The Foreign Earned Income Exclusion provides a huge tax break for some self-employed people having moveable trades or businesses. The Exclusion is also a great break for employees who have jobs involving extended assignments overseas and who aren’t required to spend a lot of time in the corporate offices.

U.S. citizens working and residing for nearly a full year in a foreign country may exclude up to $80,000 of their earned income or self-employment earnings from U.S. taxes. But to the extent the foreign country where the individual resides imposes tax on income earned, this is certainly not a way to entirely avoid taxes. The key is whether the country in where you reside and work imposes substantially less taxes than what would have to be paid in the U.S. And, in a few cases, individuals may be able to create a job for themselves in a tax haven country where there is no tax on their earnings.

For example, a couple who are s self-published writers relocated for two years to the Bahaman Islands. Their publishing business was a U.S. corporation that continued to publish and sell their books and newsletters. While they worked in the Bahamas, they each were receiving compensation of $70,000 a year for the two years they were in residence. The salaries were deductible by the corporation the same as when the couple worked in the U.S. After accumulating nearly $280,000 of tax free earnings, they returned to the U.S.

The pre-1997 law permitted U.S. citizens working and living abroad to exclude up to $70,000 a year of earnings from U.S. taxes each. This has now been increased by $2,000 a year for each year from the years1998 through 2002. In 2002, the exempt amount became $80,000 per year. After the year 2002, the amount was to be indexed for inflation.

This exclusion, which is an alternative to the foreign tax credit, is better choice for those working in high tax foreign countries. The exclusion is even more beneficial for those who work in low tax countries.

What’s more, it isn’t required that an individual reside for the entire time in the same foreign country. He can move from country to country. The requirement is that he lives and works abroad for at least 330 days out of each year in order to qualify for the full exclusion. Time that is spent traveling between countries is counted as time spent working in a foreign country. The Foreign Earned Income Exclusion is only available after a U.S. citizen has resided offshore for a period of at least 330 days out of any full year, after which the exclusion becomes available for portions of a year spent working offshore.

It should be noted, however, that any other income realized or earned while working overseas is still subject to U.S. taxes. Any earnings in exceeding the exclusion, such as capital gains, interest, dividends, royalties, etc., is subject to U.S. taxes.

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