As an American living abroad, it is very important for you to understand the differences between income earned in the US and income earned in foreign countries. This is especially important for your expat tax return since money earned inn some foreign countries can be excluded up to a certain amount.
Earned Income is defined by location. The IRS considers income earned from working abroad to be foreign earned. On the IRS website, you can learn more in depth of how they define foreign earned income. If you are working the US, it will be considered US earned. So wherever you are when this income is earned determines how the IRS defines your income. This is still true even if you work for a US company while living in a foreign country or a foreign country living in the US.
If you own your own business there will be a few key points for you to understand:
- Primary income comes from personal service? Source of the income will be where the services are performed.
- Primary income from selling products? Source of the income will be where the products are sold.
- Produce your own products? The source will be where the items are produced.
Passive Income
This kind of income is distinguished by earnings where you aren’t working. This includes interest, dividends, rental property income, retirement and more. Let’s go through each type of income and distinguish between foreign and US sources.
- Interest
- Residence of the payer
- If the payer is outside the US then foreign earned. Inside the US, then US earned.
- Residence of the payer
- Dividends
- Location of corporation
- Where the company is incorporated determines the source of income
- Location of corporation
- Rental property Income & Real Estate
- Location of the property
- Where the property is located determines if it is foreign or US earned
- Location of the property
- Royalties
- Natural Resources
- Location of the corporation
- Intellectual Property
- Where the property is used determines where the income is earned
- Natural Resources
- Sale of Property (Personal)
- Location of seller’s tax home
- Pensions and retirement income
- Location of where the services were performed
- Scholarships/Fellowships
- Generally, the residence of the taxpayer determines the source.
Knowing this information is important to help distinguish where your incomes are coming from on your next expat tax return. It is important to note that all of your worldwide income must be reported on your US tax return.
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