The United States has one of the most progressive tax systems in the industrialised world. Taxes are imposed on net income of individuals and corporations by the federal, most states, and some local governments. Citizens and residents are taxed on worldwide income and allowed a credit for foreign taxes. Income subject to tax is determined under tax accounting rules, not financial accounting principles, and includes almost all income from whatever source.
Individuals are permitted to reduce taxable income by personal allowances and certain non-business expenses, including mortgage interest, state and local taxes, charitable contributions and medical.
The United States is one of only two countries in the world that taxes its non-resident citizens on worldwide income, in the same manner and rates as residents. As an accountancy practice we find that very few US seafarers make declarations as they feel that they will have to pay the same rate of tax as their friends & family ashore. However the purpose of this article is to educate US seafarers on the Foreign Earned Income Exclusion.
The Foreign Earned Income Exclusion (FEIE) can exclude almost $100,000 of income earned in a foreign country from United States income taxes plus either an exclusion or a deduction can be claimed for certain housing costs. This income exclusion, which is adjusted for inflation, only applies to earnings from work and sadly not to investment income. If a taxpayer wishes to claim the exclusion, they must first demonstrate that they have a tax home in the foreign country and must satisfy either the foreign residence or physical presence test. In the event that foreign income is not excluded, then the taxpayer can either deduct the foreign tax paid or claim the foreign tax credit.
Types of Income to which the Foreign Earned Income Exclusion applies:
The FEIE applies only to income arising from performing services either as an employee or independent contractor. The term ‘earned income’ means wages, salaries, or professional fees, and other amounts received as compensation for professional services actually rendered under (IRS Code Section 911(d)(2)(A)). Hence, wages and self-employment income may qualify for the FEIE.
How does the FEIE impact the Tax Calculation?
United States citizens wishing to claim the FEIE will be taxed at the rates that usually apply had the exclusion not been in place. Then the federal income tax is calculated by first applying the amount of income tax that would be levied without taking into account the FEIE. The exclusion is then subtracted from the tax as calculated on the amount of foreign earned income that is excluded. The result is the amount of the federal tax liability. Unfortunately if a taxpayer earns more $100,000 a year the tax owed is levied at the higher rate for this tax bracket.