The Internal Revenue Service has announced that combat-zone contract workers may now qualify for the foreign earned income exclusion.
Typically, if you are a U.S. citizen or a U.S. resident alien, you’re taxed on your worldwide income. However, certain taxpayers can exclude some or all foreign wages from tax under the foreign earned income exclusion. The exclusion is hefty: In 2018, the exclusion can be worth as much as $103,900.
To claim the foreign earned income exclusion, you must have foreign earned income and your tax home must be in a foreign country. Your tax home is where you conduct business or are performing work as an employee and may be different from your family home: It’s not necessarily the same as your residence.
In other words, you must demonstrate that you have established residence in a foreign country for an uninterrupted period that includes an entire tax year; for most taxpayers, that means January 1—December 31. You can leave the foreign country for temporary trips back to the United States or elsewhere for vacation or business, but you must intend to return. In extreme circumstances, you can get a waiver if you don’t stay for the entire year.
You aren’t considered to have a tax home in a foreign country for any period in which your abode is in the United States. “Abode” is a complicated word but is generally defined as “one’s home, habitation, residence, domicile, or place of dwelling.” It is not the same as your principal place of business or your tax home (see IRS Pub 54 for more details).
Under prior law, taxpayers who lived and worked in designated combat zones failed to qualify for the foreign earned income exclusion because they had an abode in the United States. As part of the Bipartisan Budget Act of 2018, contractors or employees of contractors providing support to U.S. Armed Forces in designated combat zones are eligible to claim the foreign earned income exclusion even if their “abode” is in the United States. The foreign earned income exclusion is not available to federal employees or members of the military. However, service members in combat zones may qualify for the combat pay exclusion (more on the combat pay exclusion and other tax breaks for the military here).
The new law applies to tax years beginning in 2018.
The foreign earned income exclusion is not automatic. To claim the exclusion, eligible taxpayers must file a U.S. income tax return together with a federal form 2555, Foreign Earned Income (downloads as a PDF). And no double-dipping: If you opt for the exclusion, you may not claim any other exclusion, deduction or credit related to the excluded income.
For more information about claiming the exclusion, check with your tax professional.
