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

International tax accountants say this new housing allowance cap could cause U.S. taxpayers working in countries with expensive housing markets to face substantially higher taxes on their overall foreign compensation.

The IRS heard the protests and implemented a change in housing limits for some areas. For 2009, the maximum limitations on qualified housing expenses incurred in more than 300 foreign locations can be found in the table beginning on Page 5 of Form 2555 instructions. That listing shows countries that the U.S. State Department has identified as having high housing costs. Based on this data, the housing expense limits in those areas have been adjusted accordingly.

Remember, though, that these figures are not the final amount of housing costs you can exclude from your income. When you file your tax forms, you'll have to use the table amount in conjunction with the 16 percent and 30 percent limits to arrive at the actual amount you can exclude.

Filing method remains the same

While income and housing exclusion amounts have changed, eligibility requirements to claim them have not. In order to exclude any overseas earnings from U.S. taxation, you must meet two tests:
  1. You have a tax home in a foreign country.
  2. You meet either the Internal Revenue Service's bona fide residence or physical presence requirements.

Basically, your tax home is your regular or principal place of business, employment or post of duty. The IRS wants to be sure that you actually moved abroad rather than simply traveled there periodically to earn money. And you're not totally off the tax hook. If the foreign country has income tax laws, you cannot claim to be exempt from them.

The second test requires you to establish a genuine home in the country for a full tax year or, failing that, spend at least 330 days abroad earning your income.

As for your abode abroad, expenses you may count include rent, repairs, utilities (other than the telephone), real and personal property insurance, furniture rental and parking fees. But don't try to slip that villa on the Cote d'Azur past the IRS. The agency specifically says lavish or extravagant foreign housing expenses are not allowable.

File Form 2555 along with your U.S. tax return to claim the foreign-earned-income exclusion and the foreign housing exclusion or deduction. If you don't have any housing expenses to claim, you may be able to file the simpler Form 2555-EZ.

Different tax rules for U.S. possessions

One final warning: Don't jump at that job in St. Croix thinking it will get you off the tax hook while simultaneously improving your tan.

American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands and Puerto Rico are U.S. possessions, not foreign countries under the tax laws.

They have their own independent tax departments. If you have income from one of these U.S. possessions, you may have to file a U.S. tax return only, a possession tax return only or both returns.

In some cases, you may have to file a U.S. return, but be able to claim a possession exclusion similar to the foreign-earned-income exclusion. Information on the available tax exclusions and requirements can be found in IRS Publication 570, Tax Guide for Individuals With Income From U.S. Possessions.

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