Publication 54 - Tax Guide For U.s. Citizens And Resident Aliens Abroad - 2006 Page 33
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44loss in later years when you have taxable in-
your tax return and how you figure the amount
1040). On Form 2555 you will show the follow-
come from foreign sources. This is done by
ing:
allocable to your excluded income depends on
treating a part of your taxable income from for-
whether the expenses are used in figuring ad-
•
Line 20a, $103,000, gross income,
eign sources in later years as U.S. source in-
justed gross income (Form 1040, line 38) or are
•
come. This reduces the numerator of the limiting
Lines 42 and 43, $82,400, foreign earned
itemized deductions.
fraction and the resulting foreign tax credit limit.
income exclusion, and
If you have deductions used in figuring ad-
•
justed gross income, enter the total amount for
Line 44, $48,000 (80% × $60,000) busi-
Foreign tax credit carryback and carryover.
each of these items on the appropriate lines and
ness expenses attributable to the exclu-
The amount of foreign income tax not allowed as
schedules of Form 1040. Generally, you figure
sion.
a credit because of the limit can be carried back
the amount of a deduction related to the ex-
1 year and carried forward 10 years.
cluded income by multiplying the deduction by a
More information on figuring the foreign tax
In this situation (Example 2), you can-
fraction, the numerator of which is your foreign
credit can be found in Publication 514.
TIP
not use Form 2555-EZ since you had
earned income exclusion and the denominator
self-employment income and business
of which is your foreign earned income. Enter
Deduction for
expenses.
the amount of the deduction(s) related to ex-
Foreign Income Taxes
cluded income on line 44 of Form 2555.
Example 3. Assume in Example 2 that both
If you have itemized deductions related to
Instead of taking the foreign tax credit, you can
capital and personal services combine to pro-
excluded income, enter on Schedule A (Form
deduct foreign income taxes as an itemized de-
duce the business income. No more than 30% of
1040) only the part not related to excluded in-
duction on Schedule A (Form 1040).
your net income, or $12,900, assuming that this
come. You figure that amount by subtracting
You can deduct only foreign income taxes
amount is a reasonable allowance for your serv-
from the total deduction the amount related to
paid on income that is subject to U.S. tax. You
ices, is considered earned and can be excluded.
excluded income. Generally, you figure the
cannot deduct foreign taxes paid on earnings
Your exclusion of $12,900 is 12.52% of your
amount that is related to the excluded income by
gross income ($12,900 ÷ $103,000). Because
you exclude from tax under any of the following.
multiplying the total deduction by a fraction, the
•
you excluded 12.52% of your total income,
numerator of which is your foreign earned in-
Foreign earned income exclusion.
$7,512 (12.52% of your business expenses), is
come exclusion and the denominator of which is
•
Foreign housing exclusion.
attributable to the excluded income and is not
your foreign earned income. Attach a statement
•
deductible.
to your return showing how you figured the de-
Possession exclusion.
ductible amount.
•
Extraterritorial income exclusion.
Example 4. You are a U.S. citizen, have a
tax home in Brazil, and meet the physical pres-
Example 1. You are a U.S. citizen em-
ence test. You are self-employed and both capi-
ployed as an accountant. Your tax home is in
Example. You are a U.S. citizen and qualify
tal and personal services combine to produce
Germany for the entire tax year. You meet the
to exclude your foreign earned income. Your
business income. Your gross income was
physical presence test. Your foreign earned in-
excluded wages in Country X are $70,000 on
$146,000, business expenses were $172,000,
come for the year was $103,000 and your in-
which you paid income tax of $10,000. You
and your net loss was $26,000. A reasonable
vestment income was $12,000. After excluding
received dividends from Country X of $2,000 on
allowance for the services you performed for the
$82,400, your AGI is $32,600.
which you paid income tax of $600.
business is $77,000. Because you incurred a
You can deduct the $600 tax payment be-
You had unreimbursed business expenses
net loss, the earned income limit of 30% of your
cause the dividends relating to it are subject to
of $1,500 for travel and entertainment in earning
net profit does not apply. The $77,000 is foreign
U.S. tax. Because you exclude your wages, you
your foreign income, of which $500 was for
earned income. If you choose to exclude the
cannot deduct the income tax of $10,000.
meals and entertainment. These expenses are
$77,000, you exclude 52.74% of your gross in-
If you exclude only a part of your wages, see
deductible only as miscellaneous deductions on
come ($77,000 ÷ $146,000), and 52.74% of your
the earlier discussion under Foreign taxes paid
Schedule A (Form 1040). You also have $500 of
business expenses ($90,713) is attributable to
on excluded income.
miscellaneous expenses that are not related to
that income and not deductible. Show your total
your foreign income that you enter on line 22 of
income and expenses on Schedule C (Form
Deduction for
Schedule A.
1040). On Form 2555, exclude $77,000 and
You must fill out Form 2106. On that form,
Other Foreign Taxes
show $90,713 on line 44. Subtract line 44 from
reduce your deductible meal and entertainment
line 43, and enter the difference as a negative (in
expenses by 50% ($250). You must reduce the
You can deduct real property taxes you pay that
parentheses) on line 45. Because this amount is
remaining $1,250 of travel and entertainment
are imposed on you by a foreign country. You
negative, enter it as a positive (no parentheses)
expenses by 80% ($1,000) because you ex-
take this deduction on Schedule A (Form 1040).
on line 21, Form 1040, and combine it with your
cluded 80% ($82,400/$103,000) of your foreign
You cannot deduct other foreign taxes, such as
other income to arrive at total income on line 22
earned income. You carry the remaining total of
personal property taxes, unless you incurred the
of Form 1040.
$250 to line 20 of Schedule A. Add the $250 to
expenses in a trade or business or in the produc-
the $500 that you have on line 22 and enter the
In this situation (Example 4), you would
tion of income.
TIP
total ($750) on line 23.
probably not want to choose the for-
On the other hand, you generally can deduct
eign earned income exclusion if this
On line 25 of Schedule A, enter $652, which
personal property taxes when you pay them to
was the first year you were eligible. If you had
is 2% of your adjusted gross income of $32,600
U.S. possessions. But if you claim the posses-
chosen the exclusion in an earlier year, you
(line 38, Form 1040) and subtract it from the
sion exclusion, see Publication 570.
might want to revoke the choice for this year. To
amount on line 23.
The deduction for foreign taxes other than
do so would mean that you could not claim the
foreign income taxes is not related to the foreign
Enter $98 on line 26 of Schedule A.
exclusion again for the next 5 tax years without
tax credit. You can take deductions for these
IRS approval. See Choosing the Exclusion, in
miscellaneous foreign taxes and also claim the
Example 2. You are a U.S. citizen, have a
chapter 4.
foreign tax credit for income taxes imposed by a
tax home in Spain, and meet the physical pres-
foreign country.
ence test. You are self-employed and personal
services produce the business income. Your
Example 5. You are a U.S. citizen, have a
gross income was $103,000, business ex-
tax home in Venezuela, and meet the bona fide
penses $60,000, and net income (profit)
residence test. You have been performing serv-
How To Report
$43,000. You choose the foreign earned income
ices for clients as a partner in a firm that pro-
exclusion and exclude $82,400 of your gross
vides services exclusively in Venezuela. Capital
Deductions
income. Since your excluded income is 80% of
investment is not material in producing the part-
your total income, 80% of your business ex-
nership’s income. Under the terms of the part-
If you exclude foreign earned income or housing
penses are not deductible. Report your total
nership agreement, you are to receive 50% of
amounts, how you show your deductions on
income and expenses on Schedule C (Form
the net profits. The partnership received gross
Chapter 5 Exemptions, Deductions, and Credits
Page 33
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