Publication 54 - Tax Guide For U.s. Citizens And U.s. Citizens Abroad

You worked in the United States during the year

Trade or business — corporation. The sal-

repairs and collecting rents, none of his net

ary you receive from a corporation is earned

income from the house is considered earned

for 6 weeks (30 workdays). The following shows

income only if it represents a reasonable allow-

income. It is all unearned income.

how to figure the part for work done in the United

ance as compensation for work you do for the

States during the year.

Professional fees. If you are engaged in a

corporation. Any amount over what is consid-

Number of days worked in the United States

professional occupation (such as a doctor or

during the year (30) ÷ Number of days of work

ered a reasonable salary is unearned income.

lawyer), all fees received in the performance of

during the year for which payment was made

these services are earned income.

Example 1. You are a U.S. citizen and an

(240) × Total income ($88,800) = $11,100.

officer and stockholder of a corporation in Ca-

Income of an artist. Income you receive from

Your U.S. source earned income is $11,100.

nada. You perform no work or service of any

the sale of paintings is earned income if you

kind for the corporation. During the tax year you

painted the pictures yourself.

receive a $10,000 “salary” from the corporation.

Earned and

The $10,000 clearly is not for personal services

Use of employer’s property or facilities. If

Unearned Income

and is unearned income.

you receive fringe benefits in the form of the right

to use your employer’s property or facilities, you

Earned income was defined earlier as pay for

Example 2. You are a U.S. citizen and work

must add the fair market value of that right to

personal services performed. Some types of in-

full time as secretary-treasurer of your corpora-

your pay. Fair market value is the price at which

come are not easily identified as earned or

tion. During the tax year you receive $100,000

the property would change hands between a

unearned income. These types of income —

as salary from the corporation. If $80,000 is a

willing buyer and a willing seller, neither being

specifically, income from sole proprietorships,

reasonable allowance as pay for the work you

required to buy or sell, and both having reasona-

partnerships, corporations, stock options, pen-

did, then $80,000 is earned income.

ble knowledge of all the necessary facts.

sions, annuities, royalties, rents, and fringe ben-

efits — are further explained here. Income from

Stock options. You may have earned income

Example. You are privately employed and

sole proprietorships and partnerships is gener-

if you disposed of stock that you got by exercis-

live in Japan all year. You are paid a salary of

ally treated differently than income from corpo-

ing a stock option granted to you under an em-

$6,000 a month. You live rent-free in a house

rations.

ployee stock purchase plan.

provided by your employer that has a fair rental

If your gain on the disposition of stock you

value of $3,000 a month. The house is not pro-

Trade or business — sole proprietorship or

got by exercising an option is treated as capital

vided for your employer’s convenience. You re-

partnership. Income from a business in which

gain, your gain is unearned income.

port on the calendar year, cash basis. You

However, if you disposed of the stock less

capital investment is an important part of pro-

received $72,000 salary from foreign sources

than 2 years after you were granted the option or

ducing the income may be unearned income. If

plus $36,000 fair rental value of the house, or a

less than 1 year after you got the stock, part of

you are a sole proprietor or partner and your

total of $108,000 of earned income.

the gain on the disposition may be earned in-

personal services are also an important part of

come. It is considered received in the year you

producing the income, the part of the income

Reimbursement of employee expenses. If

disposed of the stock and earned in the year you

that represents the value of your personal ser-

you are reimbursed under an accountable plan

performed the services for which you were

(defined below) for expenses you incur on your

vices will be treated as earned income.

granted the option. Any part of the earned in-

employer’s behalf and you have adequately ac-

Capital a factor. If capital investment is an

come that is due to work you did outside the

counted to your employer for the expenses, do

important part of producing income, no more

United States is foreign earned income.

not include the reimbursement for those ex-

than 30% of your share of the net profits of the

See Publication 525, Taxable and Nontax-

penses in your earned income.

business is earned income.

able Income, for a discussion of the treatment of

The expenses for which you are reimbursed

If you have no net profits, the part of your

stock options.

are not considered allocable (related) to your

gross profit that represents a reasonable allow-

earned income. If expenses and reimbursement

Pensions and annuities.

For purposes of the

ance for personal services actually performed is

are equal, there is nothing to allocate to ex-

foreign earned income exclusion, the foreign

considered earned income. Because you do not

cluded income. If expenses are more than the

housing exclusion, and the foreign housing de-

have a net profit, the 30% limit does not apply.

reimbursement, the unreimbursed expenses are

duction, amounts received as pensions or annu-

considered to have been incurred in producing

ities are unearned income.

Example 1. You are a U.S. citizen and meet

earned income and must be divided between

the bona fide residence test. You invest in a

your excluded and included income in determin-

Royalties. Royalties from the leasing of oil

partnership based in Cameroon that is engaged

ing the amount of unreimbursed expenses you

and mineral lands and patents generally are a

solely in selling merchandise outside the United

can deduct. (See chapter 5.) If the reimburse-

form of rent or dividends and are unearned in-

States. You perform no services for the partner-

ment is more than the expenses, no expenses

come.

ship. At the end of the tax year, your share of the

remain to be divided between excluded and in-

Royalties received by a writer are earned

net profits is $80,000. The entire $80,000 is

cluded income and the excess reimbursement

income if they are received:

unearned income.

must be included in earned income.

1) For the transfer of property rights of the

These rules do not apply to the following

Example 2. Assume that in Example 1 you

writer in the writer’s product, or

individuals.

spend time operating the business. Your share

2) Under a contract to write a book or series

1) Straight-commission salespersons.

of the net profits is $80,000, 30% of your share

of articles.

of the profits is $24,000. If the value of your

2) Employees who have arrangements with

services for the year is $15,000, your earned

their employers under which taxes are not

Rental income. Generally, rental income is

income is limited to the value of your services,

withheld on a percentage of the commis-

unearned income. If you perform personal ser-

$15,000.

sions because the employers consider that

vices in connection with the production of rent,

percentage to be attributable to the em-

Capital not a factor. If capital is not an

up to 30% of your net rental income can be

ployees’ expenses.

income-producing factor and personal services

considered earned income.

produce the business income, the 30% rule

Accountable plan. An accountable plan is

does not apply. The entire amount of business

Example. Larry Smith, a U.S. citizen living

a reimbursement or allowance arrangement that

income is earned income.

in Australia, owns and operates a rooming

includes all three of the following rules.

house in Sydney. If he is operating the rooming

Example. You and Lou Green are manage-

house as a business that requires capital and

1) The expenses covered under the plan

ment consultants and operate as equal partners

personal services, he can consider up to 30% of

must have a business connection.

in performing services outside the United

net rental income as earned income. On the

States. Because capital is not an income-pro-

other hand, if he just owns the rooming house

2) The employee must adequately account to

ducing factor, all the income from the partner-

and performs no personal services connected

the employer for these expenses within a

ship is considered earned income.

with its operation, except perhaps making minor

reasonable period of time.

Page 16

Chapter 4 Foreign Earned Income and Housing: Exclusion – Deduction

Publication 54 - Tax Guide For U.s. Citizens And U.s. Citizens Abroad - 2001 Page 16

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