a boon to Uncle Sam.

Under U.S. tax laws, the worldwide income of any U.S. citizen or resident alien is subject to tax. It doesn't matter if you're living in the United States or overseas, or the money came to you as wages, independent contractor payments or unearned income from investments, pensions, rents or royalties. The Internal Revenue Service is due its legal percentage.

There is a bit of a break for U.S. taxpayers who live abroad and meet certain requirements. These worldly citizens may be able to exclude all or a portion of their foreign earned income from the American tax code.

Unfortunately, though, some changes to the housing portion of this tax benefit mean that some U.S. workers with international postings will likely be using any tax savings to pay for housing costs that now get less favorable treatment.

Good and bad foreign income news

First, the good news. The amount of foreign income a worker can exclude from U.S. taxation on a 2009 return is $91,400, up from the prior year's $87,600. The low inflation rate means that for 2010, the excluded income amount edges up to just $91,500.

Now, for the bad news. While the excludable-income amount is slightly higher, a law enacted in May 2006, the Tax Increase Prevention and Reconciliation Act, or TIPRA, changed the way any tax on remaining foreign income is figured.

In this tax tip:
  • Good and bad foreign income news.
  • Overseas housing limits.
  • Filing methods remain the same.
  • Different tax rules for U.S. possessions.
Before TIPRA, after an overseas worker subtracted the exclusion amount, the worker was then able to figure U.S. taxes based on the remaining income. Now, however, regardless of the final taxable dollar amount, it is taxed as if it were still in the bracket it would have been in before the exclusion was allowed.

This means that expatriate workers will lose the tax-reducing value of the lower brackets in our progressive tax system. For example, if you make $100,000 overseas, your tax bracket is based on that amount, not just on the $8,600 you have after subtracting the $91,400 exclusion from your overall $100,000 income. So instead of figuring taxes on the $8,600 by beginning at the 10 percent bracket and working up through the progressive tax scale, the foreign-based worker would calculate his or her tax bill by starting at the 28 percent bracket into which the pre-exclusion income amount falls.

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Overseas housing limits

Taxpayers who qualify for the foreign income exclusion also might be eligible for a tax break on a portion of overseas housing costs. But the changes in TIPRA greatly reduce this benefit for some workers abroad.

Employees outside the United States still can exclude from U.S. taxes a portion of salary that goes toward overseas lodging. For the self-employed, foreign housing costs still can be claimed as a deduction. But the allowable housing amount is calculated using a percentage, 16 percent, of the current exclusion amount. The worker must also take into account the new law's 30 percent limit of the income exclusion.

When all the numbers are run, the bottom line is that for 2009 taxes, the most a worker abroad can exclude for housing costs is $27,420.

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