If you are a U.S. citizen or a resident alien, your income is subject to U.S. income tax, including any foreign income, or any income that is earned outside of the U.S. It does not matter if you reside inside or outside of the U.S. when you earn this income. In addition, even if you do not receive a Form W-2, a Wage and Tax Statement, or a Form 1099 from the foreign payer, you are still required to report this income.
- If you are a U.S. citizen or a resident alien, your income is subject to U.S. income tax.
- In some circumstances, especially those related to the length and nature of your stay in a foreign country, you may qualify to exclude some of your foreign-earned income from your U.S. federal income tax return.
- The foreign tax credit is provided by the government to reduce the tax liability of certain taxpayers.
- When you file taxes, your earned income is reported on line 7 of IRS Form 1040.
- Wages, bonuses, salaries, commissions, tips, and net earnings from self-employment are all considered forms of earned income by the IRS.
U.S. Citizen vs. U.S. Resident Alien
For tax purposes, if you are not a citizen of the U.S., the IRS will either consider an individual a resident alien or a nonresident alien. You are a resident alien of the U.S. for tax purposes if you meet either the green card test or the substantial presence test for the calendar year.
IRS Publication 519, U.S. Tax Guide for Aliens, provides more information about the qualifications for being considered a U.S. resident alien for tax purposes. Both U.S. citizens and U.S. resident aliens are required to report all of their income to the U.S. government to be taxed appropriately.
Total Income Includes Both Earned and Unearned Income
The amount you are taxed on includes earned income and unearned income from foreign and non-foreign sources. The IRS considers these sources earned income: wages, salaries, bonuses, commissions, tips, and net earnings from self-employment.
According to the IRS, unearned income is income from investments and other sources unrelated to employment. Unearned income includes interest from savings accounts, bond interest, alimony, and dividends from stock.
If you are a U.S. citizen or U.S. resident alien, you report your foreign income where you normally report your U.S. income on your tax return. Your earned income is reported on line 7 of IRS Form 1040; interest and dividend income are reported on Schedule B; income from rental properties is reported on Schedule E, and so on, depending on the type of income you are reporting.
Other rules apply that could affect your eligibility to claim the foreign-earned income exclusion. IRS Publication 54 provides more complete information regarding the eligibility of taxpayers.
Foreign Earned Income Exclusion
If you meet certain requirements related to the length and nature of your stay in a foreign country, you may qualify to exclude some of your foreign-earned income from your tax return. For the tax year 2022, you may be eligible to exclude up to $112,000 of your foreign-earned income from your U.S. income taxes. For the tax year 2023, this amount increases to $120,000. This provision of the tax code is referred to as the Foreign Earned Income Exclusion.
In order to be eligible for the foreign earned income exclusion, you must meet the following three requirements:
- Your tax home must be in a foreign country. Your tax home is defined as the general area of your main place of employment—where you are permanently or indefinitely engaged to work as an employee or self-employed individual—regardless of where you maintain your family home. It's important to note that your place of residence can be different from your tax home.
You must have foreign-earned income.
You must be either:
A U.S. citizen who is a bona fide resident of a foreign country for an entire tax year.
- 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 for an entire tax year.
- 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.
Foreign Tax Credit
Although it depends on what country you earned the income in, it is likely that your foreign source of income will be taxed in two countries—both the U.S. and the respective country it was earned in. To compensate for this, the U.S. government offers a tax break to reduce the tax liability of certain taxpayers, called the Foreign Tax Credit.
This tax credit is a non-refundable tax credit for income taxes paid to a foreign government due to foreign income tax withholdings. The foreign tax credit is available to anyone who works in a foreign country or has investment income from a foreign source.
How Much Foreign Income is Tax-Free in the U.S.?
In the U.S., you may qualify to exclude foreign earnings from taxes up to a certain threshold if you work abroad. In 2022, this amount is $112,000, in 2023, the amount is $120,000. You may also be able to deduct foreign housing expenses.
How Does the IRS Know About Foreign Income?
The IRS knows about foreign income that was not reported through the Foreign Account Tax Compliance Act (FACTA)." The act stipulates that foreign financial institutions in a select number of countries must report account information for foreign account holders to the IRS.
What Happens if You Don't Report Foreign Income?
If you don't report foreign income, you may incur penalties equal to a percentage of the foreign income. There are programs that serve to lower these penalties.
The Bottom Line
As a U.S. citizen or resident alien, you must report foreign income to the IRS, regardless of whether you reside in the U.S. or not. There is a foreign earned income exclusion if you earned foreign income while residing in another country. Below the foreign earned income exclusion threshold, you do not need to pay taxes on the income. As with any complex financial situation, it is always best to consult with a tax advisor when reporting and filing taxes.