This is a guest post by Olivier Wagner, a Certified Public Accountant, U.S. immigrant, expat, and perpetual traveler who preaches the philosophy of being a worldly American. In his new book, U.S. Taxes for Worldly Americans, he uses his expertise to show you how to use 100% legal strategies (beyond traditionally maligned “tax havens”) to keep your income and assets safe from the IRS. Oliver has also written recently what you need to know about taxes if you’re an American who moves abroad.

Most Americans living abroad today know about the Foreign Earned Income Exclusion (FEIE) (Form 2555). The FEIE lets you remove up to $101,300 of foreign income from your taxable income when filing taxes back home. This is great news for U.S. citizens who stay outside the country all year and don’t make six figures annually; as it legally allows you to avoid paying any taxes to the United States. However, to take advantage of it, you must be careful to claim things the right way on your tax return.

Choosing Between The FTC And FEIE

You can also claim a credit for any taxes you have paid to foreign governments through the Foreign Tax Credit (FTC) (Form 1116). This is very useful if you are a resident or worker in another country. However, you have to choose between using either the FTC or the FEIE to lower your taxes – you can’t take advantage of both.

• Generally, if your foreign tax rate is greater than your U.S. tax rate, the FTC will save you more.

If you have children who are also American citizens, you can get a refundable tax credit of $1,000 per year per child with the Additional Child Tax credit. To qualify, you must have at least $3,000 of income and not use the Foreign Earned Income Exclusion.

U.S. Taxes for Worldly Americans

My friend Laura from Ohio used to work as a self-employed English teacher in Milan. Because she would spend the entire tax year in Italy (and made much less than the $101,300 FEIE limit), she qualified for the Foreign Earned Income Exclusion each year when she filed her American taxes.

However, there is one other requirement you must meet in order to use the FEIE. You must pass either the Bona Fide Residence Test or the Physical Presence Test. Although you only need to qualify using one of the two, having both provides a safety net. If you are ever audited and you fail one test, you can simply provide another Form 2555 using the other test.

How To Pass The Bona Fide Residence Test

This is a somewhat fancy phrase that explained Laura’s situation perfectly. A bona fide resident is someone who has legitimately established residency in a foreign country. Although she was abroad in Italy for an undetermined, potentially indefinite period of time, Ohio still saw her as a resident for tax purposes until she proved otherwise.

In order to use this test to qualify for the FEIE, she just had to remain a tax resident of Italy for an uninterrupted tax year. Even if a country doesn’t have an income tax system, so long as they would otherwise have authority to tax you, you qualify as a “tax resident”. She also must not have submitted a statement to Italy that she was a non-resident there. She could not be living in Italy as a tourist.

Every other tie to the country counts and the Bona Fide Residence test is inherently subjective. If you are unsure, I would not recommend claiming it. I advise that you use the Physical Presence test or the Foreign Tax Credit instead.

How To Pass The Physical Presence Test

Alternatively, Laura also could have qualified for the FEIE using the Physical Presence Test. To pass this test, a person must spend at least 330 days outside the US in any 12-month period.

Each of those 330 days must be an entire 24 hours. I once had a client of mine tell me, “Well, of course I can use the Physical Presence Test. I live in Canada year-round.” Then he said, “I only return to the States once a week to fill up on gas.” Oops. Those quick little trips meant he was only out of the country for 6/7ths of the year, or 312 days – not quite enough to pass the Physical Presence Test.

Additional Exceptions To The 24 Hour Rule

• Being in the U.S. for less than 24 hours while in transit between two foreign countries.
• Being in international waters for less than 24 hours in transit between two foreign countries. International waters do not count as a foreign country (hence, time spent there does not count toward the 330 days). Likewise, time spent in Cuba in violation of the embargo does not count toward the 330 days.

Since Laura was living in Italy for the entire year, she passed these tests as well.

Filing The FEIE On Your Tax Return

The FEIE can be claimed on either Form 2555-EZ or Form 2555. As a tax professional, I usually use Form 2555, but if you’re preparing your own return, you might enjoy the simplicity of Form 2555-EZ.

Requirements For Form 2555-EZ

1. You must be a U.S. citizen or resident alien.
2. You must earn wages or a salary in a foreign country.
3. You must have a total foreign earned income of $101,300 or less.
4. You must file a calendar year return that covers a 12-month period.
5. You must not have self-employment income.
6. You must not have business or moving expenses.
7. You must not claim the foreign housing exclusion or deduction.

While the 2555-EZ is an enticing option, it is not applicable to people who receive self-employed income, claim moving expenses, or claim the foreign housing exclusion or deduction. This becomes a problematic area for many English teachers who give private courses outside of a structured work environment, and are therefore considered “self-employed.”

Another Option, The Foreign House Exclusion

My friend Laura also considered claiming the foreign housing exclusion. The foreign housing exclusion is useful for those whose earned income exceeds the limit of $101,300. (The first $44.28 per day is not deductible.) The Foreign Housing Exclusion is called the Foreign Housing Deduction for self-employed people, but the concept is the same.

Many expats get extremely frustrated with the U.S. tax-filing process, with its seemingly never-ending pages of questions followed by the massive crunching of numbers. I have met many of those people, worked with them, and assured them that we would be able to comply with all the tax requirements so long as we were detailed in our approach.

As you probably already know, the Affordable Care Act (ACA), otherwise known as “Obamacare”, imposes tax penalties on American citizens without health insurance. Fortunately, anyone who qualifies for the Foreign Earned Income Exclusion is not subject to the penalties of the ACA.

In Laura’s case, we managed to successfully file her taxes and her Foreign Earned Income Exclusion. We also managed to receive a tax credit for the income taxes taken out by the Italian government.

Thank you very much Oliver for sharing some of your expertise with the many expats who may be paying taxes they don’t have to. Oliver goes further into detail in his highly rated book, U.S. Taxes for Worldly Americans. For those of you Americans living abroad, it’s probably a good idea to know how your tax situation changes – and doesn’t – which Oliver has covered previously on foXnoMad in his post, How Taxes Change When Americans Go Abroad.

This is a guest post by Olivier Wagner, a Certified Public Accountant, U.S. immigrant, expat, and perpetual traveler who preaches the philosophy of being a worldly American. In his new book, U.S. Taxes for Worldly Americans, he uses his expertise to show you how to use 100% legal strategies (beyond traditionally maligned “tax havens”) to keep your income and assets safe from the IRS.

More people are renouncing their U.S. citizenship now than ever before. Each has their own reasons for doing this. Some are worried about the changing political landscape of today. Others pay attention to new rules and restrictions on freedom of travel, or (for better or worse) how the rest of the world views Americans. Mostly, they want to avoid all the complicated tax burdens that come with the territory of being a U.S. citizen. It’s not necessarily difficult to get rid of your American citizenship, but it does warrant a lot of deep thought, planning, and a bit of money to pull off properly.

U.S. Citizens Always Have Tax Obligations

Many Americans living abroad have never even filed their taxes, or else haven’t filed in many years. Some have been abroad so long that, aside from their passports and the occasional trip back home to see family, they have no real ties to the United States (not even a Social Security number). In their minds, they’ve long ago sworn off the idea of getting involved with U.S. taxes and would be completely financially unable to get caught up on them anyway.

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Some of these people have been very lucky to coast under the radar this long without any consequences. It’s very important that they get tax compliant as quickly as possible, and that they utilize every tool available to minimize their expenses. There are very large consequences to continuing to ignore this, yet so many people don’t pay any attention to it at all because it seems so overwhelming to consider. They may even take personal offense to having to pay anything at all.

Foreign Banks Talk To The IRS About US Citizens

Things are only getting more complicated for Americans living abroad as time goes on. Starting in 2015, a new law went into effect across the globe requiring foreign banks to identify which of their clients are American citizens and report their name, address, and account balance to the IRS back home (although litigation between the Department of Justice and Swiss banks caused the trend to start in Switzerland as early as 2012). It’s called FATCA, and it stands for Foreign Account Tax Compliance Act.

Additionally, anyone holding an equivalent balance of more than $10,000 in foreign bank accounts must file an FBAR report. When the IRS receives this data, they will try to match that to the taxpayer on record as reported by the foreign banks directly. The penalty for willfully failing to file an FBAR could be up to 50% of the account balance per year, giving serious caution to anyone interested in holding even some of their money offshore (or $10,000 per account if the failure to file was not willful, and possibly zero if the taxpayer had a reasonable cause).

Some Taxes Can Be Avoided By Expats

Some Americans living abroad today know about the Foreign Earned Income Exclusion (FEIE), which allows them to exclude up to $101,300 (as of 2016) of foreign income from their taxable income. Nomads and expatriates who don’t make a ton of money will typically use this to avoid paying taxes at all in the US, but only if they know how to claim things on their tax return correctly. One can claim the FEIE by being an actual resident of a foreign country (a “bona fide resident”). There’s also a physical presence test for people who spend at least 330 days in any 12-month period outside the U.S. This is fine for those who have truly relocated outside the states, but what about others who still return frequently to visit friends and family, or split their time equally between multiple homes?

It’s important to understand that your tax situation will never be the same once you start traveling, yet so long as you remain an American you will always have some kind of tax obligation. The IRS will always be checking up on you, no matter where you live or work. But that’s okay so long as you can keep up with the new rules that apply to you, and learn to (legally) work the system to your advantage. You may even be able to reduce your tax obligation to nothing at all.

Thank you very much Oliver for sharing some of your expertise with many who might not know they owe taxes. Oliver goes further into detail in his highly rated book, U.S. Taxes for Worldly Americans.