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

of which is your foreign earned income. Enter

In this situation (Example 2), you can-

tive share of the partnership net profit, on

TIP

not use Form 2555 – EZ since you had

Schedule E (Form 1040). On Form 2555, show

the amount of the deduction(s) related to ex-

self-employment income and business

$78,000 on line 40 and show $31,200 on line 42.

cluded income on line 42 of Form 2555.

expenses.

Your exclusion on Form 2555 is $46,800.

If you have itemized deductions related to

excluded income, enter on Schedule A (Form

In this situation (Example 5), you would

TIP

Example 3. Assume in Example 2, that both

not use Form 2555 – EZ since you had

1040) only the part not related to excluded in-

capital and personal services combine to pro-

earned income other than salaries and

come. You figure that amount by subtracting

duce the business income. No more than 30% of

wages and you had business expenses.

from the deduction the amount related to ex-

your net income, or $12,000, assuming that this

cluded income. Generally, you figure the

amount is a reasonable allowance for your ser-

amount that is related to the excluded income by

vices, is considered earned and can be ex-

multiplying the deduction by a fraction, the nu-

cluded. Your exclusion of $12,000 is 12% of

merator of which is your foreign earned income

your gross income ($12,000/$100,000). Be-

exclusion and the denominator of which is your

cause you excluded 12% of your total income,

foreign earned income. Attach a statement to

$7,200, or 12% of your business expenses, are

your return showing how you figured the deduct-

attributable to the excluded income and are not

ible amount.

deductible.

Example 1. You are a U.S. citizen em-

Example 4. You are a U.S. citizen, have a

Tax Treaty

ployed as an accountant. Your tax home is in

tax home in Brazil, and meet the physical pres-

Germany for the entire tax year. You meet the

ence test. You are self-employed and both capi-

physical presence test. Your foreign earned in-

Benefits

tal and personal services combine to produce

come for the year was $100,000 and your in-

business income. Your gross income was

vestment income was $12,000. After excluding

$146,000, business expenses were $172,000,

$78,000, your AGI is $34,000.

and your net loss was $26,000. A reasonable

Topics

allowance for the services you performed for the

You had unreimbursed business expenses

business is $77,000. Because you incurred a

This chapter discusses:

of $1,500 for travel and entertainment in earning

net loss, the earned income limit of 30% of your

your foreign income, of which $500 were for

•

net profit does not apply. The $77,000 is foreign

Some common tax treaty benefits,

meals and entertainment. These expenses are

earned income. If you choose to exclude the

•

deductible only as miscellaneous deductions on

How to get help in certain situations, and

$77,000, you exclude 52.74% of your gross in-

Schedule A (Form 1040). You also have $500 of

•

come ($77,000/$146,000), and 52.74% of your

How to get copies of tax treaties.

miscellaneous expenses that are not related to

business expenses ($90,712) are attributable to

your foreign income that you enter on line 22 of

that income and not deductible. Show your total

Schedule A.

Useful Items

income and expenses on Schedule C (Form

You must fill out Form 2106. On that form,

You may want to see:

1040). On Form 2555, exclude $77,000 and

reduce your deductible meal and entertainment

show $90,712 on line 42. Subtract line 42 from

expenses by 50% ($250). You must reduce the

Publication

line 41, and enter the difference as a negative (in

remaining $1,250 of travel and entertainment

parentheses) on line 43. Because this amount is

597

Information on the United

expenses by 78% ($975) because you excluded

negative, enter it as a positive (no parentheses)

States – Canada Income Tax

78% ($78,000/$100,000) of your foreign earned

on line 21, Form 1040, and combine it with your

Treaty

other income to arrive at total income on line 22

income. You carry the remaining total of $275 to

of Form 1040.

line 20 of Schedule A. Add the $275 to the $500

901

U.S. Tax Treaties

that you have on line 22 and enter the total

In this situation (Example 4), you would

See chapter 7 for information about getting

($775) on line 23.

TIP

probably not want to choose the for-

these publications.

On line 25 of Schedule A, enter $680, which

eign earned income exclusion if this

was the first year you were eligible. If you had

is 2% of your adjusted gross income of $34,000

chosen the exclusion in an earlier year, you

(line 34, Form 1040) and subtract it from the

might want to revoke the choice for this year. To

amount on line 23.

Purpose of Tax

do so would mean that you could not claim the

Enter $95 on line 26 of Schedule A.

exclusion again for the next 5 tax years without

Treaties

IRS approval. See Choosing the Exclusion, in

Example 2. You are a U.S. citizen, have a

chapter 4.

tax home in France, and meet the physical pres-

The United States has tax treaties or conven-

ence test. You are self-employed and personal

tions with many countries. Under these treaties

Example 5. You are a U.S. citizen, have a

services produce the business income. Your

and conventions, citizens and residents of the

tax home in Venezuela, and meet the bona fide

gross income was $100,000, business ex-

United States who are subject to taxes imposed

residence test. You have been performing ser-

penses $60,000, and net income (profit)

by the foreign countries are entitled to certain

vices for clients as a partner in a firm that pro-

$40,000. You choose the foreign earned income

credits, deductions, exemptions, and reductions

vides services exclusively in Venezuela. Capital

exclusion and exclude $78,000 of your gross

in the rate of taxes of those foreign countries. If a

investment is not material in producing the

income. Since your excluded income is 78% of

foreign country with which the United States has

partnership’s income. Under the terms of the

your total income, 78% of your business ex-

a treaty imposes a tax on you, you may be

partnership agreement, you are to receive 50%

penses are not deductible. Report your total

entitled to benefits under the treaty. See Table

of the net profits. The partnership received gross

income and expenses on Schedule C (Form

6 – 1, later.

income of $200,000 and incurred operating ex-

1040). On Form 2555 you will show the follow-

Treaty benefits generally are available to re-

penses of $80,000. Of the net profits of

ing:

sidents of the United States. They generally are

$120,000, you received $60,000 as your distrib-

not available to U.S. citizens who do not reside

utive share.

1) Line 20a, $100,000, gross income

in the United States. However, certain treaty

You choose to exclude $78,000 of your

benefits and safeguards, such as the nondis-

2) Lines 40 and 41, $78,000, foreign earned

share of the gross income. Because you ex-

crimination provisions, are available to U.S. citi-

income exclusion

clude 78% ($78,000/$100,000) of your share of

zens residing in the treaty countries. U.S.

3) Line 42, $46,800 (78% × $60,000) busi-

the gross income, you cannot deduct $31,200,

citizens residing in a foreign country may also be

ness expenses attributable to the exclu-

78% of your share of the operating expenses

entitled to benefits under that country’s tax trea-

(78% × $40,000). Report $60,000, your distribu-

sion.

ties with third countries.

Page 32

Chapter 6 Tax Treaty Benefits

Publication 54 - Tax Guide For U.s. Citizens And U.s. Citizens Abroad - 2001 Page 32

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