36.1 Claiming the Foreign Earned Income Exclusion

If your tax home is in a foreign country and you meet either the foreign residence test or physical presence test (36.3), you may exclude up to $95,100 of foreign earned income earned in 2012. You must file a U.S. return if your gross income exceeds the filing threshold for your personal status, even though all or part of your foreign earned income may be tax free. For years after 2012, the maximum $95,100 exclusion may be increased by an inflation adjustment. The exclusion is not automatic; you must elect it. You elect the foreign earned income exclusion on Form 2555, which you attach to Form 1040. The housing cost exclusion (36.4) is also elected on Form 2555.

You may file simplified Form 2555-EZ if your 2012 foreign wages are $95,100 or less, you do not have self-employment income, and you do not claim the foreign housing exclusion, housing deduction, business expenses, or moving expenses.

A separate exclusion is allowed for the value of meals and lodging received by employees living in qualified camps; see 36.8.

If you claim the foreign income exclusion of $95,100, you may not:

• Claim business deductions allocable to the excluded income;
• Make a deductible traditional IRA contribution, or a Roth IRA contribution, based on the excluded income; or
• Claim foreign taxes paid on excluded income as a credit or deduction.

In deciding whether to claim the exclusion, compare the overall tax (1) with the exclusion and (2) without the exclusion but with the full foreign tax credit and allocable deductions. Choose whichever gives you the lower tax; see 36.3 and 36.6.

Caution

Claiming Foreign Tax Credit Revokes Prior Election

If you have been claiming the exclusion and decide that it would be advantageous this year to forego the exclusion and instead claim the foreign tax credit for foreign earned income, be aware that claiming the credit is treated by the IRS as a revocation of the prior exclusion election. You may not claim an exclusion for the next five years unless the IRS allows you to reelect the exclusion.

Claiming a foreign tax credit also may revoke a prior election to claim the housing cost exclusion. Depending on the foreign earned income in the year the credit is claimed, the credit may be considered a revocation of a prior earned income exclusion election and also a prior housing cost exclusion election, or as a revocation of only one of the elections.

A good faith error in calculating foreign earned income that leads to claiming a foreign credit will not be treated as a revocation of prior elections.

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Keep in mind that if you claim the exclusion, any taxable income not subject to the earned income and housing exclusions will be taxed at the same rates that would have applied had no exclusions been allowed. To apply this “stacking” rule, you must figure your regular tax liability using the Foreign Earned Income Tax Worksheet in the instructions to Form 1040. Also, to figure AMT liability, use the Foreign Earned Income Tax Worksheet in the instructions to Form 6251.

Election applies until revoked.

Once you elect the exclusion, that election remains in effect for all future years unless you revoke it. If you revoke the election, you cannot elect the exclusion again during the next five years without IRS consent. A revocation is made in a statement attached to your return for the year you want it to take effect. The foreign earned income exclusion and the housing cost exclusion must be revoked separately.

The IRS may consent to a reinstatement of the exclusion following a revocation under the following circumstances: you return for a period of time to the United States, you move to another foreign country with different tax rates, you change employers, or there has been substantial change in the tax law of the foreign country of residence or physical presence.