What's New

Exclusion amount. The maximum foreign earned income exclusion is now adjusted annually for inflation. For 2007, the maximum exclusion has increased to $85,700. See Limit on Excludable Amount under Foreign Earned Income Exclusion in chapter 4.

Housing expenses—base amount. The computation of the base housing amount (line 32 of Form 2555) is tied to the maximum foreign earned income exclusion. The amount is 16 percent of the exclusion amount (computed on a daily basis), multiplied by the number of days in your qualifying period that fall within your 2007 tax year. For 2007, this amount is $37.57 per day ($13,712 per year). See Housing Amount under Foreign Housing Exclusion and Deduction in Chapter 4.

Housing expenses—maximum amount. The amount of qualified housing expenses eligible for the housing exclusion and housing deduction has changed for many locations. See Limit on housing expenses under Foreign Housing Exclusion and Deduction in chapter 4.

Exemption amount. The amount you can deduct for each exemption (based on your filing status and adjusted gross income) is at least $1,133 but not more than $3,400.

Exemption phaseout. You lose part of the benefit of your exemptions if your adjusted gross income is above a certain amount. The amount at which the phaseout begins depends on your filing status. For 2007, the phaseout begins at:

$117,300 for married persons filing separately,
$156,400 for single individuals,
$195,500 for heads of household, and
$234,600 for married persons filing jointly or qualifying widow(er)s.

However, you can lose no more than ⅔ of the amount of your exemptions. In other words, each exemption cannot be reduced to less than $1,133.

Standard deduction. The standard deduction for people who do not itemize deductions on Schedule A (Form 1040) is, in most cases, higher for 2007. The amount depends on your filing status, whether you are 65 or older or blind, and whether an exemption can be claimed for you by another person. The amounts for the standard deduction for 2007 are shown in the instructions for your tax return.

Itemized deductions phaseout. If your adjusted gross income is above a certain amount, you may lose part of your itemized deductions. In 2007, this amount has increased to $156,400 ($78,200 if married filing separately). However, the amount by which these deductions are reduced is only 2/3 of the amount of the reduction that otherwise would have applied.

Filing requirements. Generally, the amount of income you can receive before you must file an income tax return has increased. These amounts are shown in chapter 1 under Filing Requirements.

Maximum self-employment tax. For 2007, the maximum amount of net earnings from self-employment that is subject to the social security part of the self-employment tax has increased to $97,500. All net earnings are subject to the Medicare part of the tax. For more information, see chapter 3.

Reminders

Change of address. If you change your mailing address, be sure to notify the Internal Revenue Service using Form 8822, Change of Address. If you are changing both your home and business addresses, you need to complete two forms.

Figuring tax on income not excluded. If you claim the foreign earned income exclusion, the housing exclusion, or both, you must figure the tax on your nonexcluded income using the tax rates that would have applied had you not claimed the exclusions. See the instructions for Form 1040 and complete the Foreign Earned Income Tax Worksheet to figure the amount of tax to enter on Form 1040, line 44. If you must attach Form 6251 to your return, use the Foreign Earned Income Tax Worksheet provided in the instructions for Form 6251.

Introduction

This publication discusses special tax rules for U.S. citizens and resident aliens who work abroad or who have income earned in foreign countries. As a U.S. citizen or resident alien, your worldwide income generally is subject to U.S. income tax, regardless of where you are living. Also, you are subject to the same income tax filing requirements that apply to U.S. citizens or resident aliens living in the United States.

Resident alien

A resident alien is an individual who is not a citizen or national of the United States and who meets either the green card test or the substantial presence test for the calendar year.

Green card test. You are a U.S. resident if you were a lawful permanent resident of the United States at any time during the calendar year. This is known as the green card test because resident aliens hold immigrant visas (also known as green cards).
Substantial presence test. You are considered a U.S. resident if you meet the substantial presence test for the calendar year. To meet this test, you must be physically present in the United States on at least:
1. 31 days during the current calendar year, and
2. 183 days during the current year and the 2 preceding years, counting all the days of physical presence in the current year, but only ⅙ the number of days of presence in the first preceding year, and only ⅙ the number of days in the second preceding year.

Example —

You were physically present in the United States on 120 days in each of the years 2005, 2006, and 2007. To determine if you meet the substantial presence test for 2007, count the full 120 days of presence in 2007, 40 days in 2006 (⅓ of 120), and 20 days in 2005 (⅙ of 120). Because the total for the 3-year period is 180 days, you are not considered a resident under the substantial presence test for 2007.

For more information on resident and nonresident status, the tests for residence, and the exceptions to them, see Publication 519, U.S. Tax Guide for Aliens.

Filing information

Chapter 1 contains general filing information, such as:

Whether you must file a U.S. tax return,
When and where to file your return,
How to report your income if it is paid in foreign currency,
How to treat a nonresident alien spouse as a U.S. resident, and
Whether you must pay estimated tax.

Withholding tax

Chapter 2 discusses the withholding of income, social security, and Medicare taxes from the pay of U.S. citizens and resident aliens. Self-employment tax. Chapter 3 discusses who must pay self-employment tax.

Foreign earned income exclusion and housing exclusion and deduction

Chapter 4 discusses income tax benefits that apply if you meet certain requirements while living abroad. You may qualify to treat up to $85,700 of your income as not taxable by the United States. You may also be able to either deduct part of your housing expenses from your income or treat a limited amount of income used for housing expenses as not taxable by the United States. These benefits are called the foreign earned income exclusion and the foreign housing deduction and exclusion. To qualify for either of the exclusions or the deduction, you must have a tax home in a foreign country and earn income from personal services performed in a foreign country. These rules are explained in chapter 4. If you are going to exclude or deduct your income as discussed above, you must file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion. You will find an example with filled-in Forms 2555 and 2555-EZ in chapter 4.

Exemptions, deductions, and credits

Chapter 5 discusses exemptions, deductions, and credits you may be able to claim on your return. These are generally the same as if you were living in the United States. However, if you choose to exclude foreign earned income or housing amounts, you cannot deduct or exclude any item or take a credit for any item that is related to the amounts you exclude. Among the topics discussed in chapter 5 are:

Exemptions you can claim,
Contributions you can deduct,
Moving expenses you can deduct, and
Foreign taxes you can either deduct or take a credit for.

Tax treaty benefits

Chapter 6 discusses some benefits that are common to most tax treaties and explains how to get help if you think you are not receiving a treaty benefit to which you are entitled. It also explains how to get copies of tax treaties.

Expatriates

Expatriation tax provisions apply to U.S. citizens who have renounced their citizenship and long-term residents who have ended their residency. These provisions are discussed in chapter 4 of Publication 519.

1. Filing Information

Topics - This chapter discusses:

Whether you have to file a return,
When to file your return and pay any tax due,
How to treat foreign currency,
Where to file your return,
When you can treat your nonresident alien spouse as a resident, and
When you may have to make estimated tax payments.

Useful Items - You may want to see:

Publication

Form (and Instructions)

1040-ES
Estimated Tax for Individuals
1040X
Amended U.S. Individual Income Tax Return
2350
Application for Extension of Time To File U.S. Income Tax Return
2555
Foreign Earned Income
2555-EZ
Foreign Earned Income Exclusion
4868
Application for Automatic Extension of Time To File U.S. Individual Income Tax Return
8822
Change of Address

See chapter 7 for information about getting these publications and forms.

Filing Requirements

If you are a U.S. citizen or resident alien, the rules for filing income, estate, and gift tax returns and for paying estimated tax are generally the same whether you are in the United States or abroad.

Your income, filing status, and age generally determine whether you must file an income tax return. Generally, you must file a return for 2007 if your gross income from worldwide sources is at least the amount shown for your filing status in the following table.

Filing Status*		Amount
Single		$8,750
65 or older		$10,050
Head of household		$11,250
65 or older		$12,550
Qualifying widow(er)		$14,100
65 or older		$15,150
Married filing jointly		$17,500
Not living with spouse at end of year		$3,400
One spouse 65 or older		$18,550
Both spouses 65 or older		$19,600
Married filing separately		$3,400
If you are the dependent of another taxpayer, see the instructions for Form 1040* for more information on whether you must file a return.

Gross income

This includes all income you receive in the form of money, goods, property, and services that is not exempt from tax. For purposes of determining whether you must file a return, gross income includes any income that you can exclude as foreign earned income or as a foreign housing amount.

If you are self-employed, your gross income includes the amount on line 7 of Schedule C (Form 1040), Profit or Loss From Business, or line 1 of Schedule C-EZ (Form 1040), Net Profit From Business.

Self-employed individuals. If your net earnings from self-employment are $400 or more, you must file a return even if your gross income is below the amount listed for your filing status in the table shown earlier. Net earnings from self-employment are defined in Publication 334, Tax Guide for Small Business.

65 or older

You are considered to be age 65 on the day before your 65th birthday. For example, if your 65th birthday is on January 1, 2008, you are considered 65 for 2007. Residents of U.S. possessions. If you are (or were) a bona fide resident of a U.S. possession, you may be required to file Form 8898, Statement for Individuals Who Begin or End Residency in a U.S. Possession. See the instructions on the form for more information.

When To File and Pay

If you file on the calendar year basis, the due date for filing your return is April 15 of the following year. If you file on a fiscal year basis (a year ending on the last day of any month except December), the due date is 3 months and 15 days after the close of your fiscal year. In general, the tax shown on your return should be paid by the due date of the return, without regard to any extension of time for filing the return.

When the due date for doing any act for tax purposes—filing a return, paying taxes, etc.— falls on a Saturday, Sunday, or legal holiday, the due date is delayed until the next business day.

A tax return delivered by the U.S. mail or a designated delivery service that is postmarked or dated by the delivery service on or before the due date is considered to have been filed on or before that date. See your Form 1040 or Form 1040A instructions for a list of designated delivery services.

Extensions

You can get an extension of time to file your return. In some circumstances, you can also get an extension of time to file and pay any tax due.

However, if you pay the tax due after the regular due date, interest will be charged from the regular due date until the date the tax is paid.

This publication discusses three extensions: an automatic 2-month extension, an automatic 6-month extension, and an extension of time to meet tests. If you served in a combat zone or qualified hazardous duty area, see Publication 3 for a discussion of an extension of time to file.

Automatic 2-month extension. You are allowed an automatic 2-month extension to file your return and pay any federal income tax that is due if you are a U.S. citizen or resident alien, and on the regular due date of your return:

You are living outside of the United States and Puerto Rico and your main place of business or post of duty is outside the United States and Puerto Rico, or
You are in military or naval service on duty outside the United States and Puerto Rico.

If you use a calendar year, the regular due date of your return is April 15. Even if you are allowed an extension, you will have to pay interest on any tax not paid by the regular due date of your return.

Married taxpayers

If you file a joint return, either you or your spouse can qualify for the automatic extension. If you and your spouse file separate returns, this automatic extension applies only to the spouse who qualifies for it.

How to get the extension

To use this automatic 2-month extension, you must attach a statement to your return explaining which of the two situations listed earlier qualified you for the extension. Automatic 6-month extension. If you are not able to file your return by the due date, you generally can get an automatic 6-month extension of time to file (but not of time to pay). To get this automatic extension, you must file a paper Form 4868 or use IRS e-file (electronic filing). For more information about filing electronically, see E-file options, later. The form must show your properly estimated tax liability based on the information available to you. You may not be eligible. You cannot use the automatic 6-month extension of time to file if:

You want the IRS to figure your tax, or
You are under a court order to file by the regular due date.

E-file options. There are two ways you can use e-file to get an extension of time to file. Complete Form 4868 to use as a worksheet. If you think you may owe tax when you file your return, use Part II of the form to estimate your balance due. If you e-file Form 4868 to the IRS, do not also send a paper Form 4868.

E-file using your personal computer or a tax professional. You can use a tax software package with your personal computer or a tax professional to file Form 4868 electronically. You will need to provide certain information from your tax return for 2006. If you wish to make a payment by electronic funds withdrawal, see the instructions for Form 4868.
E-file and pay by credit card.You can get an extension by paying part or all of your estimate of tax due by using a credit card. You can do this by phone or over the Internet. You do not File Form 4868. For more information, see the instructions for your tax return.

When to file

Generally, you must request the 6-month extension by the regular due date of your return. Previous 2-month extension. If you cannot file your return within the automatic 2-month extension period, you generally can get an additional 4 months to file your return, for a total of 6 months. The 2-month period and the 6-month period start at the same time. You do not have to request the additional 4 months until the new due date allowed by the 2-month extension. The additional 4 months of time to file (unlike the original 2-month extension) is not an extension of time to pay. You must make an accurate estimate of your tax based on the information available to you. If you find you cannot pay the full amount due with Form 4868, you can still get the extension. You will owe interest on the unpaid amount. You also may be charged a penalty for paying the tax late unless you have reasonable cause for not paying your tax when due. Interest and penalties are assessed (charged) from the original due date of your return.

Additional extension of time for taxpayers out of the country

In addition to the 6-month extension, taxpayers who are out of the country can request a discretionary 2-month additional extension of time to file their returns (to December 15 for calendar year taxpayers). To request this extension, you must send the Internal Revenue Service a letter explaining the reasons why you need the additional 2 months. Send the letter by the extended due date (October 15 for calendar year taxpayers) to the following address:

Department of the Treasury
Internal Revenue Service Center
Austin, TX 73301-0215

You will not receive any notification from the Internal Revenue Service unless your request is denied for being untimely. The discretionary 2-month additional extension is not available to taxpayers who have an approved extension of time to file on Form 2350, discussed next.

Extension of time to meet tests

You generally cannot get an extension of more than 6 months. However, if you are outside the United States and meet certain requirements, you may be able to get a longer extension. You can get an extension of more than 6 months to file your tax return if you need the time to meet either the bona fide residence test or the physical presence test to qualify for either the foreign earned income exclusion or the foreign housing exclusion or deduction. The tests, the exclusions, and the deduction are explained in chapter 4. You should request an extension if all three of the following apply.

You are a U.S. citizen or resident alien.
You expect to meet either the bona fide residence test or the physical presence test, but not until after your tax return is due.
Your tax home is in a foreign country (or countries) throughout your period of bona fide residence or physical presence, whichever applies.

If you are granted an extension, it generally will be to 30 days beyond the date on which you can reasonably expect to qualify for an exclusion or deduction under either the bona fide residence test or the physical presence test. However, if you have moving expenses that are for services performed in 2 years, you may be granted an extension to 90 days beyond the close of the year following the year of first arrival in the foreign country.

How to get an extension

To obtain an extension, you should file Form 2350 with the Department of the Treasury, Internal Revenue Service Center, Austin, TX 73301-0215, or the local IRS representative, or other IRS employee. You must file Form 2350 by the due date for filing your return. Generally, if both your tax home and your abode are outside the United States and Puerto Rico on the regular due date of your return and you file on a calendar year basis, the due date for filing your return is June 15.

What if tests are not met

If you obtain an extension and unforeseen events make it impossible for you to meet either the bona fide residence test or the physical presence test, you should file your income tax return as soon as possible because you must pay interest on any tax due after the regular due date of the return (even though an extension was granted). You should make any request for an extension early, so that if it is denied you still can file your return on time. Otherwise, if you file late and additional tax is due, you may be subject to a penalty.

Return filed before test is met

If you file a return before you meet the bona fide residence test or the physical presence test, you must include all income from both U.S. and foreign sources and pay the tax on that income. If you meet either of the tests later and qualify for the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you can file a claim for refund of tax on Form 1040X. The refund will be the difference between the amount of tax already paid and the tax liability as figured after the exclusion or deduction.

Foreign Currency

You must express the amounts you report on your U.S. tax return in U.S. dollars. If you receive all or part of your income or pay some or all of your expenses in foreign currency, you must translate the foreign currency into U.S. dollars. How you do this depends on your functional currency. Your functional currency generally is the U.S. dollar unless you are required to use the currency of a foreign country.

You must make all federal income tax determinations in your functional currency. The U.S. dollar is the functional currency for all taxpayers except some qualified business units (QBUs). A QBU is a separate and clearly identified unit of a trade or business that maintains separate books and records.

Even if you have a QBU, your functional currency is the dollar if any of the following apply.

You conduct the business in dollars.
The principal place of business is located in the United States.
You choose to or are required to use the dollar as your functional currency.
The business books and records are not kept in the currency of the economic environment in which a significant part of the business activities is conducted.

Make all income tax determinations in your functional currency. If your functional currency is the U.S. dollar, you must immediately translate into dollars all items of income, expense, etc. (including taxes), that you receive, pay, or accrue in a foreign currency and that will affect computation of your income tax. Use the exchange rate prevailing when you receive, pay, or accrue the item. If there is more than one exchange rate, use the one that most properly reflects your income. You can generally get exchange rates from banks and U.S. Embassies.

If your functional currency is not the U.S. dollar, make all income tax determinations in your functional currency. At the end of the year, translate the results, such as income or loss, into U.S. dollars to report on your income tax return.

Blocked Income

You generally must report your foreign income in terms of U.S. dollars and, with one exception (see Fulbright Grant, later), you must pay taxes due on it in U.S. dollars.

If, because of restrictions in a foreign country, your income is not readily convertible into U.S. dollars or into other money or property that is readily convertible into U.S. dollars, your income is “blocked” or “deferrable” income. You can report this income in one of two ways:

Report the income and pay your federal income tax with U.S. dollars that you have in the United States or in some other country, or
Postpone the reporting of the income until it becomes unblocked.

If you choose to postpone the reporting of the income, you must file an information return with your tax return. For this information return, you should use another Form 1040 labeled “Report of Deferrable Foreign Income, pursuant to Rev. Rul. 74-351.” You must declare on the information return that you will include the deferrable income in your taxable income for the year that it becomes unblocked. You also must state that you waive any right to claim that the deferrable income was includible in your income for any earlier year.

You must report your income on your information return using the foreign currency in which you received that income. If you have blocked income from more than one foreign country, include a separate information return for each country.

Income becomes unblocked and reportable for tax purposes when it becomes convertible, or when it is converted, into dollars or into other money or property that is convertible into U.S. currency. Also, if you use blocked income for your personal expenses or dispose of it by gift, bequest, or devise, you must treat it as unblocked and reportable.

If you have received blocked income on which you have not paid tax, you should check to see whether that income is still blocked. If it is not, you should take immediate steps to pay tax on it, file a declaration or amended declaration of estimated tax, and include the income on your tax return for the year in which the income became unblocked.

If you choose to postpone reporting blocked income and in a later tax year you wish to begin including it in gross income although it is still blocked, you must obtain the permission of the IRS to do so. To apply for permission, file Form 3115, Application for Change in Accounting Method. You also must request permission from the IRS on Form 3115 if you have not chosen to defer the reporting of blocked income in the past, but now wish to begin reporting blocked income under the deferred method. See the instructions for Form 3115 for information.

Fulbright Grant

All income must be reported in U.S. dollars. In most cases, the tax must also be paid in U.S. dollars. If, however, at least 70% of your Fulbright grant has been paid in nonconvertible foreign currency (blocked income), you can use the currency of the host country to pay the part of the U.S. tax that is based on the blocked income.

Paying U.S. tax in foreign currency. To qualify for this method of payment, you must prepare a statement that shows the following information.

You were a Fulbright grantee and were paid in nonconvertible foreign currency.
The total grant you received during the year and the amount you received in nonconvertible foreign currency.
At least 70% of the grant was paid in nonconvertible foreign currency.

The statement must be certified by the U.S. educational foundation or commission paying the grant or other person having control of grant payments to you. You should prepare at least two copies of this statement. Attach one copy to your Form 1040 and keep the other copy for identification purposes when you make a tax deposit of nonconvertible foreign currency.

Figuring actual tax

When you prepare your income tax return, you may owe tax or the entire liability may have been satisfied with your estimated tax payments. If you owe tax, figure the part due to (and payable in) the nonconvertible foreign currency by using the following formula.

	Adjusted gross income that is blocked income	×	Total U.S. tax	=	Tax on blocked income
	Total adjusted gross income

You must attach all of the following to the return.

A copy of the certified statement discussed earlier.
A detailed statement showing the allocation of tax attributable to amounts received in foreign currency and the rates of exchange used in determining your tax liability in U.S. dollars.
The original deposit receipt for any balance of tax due that you paid in nonconvertible foreign currency.

Figuring estimated tax on nonconvertible foreign currency

If you are liable for estimated tax (discussed later), figure the amount you can pay to IRS in nonconvertible foreign currency using the following formula.

	Adjusted gross income that is blocked income	×	Total estimated U.S. tax	=	Estimated tax on blocked income
	Total adjusted gross income

If you must pay your host country income tax on your grant, subtract any estimated foreign tax credit that applies to your grant from the estimated tax on the blocked income.

Deposit of foreign currency with disbursing officer

Once you have determined the amount of the actual tax or estimated tax that you can pay in nonconvertible foreign currency, deposit that amount with the disbursing officer of the Department of State in the foreign country in which the foundation or commission paying the grant is located.

Estimated tax installments

You can either deposit the full estimated tax amount before the first installment due date or make four equal payments before the installment due dates. See Estimated Tax, later.

Deposit receipt

Upon accepting the foreign currency, the disbursing officer will give you a receipt in duplicate. The original of this receipt (showing the amount of foreign currency deposited and its equivalent in U.S. dollars) should be attached to your Form 1040 or payment voucher from Form 1040-ES. Keep the copy for your records.

Does My Return Have To Be On Paper?

IRS e-file (electronic filing) is the fastest, easiest, and most convenient way to file your income tax return electronically. It's so easy, more than half a billion federal returns have been e-filed.

IRS e-file offers accurate, safe, and fast alternatives to filing on paper. IRS computers quickly and automatically check for errors or other missing information. Even returns with a foreign address can be e-filed!

How to e-file. There are three ways you can e-file.

Use your personal computer.
Use a volunteer. Many programs offering free tax help can e-file your return.
Use a tax professional. Most tax professionals can e-file your return.

These methods are explained in detail in the instructions for your tax return.

Where To File

If any of the following situations apply to you, file your return with the:

Department of the Treasury
Internal Revenue Service Center
Austin, TX 73301-0215

You claim the foreign earned income exclusion.
You claim the foreign housing exclusion or deduction.
You live in a foreign country.

The exclusions and the deduction are explained in chapter 4.

If you do not know where your legal residence is and you do not have a principal place of business in the United States, you can file with the Austin Service Center.

However, you should not file with the Austin Service Center if you are a bona fide resident of the U.S. Virgin Islands, Guam, or the Commonwealth of the Northern Mariana Islands during your entire tax year.

Resident of U.S. Virgin Islands (USVI) If you are a bona fide resident of the USVI during your entire tax year, you generally are not required to file a U.S. return. However, you must file a return with the USVI. Send your return to the:

Virgin Islands Bureau of Internal Revenue
9601 Estate Thomas
Charlotte Amalie
St. Thomas, Virgin Islands 00802

Non-USVI resident with USVI income. If you are a U.S. citizen or resident alien and you have income from sources in the USVI or income effectively connected with the conduct of a trade or business in the USVI, and you are not a bona fide resident of the USVI during your entire tax year, you must file identical tax returns with the United States and the USVI. File the original return with the United States and file a copy of the U.S. return (including all attachments, forms, and schedules) with the Virgin Islands Bureau of Internal Revenue. You must complete Form 8689, Allocation of Individual Income Tax to the U.S. Virgin Islands, and attach a copy to both your U.S. return and your USVI return. You should file your U.S. return with the Department of the Treasury, Internal Revenue Service Center, Austin, TX 73301-0215. See Publication 570, Tax Guide for Individuals With Income From U.S. Possessions, for information about filing Virgin Islands returns. Resident of Guam If you are a bona fide resident of Guam during your entire tax year, you should file a return with Guam. Send your return to the:

Department of Revenue and Taxation
Government of Guam
P.O. Box 23607
GMF, GU 96921

However, if you have income from sources within Guam and you are a U.S. citizen or resident alien, but not a bona fide resident of Guam during the entire tax year, you should file a return with the United States. Send your return to the Department of the Treasury, Internal Revenue Service Center, Austin, TX 73301-0215. See Publication 570 for information about filing Guam returns. Resident of the Commonwealth of the Northern Mariana Islands If you are a bona fide resident of the Commonwealth of the Northern Mariana Islands (CNMI) during your entire tax year, you should file a return with the Northern Mariana Islands. Send your return to the:

Division of Revenue and Taxation
Commonwealth of the Northern Mariana Islands
P.O. Box 5234, CHRB
Saipan, MP 96950

However, if you have income from sources within the CNMI and you are a U.S. citizen or resident alien, but not a bona fide resident of the CNMI during the entire tax year, you should file a return with the United States. Send your return to the Department of the Treasury, Internal Revenue Service Center, Austin, TX 73301-0215. See Publication 570 for information about filing Northern Mariana Islands returns.

Nonresident Alien Spouse Treated as a Resident

If, at the end of your tax year, you are married and one spouse is a U.S. citizen or a resident alien and the other is a nonresident alien, you can choose to treat the nonresident as a U.S. resident. This includes situations in which one of you is a nonresident alien at the beginning of the tax year and a resident alien at the end of the year and the other is a nonresident alien at the end of the year.

If you make this choice, the following two rules apply.

You and your spouse are treated, for income tax purposes, as residents for all tax years that the choice is in effect.
You must file a joint income tax return for the year you make the choice.

This means that neither of you can claim tax treaty benefits as a resident of a foreign country for a tax year for which the choice is in effect.

You can file joint or separate returns in years after the year in which you make the choice.

Example —

Pat Smith, a U.S. citizen, is married to Norman, a nonresident alien. Pat and Norman make the choice to treat Norman as a resident alien by attaching a statement to their joint return. Pat and Norman must report their worldwide income for the year they make the choice and for all later years unless the choice is ended or suspended. Although Pat and Norman must file a joint return for the year they make the choice, they can file either joint or separate returns for later years.

Example —

When Bob and Sharon Williams got married, both were nonresident aliens. In June of last year, Bob became a resident alien and remained a resident for the rest of the year. Bob and Sharon both choose to be treated as resident aliens by attaching a statement to their joint return for last year. Bob and Sharon must report their worldwide income for last year and all later years unless the choice is ended or suspended. Bob and Sharon must file a joint return for last year, but they can file either joint or separate returns for later years.

If you do not choose to treat your nonresident alien spouse as a U.S. resident, you may be able to use head of household filing status. To use this status, you must pay more than half the cost of maintaining a household for certain dependents or relatives other than your nonresident alien spouse. For more information, see Publication 501.

Social Security Number (SSN)

If you choose to treat your nonresident alien spouse as a U.S. resident, your spouse must have either an SSN or an individual taxpayer identification number (ITIN).

To get an SSN for your spouse, apply at a social security office or U.S. consulate. You must complete Form SS-5. You must also provide original or certified copies of documents to verify your spouse's age, identity, and citizenship.

If your spouse is not eligible to get an SSN, he or she can file Form W-7 with the IRS to apply for an ITIN.

How To Make the Choice

Attach a statement, signed by both spouses, to your joint return for the first tax year for which the choice applies. It should contain the following:

A declaration that one spouse was a nonresident alien and the other spouse a U.S. citizen or resident alien on the last day of your tax year and that you choose to be treated as U.S. residents for the entire tax year, and
The name, address, and social security number (or individual taxpayer identification number) of each spouse. (If one spouse died, include the name and address of the person making the choice for the deceased spouse.)

You generally make this choice when you file your joint return. However, you can also make the choice by filing a joint amended return on Form 1040X. Attach Form 1040, 1040A, or 1040EZ and print “Amended” across the top of the amended return. If you make the choice with an amended return, you and your spouse must also amend any returns that you may have filed after the year for which you made the choice.

You generally must file the amended joint return within 3 years from the date you filed your original U.S. income tax return or 2 years from the date you paid your income tax for that year, whichever is later.

Suspending the Choice

The choice to be treated as a resident alien does not apply to any later tax year if neither of you is a U.S. citizen or resident alien at any time during the later tax year.

Example —

Dick Brown was a resident alien on December 31, 2004, and married to Judy, a nonresident alien. They chose to treat Judy as a resident alien and filed a joint 2004 income tax return. On January 10, 2006, Dick became a nonresident alien. Judy had remained a nonresident alien. Because both were resident aliens during part of 2006, Dick and Judy can file joint or separate returns for that year. Neither Dick nor Judy was a resident alien at any time during 2007 and their choice is suspended for that year. For 2007, both are treated as nonresident aliens. If Dick becomes a resident alien again in 2008, their choice is no longer suspended and both are treated as resident aliens.

Ending the Choice

Once made, the choice to be treated as a resident applies to all later years unless suspended (as explained earlier) or ended in one of the ways shown in Table 1-1 below.

If the choice is ended for any of the reasons listed in Table 1-1, neither spouse can make a choice in any later tax year.

Estimated Tax

The requirements for determining who must pay estimated tax are the same for a U.S. citizen or resident abroad as for a taxpayer in the United States. For current instructions on making estimated tax payments, see Form 1040-ES.

If you had a tax liability for 2007, you may have to pay estimated tax for 2008. Generally, you must make estimated tax payments for 2008 if you expect to owe at least $1,000 in tax for 2008 after subtracting your withholding and credits and you expect your withholding and credits to be less than the smaller of:

90% of the tax to be shown on your 2008 tax return, or
100% of the tax shown on your 2007 tax return. (The return must cover all 12 months.)

If less than two-thirds of your gross income for 2007 or 2008 is from farming or fishing and your adjusted gross income for 2007 is more than $150,000 ($75,000 if you are married and file separately), substitute 110% for 100% in (2) above. See Publication 505 for more information.

The first installment of estimated tax is due on April 15, 2008.

Foreign earned income exclusion. When figuring your estimated gross income, subtract amounts you expect to exclude under the foreign earned income exclusion and the foreign housing exclusion. In addition, you can reduce your income by your estimated foreign housing deduction. However, you must estimate tax on your nonexcluded income using the tax rates that will apply had you not excluded the income. If the actual amount of the exclusion or deduction is less than you estimate, you may have to pay a penalty for underpayment of estimated tax. For more information about figuring your estimated tax, see Publication 505.

Table 1-1. Ending the Choice

Revocation	•	Either spouse can revoke the choice for any tax year.
	•	The revocation must be made by the due date for filing the tax return for that tax year.
	•	The spouse who revokes the choice must attach a signed statement declaring that the choice is being revoked. The statement revoking the choice must include the following:
		•	The name, address, and social security number (or taxpayer identification number) of each spouse.
		•	The name and address of any person who is revoking the choice for a deceased spouse.
		•	A list of any states, foreign countries, and possessions that have community property laws in which either spouse is domiciled or where real property is located from which either spouse receives income.
	•	If the spouse revoking the choice does not have to file a return and does not file a claim for refund, send the statement to the Internal Revenue Service Center where the last joint return was filed.
Death	•	The death of either spouse ends the choice, beginning with the first tax year following the year in which the spouse died.
	•	If the surviving spouse is a U.S. citizen or resident alien and is entitled to the joint tax rates as a surviving spouse, the choice will not end until the close of the last year for which these joint rates may be used.
	•	If both spouses die in the same tax year, the choice ends on the first day after the close of the tax year in which the spouses died.
Divorce or Legal separation	•	A divorce or legal separation ends the choice as of the beginning of the tax year in which the legal separation occurs.
Inadequate records	•	The Internal Revenue Service can end the choice for any tax year that either spouse has failed to keep adequate books, records, and other information necessary to determine the correct income tax liability, or to provide adequate access to those records.

2. Withholding Tax

Topics - This chapter discusses:

Withholding income tax from the pay of U.S. citizens,
Withholding tax at a flat rate, and
Social security and Medicare taxes.

Useful Items - You may want to see:

Publication

505 Tax Withholding and Estimated Tax

Form (and Instructions)

673
Statement For Claiming Exemption From Withholding on Foreign Earned Income Eligible for the Exclusion Provided by Section 911
W-4
Employee's Withholding Allowance Certificate
W-9
Request for Taxpayer Identification Number and Certification

See chapter 7 for information about getting this publication and these forms.

Income Tax Withholding

U.S. employers generally must withhold U.S. income tax from the pay of U.S. citizens working abroad unless the employer is required by foreign law to withhold foreign income tax.

Foreign earned income exclusion. Your employer does not have to withhold U.S. income taxes from wages you earn abroad if it is reasonable to believe that you will exclude them from income under the foreign earned income exclusion or the foreign housing exclusion. Your employer should withhold taxes from any wages you earn for working in the United States.

Statement

You can give a statement to your employer indicating that you expect to qualify for the foreign earned income exclusion under either the bona fide residence test or the physical presence test and indicating your estimated housing cost exclusion. Form 673 is an acceptable statement. You can use Form 673 only if you are a U.S. citizen. You do not have to use the form. You can prepare your own statement. See the next page for a copy of Form 673. This image is too large to be displayed in the current screen. Please click the link to view the image.

Form 673

Generally, your employer can stop the withholding once you submit the statement that includes a declaration that the statement is made under penalties of perjury. However, if your employer has reason to believe that you will not qualify for either the foreign earned income or the foreign housing exclusion, your employer must continue to withhold. In determining whether your foreign earned income is more than the limit on either the foreign earned income exclusion or the foreign housing exclusion, if your employer has any information about pay you received from any other source outside the United States, your employer must take that information into account.

Foreign tax credit

If you plan to take a foreign tax credit, you may be eligible for additional withholding allowances on Form W-4. You can take these additional withholding allowances only for foreign tax credits attributable to taxable salary or wage income.

Withholding from pension payments

U.S. payers of benefits from employer-deferred compensation plans, individual retirement plans, and commercial annuities generally must withhold income tax from payments delivered outside of the United States. You can choose exemption from withholding if you:

Provide the payer of the benefits with a residence address in the United States or a U.S. possession, or
Certify to the payer that you are not a U.S. citizen or resident alien or someone who left the United States to avoid tax.

Check your withholding

Before you report U.S. income tax withholding on your tax return, you should carefully review all information documents, such as Form W-2, Wage and Tax Statement, and the Form 1099 information returns. Compare other records, such as final pay records or bank statements, with Form W-2 or Form 1099 to verify the withholding on these forms. Check your U.S. income tax withholding even if you pay someone else to prepare your tax return. You may be assessed penalties and interest if you claim more than your correct amount of withholding.

30% Flat Rate Withholding

Generally, U.S. payers of income other than wages, such as dividends and royalties, are required to withhold tax at a flat 30% (or lower treaty) rate on nonwage income paid to nonresident aliens. If you are a U.S. citizen or resident alien and this tax is withheld in error from payments to you because you have a foreign address, you should notify the payer of the income to stop the withholding. Use Form W-9 to notify the payer.

You can claim the tax withheld in error as a withholding credit on your tax return if the amount is not adjusted by the payer.

Social security benefits paid to residents

If you are a lawful permanent resident (green card holder) and a flat 30% tax was withheld in error on your social security benefits, the tax is refundable by the Social Security Administration (SSA) or the IRS. SSA will refund the tax withheld if the refund can be processed during the same calendar year in which the tax was withheld. If SSA cannot refund the tax withheld, you must file a Form 1040 or 1040A with the Internal Revenue Service Center in Austin to determine if you are entitled to a refund. The following information must be submitted with your Form 1040 or Form 1040A.

A copy of the Form SSA-1042S, Social Security Benefit Statement.
A copy of the “green card.”
A signed declaration that includes the following statements.

I am a U.S. lawful permanent resident and my green card has been neither revoked nor administratively or judicially determined to have been abandoned. I am filing a U.S. income tax return for the taxable year as a resident alien reporting all of my worldwide income. I have not claimed benefits for the taxable year under an income tax treaty as a nonresident alien.

Social Security and Medicare Taxes

Social security and Medicare taxes may apply to wages paid to an employee regardless of where the services are performed.

General Information

In general, U.S. social security and Medicare taxes do not apply to wages for services you perform as an employee outside of the United States unless one of the following exceptions applies.

You perform the services on or in connection with an American vessel or aircraft (defined later) and either:
1. You entered into your employment contract within the United States, or
2. The vessel or aircraft touches at a U.S. port while you are employed on it.
You are working in one of the countries with which the United States has entered into a binational social security agreement (discussed later).
You are working for an American employer (defined later).
You are working for a foreign affiliate (defined later) of an American employer under a voluntary agreement entered into between the American employer and the U.S. Treasury Department.

American vessel or aircraft

An American vessel is any vessel documented or numbered under the laws of the United States and any other vessel whose crew is employed solely by one or more U.S. citizens, residents, or corporations. An American aircraft is an aircraft registered under the laws of the United States.

American employer

An American employer includes any of the following employers.

The U.S. Government or any of its instrumentalities.
An individual who is a resident of the United States.
A partnership of which at least two-thirds of the partners are U.S. residents.
A trust of which all the trustees are U.S. residents.
A corporation organized under the laws of the United States, any U.S. state, or the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Guam, or American Samoa.

Foreign affiliate

A foreign affiliate of an American employer is any foreign entity in which the American employer has at least a 10% interest, directly or through one or more entities. For a corporation, the 10% interest must be in its voting stock. For any other entity, the 10% interest must be in its profits. Form 2032, Contract Coverage Under Title II of the Social Security Act, is used by American employers to extend social security coverage to U.S. citizens and resident aliens working abroad for foreign affiliates of the American employers. Once you enter into an agreement, coverage cannot be terminated.

Excludable meals and lodging

Social security tax does not apply to the value of meals and lodging provided to you for the convenience of your employer if it is reasonable to believe that you will be able to exclude the value from your income.

Binational Social Security (Totalization) Agreements

The United States has entered into agreements with several foreign countries to coordinate social security coverage and taxation of workers who are employed in those countries. These agreements are commonly referred to as totalization agreements and are in effect with the following countries.

Australia	Greece	Republic of
Austria	Ireland	Korea (South
Belgium	Italy	Korea)
Canada	Japan	Spain
Chile	Luxembourg	Sweden
Finland	Netherlands	Switzerland
France	Norway	United
Germany	Portugal	Kingdom

Under these agreements, dual coverage and dual contributions (taxes) for the same work are eliminated. The agreements generally make sure that you pay social security taxes to only one country.

Generally, under these agreements, you will only be subject to social security taxes in the country where you are working. However, if you are temporarily sent to work in a foreign country and your pay would otherwise be subject to social security taxes in both the United States and that country, you generally can remain covered only by U.S. social security. You can get more information on any specific agreement by contacting:

Social Security Administration
Office of International Programs
P.O. Box 17741
Baltimore, MD 21235-7741

If you have access to the Internet, you can get more information at:

http://www.socialsecurity.gov/international

Covered by U.S. only. If your pay in a foreign country is subject only to U.S. social security tax and is exempt from foreign social security tax, your employer should get a certificate of coverage from the Office of International Programs.

Covered by foreign country only

If you are permanently working in a foreign country with which the United States has a social security agreement and, under the agreement, your pay is exempt from U.S. social security tax, you or your employer should get a statement from the authorized official or agency of the foreign country verifying that your pay is subject to social security coverage in that country. If the authorities of the foreign country will not issue such a statement, either you or your employer should get a statement from the U.S. Social Security Administration, Office of International Programs, at the above address. The statement should indicate that your wages are not covered by the U.S. social security system. This statement should be kept by your employer because it establishes that your pay is exempt from U.S. social security tax. Only wages paid on or after the effective date of the totalization agreement can be exempt from U.S. social security tax.

3. Self-Employment Tax

Topics - This chapter discusses:

Who must pay self-employment tax, and
Who is exempt from self-employment tax.

Useful Items - You may want to see:

Publication

Form (and Instructions)

Form 1040-PR
Planilla para la Declaración de la Contribución Federal sobre el Trabajo por Cuenta Propia
Form 1040-SS
U.S. Self-Employment Tax Return
Form 4361
Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners
Schedule SE (Form 1040)
Self-Employment Tax

See chapter 7 for information about getting these publications and forms.

Who Must Pay Self-Employment Tax?

If you are a self-employed U.S. citizen or resident, the rules for paying self-employment tax are generally the same whether you are living in the United States or abroad.

The self-employment tax is a social security and Medicare tax on net earnings from self-
employment. You must pay self-employment tax if your net earnings from self-employment are at least $400.

For 2007, the maximum amount of net earnings from self-employment that is subject to the social security portion of the tax is $97,500. All net earnings are subject to the Medicare portion of the tax.

Employed by a U.S. Church

If you were employed by a U.S. church or a qualified church-controlled organization that chose exemption from social security and Medicare taxes and you received wages of $108.28 or more from the organization, the amounts paid to you are subject to self-employment tax. However, you can choose to be exempt from social security and Medicare taxes if you are a member of a recognized religious sect. See Publication 517 for more information about church employees and self-employment tax.

Effect of Exclusion

You must take all of your self-employment income into account in figuring your net earnings from self-employment, even income that is exempt from income tax because of the foreign earned income exclusion.

Example —

You are in business abroad as a consultant and qualify for the foreign earned income exclusion. Your foreign earned income is $95,000, your business deductions total $27,000, and your net profit is $68,000. You must pay self-employment tax on all of your net profit, including the amount you can exclude from income.

Members of the Clergy

If you are a member of the clergy, you are treated as self-employed for self-employment tax purposes. Your U.S. self-employment tax is based upon net earnings from self-employment figured without regard to the foreign earned income exclusion or the foreign housing exclusion.

You can receive exemption from coverage for your ministerial duties if you conscientiously oppose public insurance due to religious reasons or if you oppose it due to the religious principles of your denomination. You must file Form 4361 to apply for this exemption.

This subject is discussed in further detail in Publication 517.

Income From U.S. Possessions

If you are a U.S. citizen or resident alien and you own and operate a business in Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, American Samoa, or the U.S. Virgin Islands, you must pay tax on your net earnings from self-employment (if they are $400 or more) from those sources. You must pay the self-employment tax whether or not the income is exempt from U.S. income taxes (or whether or not you must otherwise file a U.S. income tax return). Unless your situation is described below, attach Schedule SE (Form 1040) to your U.S. income tax return.

If you do not have to file Form 1040 with the United States and you are a resident of any of the U.S. possessions listed in the preceding paragraph, figure your self-employment tax on Form 1040-SS. Residents of Puerto Rico may file the Spanish-language Form 1040-PR.

You must file these forms with the Department of the Treasury, Internal Revenue Service Center, Austin, TX 73301-0215.

Exemption From Social Security and Medicare Taxes

The United States may reach agreements with foreign countries to eliminate dual coverage and dual contributions (taxes) to social security systems for the same work. See Binational Social Security (Totalization) Agreements in chapter 2 under Social Security and Medicare Taxes. As a general rule, self-employed persons who are subject to dual taxation will only be covered by the social security system of the country where they reside. For more information on how any specific agreement affects self-employed persons, contact the United States Social Security Administration, as discussed under Binational Social Security (Totalization) Agreements in chapter 2.

If your self-employment earnings should be exempt from foreign social security tax and subject only to U.S. self-employment tax, you should request a certificate of coverage from the U.S. Social Security Administration, Office of International Programs. The certificate will establish your exemption from the foreign social security tax.

Send the request to the:

Social Security Administration
Office of International Programs
P.O. Box 17741
Baltimore, MD 21235-7741

4. Foreign Earned Income and Housing: Exclusion - Deduction

Topics - This chapter discusses:

Who qualifies for the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction,
The requirements that must be met to claim either exclusion or the deduction,
How to figure the foreign earned income exclusion, and
How to figure the foreign housing exclusion and the foreign housing deduction.

Useful Items - You may want to see:

Publication

Form (and Instructions)

1040X
Amended U.S. Individual Income Tax Return
2555
Foreign Earned Income
2555-EZ
Foreign Earned Income Exclusion

See chapter 7 for information about getting these publications and forms.

Who Qualifies for the Exclusions and the Deduction?

If you meet certain requirements, you may qualify for the foreign earned income and foreign housing exclusions and the foreign housing deduction.

If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude from income up to $85,700 of your foreign earnings. In addition, you can exclude or deduct certain foreign housing amounts. See Foreign Earned Income Exclusion and Foreign Housing Exclusion and Deduction, later.

You may also be entitled to exclude from income the value of meals and lodging provided to you by your employer. See Exclusion of Meals and Lodging, later.

Requirements

To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must meet all three of the following requirements.

Your tax home must be in a foreign country.
You must have foreign earned income.
You must be either:
1. A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,
2. A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
3. A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

See Publication 519 to find out if you are a U.S. resident alien for tax purposes and whether you keep that alien status when you temporarily work abroad.

If you are a nonresident alien married to a U.S. citizen or resident alien, and both you and your spouse choose to treat you as a resident alien, you are a resident alien for tax purposes. For information on making the choice, see the discussion in chapter 1 under Nonresident Alien Spouse Treated as a Resident.

Waiver of minimum time requirements

The minimum time requirements for bona fide residence and physical presence can be waived if you must leave a foreign country because of war, civil unrest, or similar adverse conditions in that country. This is fully explained under Waiver of Time Requirements, later. See Figure 4-A and information on the following pages to determine if you are eligible to claim either exclusion or the deduction.

Tax Home in Foreign Country

To qualify for the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, your tax home must be in a foreign country throughout your period of bona fide residence or physical presence abroad. Bona fide residence and physical presence are explained later.

Tax Home

Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. Having a “tax home” in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes.

If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and your tax home is wherever you work.

You are not considered to have a tax home in a foreign country for any period in which your abode is in the United States. However, your abode is not necessarily in the United States while you are temporarily in the United States. Your abode is also not necessarily in the United States merely because you maintain a dwelling in the United States, whether or not your spouse or dependents use the dwelling.

“Abode” has been variously defined as one's home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. “Abode” has a domestic rather than a vocational meaning and does not mean the same as “tax home.” The location of your abode often will depend on where you maintain your economic, family, and personal ties.

Example —

You are employed on an offshore oil rig in the territorial waters of a foreign country and work a 28-day on/28-day off schedule. You return to your family residence in the United States during your off periods. You are considered to have an abode in the United States and do not satisfy the tax home test in the foreign country. You cannot claim either of the exclusions or the housing deduction.

Example —

For several years, you were a marketing executive with a producer of machine tools in Toledo, Ohio. In November of last year, your employer transferred you to London, England, for a minimum of 18 months to set up a sales operation for Europe. Before you left, you distributed business cards showing your business and home addresses in London. You kept ownership of your home in Toledo but rented it to another family. You placed your car in storage. In November of last year, you moved your spouse, children, furniture, and family pets to a home your employer rented for you in London.

Shortly after moving, you leased a car and you and your spouse got British driving licenses. Your entire family got library cards for the local public library. You and your spouse opened bank accounts with a London bank and secured consumer credit. You joined a local business league and both you and your spouse became active in the neighborhood civic association and worked with a local charity. Your abode is in London for the time you live there. You satisfy the tax home test in the foreign country.

Temporary or Indefinite Assignment

The location of your tax home often depends on whether your assignment is temporary or indefinite. If you are temporarily absent from your tax home in the United States on business, you may be able to deduct your away-from-home expenses (for travel, meals, and lodging), but you would not qualify for the foreign earned income exclusion. If your new work assignment is for an indefinite period, your new place of employment becomes your tax home and you would not be able to deduct any of the related expenses that you have in the general area of this new work assignment. If your new tax home is in a foreign country and you meet the other requirements, your earnings may qualify for the foreign earned income exclusion.

If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise. If you expect it to last for more than 1 year, it is indefinite. If you expect it to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary (in the absence of facts and circumstances indicating otherwise) until your expectation changes.

Foreign Country

To meet the bona fide residence test or the physical presence test, you must live in or be present in a foreign country. A foreign country usually is any territory (including the air space and territorial waters) under the sovereignty of a government other than that of the United States.

The term “foreign country” includes the seabed and subsoil of those submarine areas adjacent to the territorial waters of a foreign country and over which the foreign country has exclusive rights under international law to explore and exploit the natural resources.

The term “foreign country” does not include Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or U.S. possessions such as Johnston Island. For purposes of the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction, the terms “foreign,” “abroad,” and “overseas” refer to areas outside the United States, American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, Puerto Rico, the U.S. Virgin Islands, and the Antarctic region.

American Samoa, Guam, and the Commonwealth of the Northern Mariana Islands

Residence or presence in a U.S. possession does not qualify you for the foreign earned income exclusion. You may, however, qualify for an exclusion of your possession income on your U.S. return.

American Samoa

There is a possession exclusion available to individuals who are bona fide residents of American Samoa for the entire tax year. Gross income from sources within American Samoa may be eligible for this exclusion. Income that is effectively connected with the conduct of a trade or business within American Samoa also may be eligible for this exclusion. Use Form 4563, Exclusion of Income for Bona Fide Residents of American Samoa, to figure the exclusion.

Guam and the Commonwealth of the Northern Mariana Islands

An exclusion will be available to residents of Guam and the Commonwealth of the Northern Mariana Islands if, and when, new implementation agreements take effect between the United States and those possessions. For more information, see Publication 570.

Puerto Rico and U.S. Virgin Islands

Residents of Puerto Rico and the U.S. Virgin Islands cannot claim the foreign earned income exclusion or the foreign housing exclusion.

Puerto Rico

Generally, if you are a U.S. citizen who is a bona fide resident of Puerto Rico for the entire tax year, you are not subject to U.S. tax on income from Puerto Rican sources. This does not include amounts paid for services performed as an employee of the United States. However, you are subject to U.S. tax on your income from sources outside Puerto Rico. In figuring your U.S. tax, you cannot deduct expenses allocable to income not subject to tax.

Figure 4–A Can I Claim the Exclusion or Deduction?

Bona Fide Residence Test

You meet the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. You can use the bona fide residence test to qualify for the exclusions and the deduction only if you are either:

A U.S. citizen, or
A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect.

You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for 1 year. If you go to a foreign country to work on a particular job for a specified period of time, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for 1 tax year or longer. The length of your stay and the nature of your job are only some of the factors to be considered in determining whether you meet the bona fide residence test.

Bona fide residence

To meet the bona fide residence test, you must have established such a residence in a foreign country. Your bona fide residence is not necessarily the same as your domicile. Your domicile is your permanent home, the place to which you always return or intend to return.

Example —

You could have your domicile in Cleveland, Ohio, and a bona fide residence in Edinburgh, Scotland, if you intend to return eventually to Cleveland.

The fact that you go to Scotland does not automatically make Scotland your bona fide residence. If you go there as a tourist, or on a short business trip, and return to the United States, you have not established bona fide residence in Scotland. But if you go to Scotland to work for an indefinite or extended period and you set up permanent quarters there for yourself and your family, you probably have established a bona fide residence in a foreign country, even though you intend to return eventually to the United States.

You are clearly not a resident of Scotland in the first instance. However, in the second, you are a resident because your stay in Scotland appears to be permanent. If your residency is not as clearly defined as either of these illustrations, it may be more difficult to decide whether you have established a bona fide residence.

Determination

Questions of bona fide residence are determined according to each individual case, taking into account factors such as your intention, the purpose of your trip, and the nature and length of your stay abroad. You must show the Internal Revenue Service (IRS) that you have been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. The IRS decides whether you are a bona fide resident of a foreign country largely on the basis of facts you report on Form 2555. IRS cannot make this determination until you file Form 2555.

Statement to foreign authorities

You are not considered a bona fide resident of a foreign country if you make a statement to the authorities of that country that you are not a resident of that country, and the authorities:

Hold that you are not subject to their income tax laws as a resident, or
Have not made a final decision on your status.

Special agreements and treaties

An income tax exemption provided in a treaty or other international agreement will not in itself prevent you from being a bona fide resident of a foreign country. Whether a treaty prevents you from becoming a bona fide resident of a foreign country is determined under all provisions of the treaty, including specific provisions relating to residence or privileges and immunities.

Example —

You are a U.S. citizen employed in the United Kingdom by a U.S. employer under contract with the U.S. Armed Forces. You are not subject to the North Atlantic Treaty Status of Forces Agreement. You may be a bona fide resident of the United Kingdom.

Example —

You are a U.S. citizen in the United Kingdom who qualifies as an “employee” of an armed service or as a member of a “civilian component” under the North Atlantic Treaty Status of Forces Agreement. You are not a bona fide resident of the United Kingdom.

Example —

You are a U.S. citizen employed in Japan by a U.S. employer under contract with the U.S. Armed Forces. You are subject to the agreement of the Treaty of Mutual Cooperation and Security between the United States and Japan. Being subject to the agreement does not make you a bona fide resident of Japan.

Example —

You are a U.S. citizen employed as an “official” by the United Nations in Switzerland. You are exempt from Swiss taxation on the salary or wages paid to you by the United Nations. This does not prevent you from being a bona fide resident of Switzerland.

Effect of voting by absentee ballot

If you are a U.S. citizen living abroad, you can vote by absentee ballot in any election held in the United States without risking your status as a bona fide resident of a foreign country. However, if you give information to the local election officials about the nature and length of your stay abroad that does not match the information you give for the bona fide residence test, the information given in connection with absentee voting will be considered in determining your status, but will not necessarily be conclusive.

Uninterrupted period including entire tax year

To meet the bona fide residence test, you must reside in a foreign country or countries for an uninterrupted period that includes an entire tax year. An entire tax year is from January 1 through December 31 for taxpayers who file their income tax returns on a calendar year basis. During the period of bona fide residence in a foreign country, you can leave the country for brief or temporary trips back to the United States or elsewhere for vacation or business. To keep your status as a bona fide resident of a foreign country, you must have a clear intention of returning from such trips, without unreasonable delay, to your foreign residence or to a new bona fide residence in another foreign country.

Example —

You arrived with your family in Lisbon, Portugal, on November 1, 2005. Your assignment is indefinite, and you intend to live there with your family until your company sends you to a new post. You immediately established residence there. On April 1, 2006, you arrived in the United States to meet with your employer, leaving your family in Lisbon. You returned to Lisbon on May 1, and continued living there. On January 1, 2007, you completed an uninterrupted period of residence for a full tax year (2006), and you meet the bona fide residence test.

Example —

Assume the same facts as in Example 1, except that you transferred back to the United States on December 13, 2006. You would not meet the bona fide residence test because your bona fide residence in the foreign country, although it lasted more than a year, did not include a full tax year. You may, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction under the physical presence test (discussed later).

Bona fide resident for part of a year

Once you have established bona fide residence in a foreign country for an uninterrupted period that includes an entire tax year, you are a bona fide resident of that country for the period starting with the date you actually began the residence and ending with the date you abandon the foreign residence. You can be a bona fide resident for an entire tax year plus parts of 1 or 2 other tax years.

Example —

You were a bona fide resident of Singapore from March 1, 2005, through September 14, 2007. On September 15, 2007, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2006, you were also a bona fide resident of a foreign country from March 1, 2005, through the end of 2005 and from January 1, 2007, through September 14, 2007.

Reassignment

If you are assigned from one foreign post to another, you may or may not have a break in foreign residence between your assignments, depending on the circumstances.

Example —

You were a resident of Pakistan from October 1, 2006, through November 30, 2007. On December 1, 2007, you and your family returned to the United States to wait for an assignment to another foreign country. Your household goods also were returned to the United States.

Your foreign residence ended on November 30, 2007, and did not begin again until after you were assigned to another foreign country and physically entered that country. Since you were not a bona fide resident of a foreign country for the entire tax year of 2006 or 2007, you do not meet the bona fide residence test in either year. You may, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction under the physical presence test, discussed later.

Example —

Assume the same facts as in Example 1, except that upon completion of your assignment in Pakistan you were given a new assignment to Turkey. On December 1, 2007, you and your family returned to the United States for a month's vacation. On January 2, 2008, you arrived in Turkey for your new assignment. Because you did not interrupt your bona fide residence abroad, you meet the bona fide residence test.

Physical Presence Test

You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive. Any U.S. citizen or resident alien can use the physical presence test to qualify for the exclusions and the deduction.

The physical presence test is based only on how long you stay in a foreign country or countries. This test does not depend on the kind of residence you establish, your intentions about returning, or the nature and purpose of your stay abroad.

330 full days

Generally, to meet the physical presence test, you must be physically present in a foreign country or countries for at least 330 full days during a 12-month period. You can count days you spent abroad for any reason. You do not have to be in a foreign country only for employment purposes. You can be on vacation time. You do not meet the physical presence test if illness, family problems, a vacation, or your employer's orders cause you to be present for less than the required amount of time.

Exception

You can be physically present in a foreign country or countries for less than 330 full days and still meet the physical presence test if you are required to leave a country because of war or civil unrest. See Waiver of Time Requirements, later.

Full day

A full day is a period of 24 consecutive hours, beginning at midnight.

Travel

When you leave the United States to go directly to a foreign country or when you return directly to the United States from a foreign country, the time you spend on or over international waters does not count toward the 330-day total.

Example —

You leave the United States for France by air on June 10. You arrive in France at 9:00 a.m. on June 11. Your first full day of physical presence in France is June 12.

Passing over foreign country

If, in traveling from the United States to a foreign country, you pass over a foreign country before midnight of the day you leave, the first day you can count toward the 330-day total is the day following the day you leave the United States.

Example —

You leave the United States by air at 9:30 a.m. on June 10 to travel to Kenya. You pass over western Africa at 11:00 p.m. on June 10 and arrive in Kenya at 12:30 a.m. on June 11. Your first full day in a foreign country is June 11.

Change of location

You can move about from one place to another in a foreign country or to another foreign country without losing full days. If any part of your travel is not within any foreign country and takes less than 24 hours, you are considered to be in a foreign country during that part of travel.

Example —

You leave Ireland by air at 11:00 p.m. on July 6 and arrive in Sweden at 5:00 a.m. on July 7. Your trip takes less than 24 hours and you lose no full days.

Example —

You leave Norway by ship at 10:00 p.m. on July 6 and arrive in Portugal at 6:00 a.m. on July 8. Since your travel is not within a foreign country or countries and the trip takes more than 24 hours, you lose as full days July 6, 7, and 8. If you remain in Portugal, your next full day in a foreign country is July 9.

In United States while in transit

If you are in transit between two points outside the United States and are physically present in the United States for less than 24 hours, you are not treated as present in the United States during the transit. You are treated as traveling over areas not within any foreign country. How to figure the 12-month period. There are four rules you should know when figuring the 12-month period.

Your 12-month period can begin with any day of the month. It ends the day before the same calendar day, 12 months later.
Your 12-month period must be made up of consecutive months. Any 12-month period can be used if the 330 days in a foreign country fall within that period.
You do not have to begin your 12-month period with your first full day in a foreign country or end it with the day you leave. You can choose the 12-month period that gives you the greatest exclusion.
In determining whether the 12-month period falls within a longer stay in the foreign country, 12-month periods can overlap one another.

Example —

You are a construction worker who works on and off in a foreign country over a 20-month period. You might pick up the 330 full days in a 12-month period only during the middle months of the time you work in the foreign country because the first few and last few months of the 20-month period are broken up by long visits to the United States.

Example —

You work in New Zealand for a 20-month period from January 1, 2006, through August 31, 2007, except that you spend 28 days in February 2006 and 28 days in February 2007 on vacation in the United States. You are present in New Zealand 330 full days during each of the following two 12-month periods: January 1, 2006 - December 31, 2006, and September 1, 2006 - August 31, 2007. By overlapping the 12-month periods in this way, you meet the physical presence test for the whole 20-month period. See Figure 4-B above.

Waiver of Time Requirements

Both the bona fide residence test and the physical presence test contain minimum time requirements. The minimum time requirements can be waived, however, if you must leave a foreign country because of war, civil unrest, or similar adverse conditions in that country. You also must be able to show that you reasonably could have expected to meet the minimum time requirements if not for the adverse conditions. To qualify for the waiver, you must actually have your tax home in the foreign country and be a bona fide resident of, or be physically present in, the foreign country on or before the beginning date of the waiver.

Early in 2008, the IRS will publish in the Internal Revenue Bulletin a list of countries qualifying for the waiver for 2007 and the effective dates. If you left one of the countries on or after the date listed for each country, you can meet the bona fide residence test or physical presence test for 2007 without meeting the minimum time requirement. However, in figuring your exclusion, the number of your qualifying days of bona fide residence or physical presence includes only days of actual residence or presence within the country.

Figure 4-B — How to Figure Overlapping 12-Month Periods

Figure 4-B

You can read the Internal Revenue Bulletin on the Internet at www.irs.gov. Or, you can get a copy of the list of countries by writing to:

Internal Revenue Service
International Section
P.O. Box 920
Bensalem, PA 19020-8518

U.S. Travel Restrictions

If you are present in a foreign country in violation of U.S. law, you will not be treated as a bona fide resident of a foreign country or as physically present in a foreign country while you are in violation of the law. Income that you earn from sources within such a country for services performed during a period of violation does not qualify as foreign earned income. Your housing expenses within that country (or outside that country for housing your spouse or dependents) while you are in violation of the law cannot be included in figuring your foreign housing amount.

For 2007, the only country to which travel restrictions applied was Cuba. The restrictions applied for the entire year.

However, individuals working at the U.S. Naval Base at Guantanamo Bay in Cuba are not in violation of U.S. law. Personal service income earned by individuals at the base is eligible for the foreign earned income exclusion provided the other requirements are met.

Foreign Earned Income

To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income.

Foreign earned income generally is income you receive for services you perform during a period in which yo