TAX TIP No. 63

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.

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 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

This increase is thanks to inflation. Each fall, the IRS examines the foreign-income-exclusion amount for the coming year and see how much, if any, it will be increased for the coming tax year.

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.

Before TIPRA, after an overseas worker subtracted the exclusion amount, the worker was 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 $12,400 you have after subtracting the $87,600 exclusion from your overall $100,000 income. So instead of figuring taxes on the $12,400 by beginning at the 10-percent bracket and working up through the progressive tax scale, the foreign-based worker would calculate his tax bill by starting at the 28-percent bracket into which the pre-exclusion income amount falls.

Overseas housing limits

Employees outside the United States still can exclude from U.S. taxes a portion of salary that goes toward your overseas lodgings. 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 2008 taxes, the most a worker abroad can exclude for housing costs is $26,280.