The Pluses and Minuses of Foreign Employment

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The Pluses and Minuses of Foreign Employment

As an incentive for individuals to take foreign employment, they are allowed to exclude some or all of their foreign earned income and take a deduction for added foreign housing costs, provided they meet certain foreign residency requirements. The recently-enacted law includes three changes to this foreign employment incentive.

Exclusion is now Inflation-Adjusted – Under law, the exclusion was $80,000(1). Under the new legislation, the exclusion will be inflation-adjusted, making the exclusion amount $82,400(1) for 2006.

Housing Allowance Base Amount – Taxpayers are allowed to deduct, as a housing allowance, the excess of their actual housing costs over a base amount. Under the old law, that base amount was 16% of a U.S. government employee grade GS-14 salary. Under the new law, the base amount will be 16% of the annual exclusion amount. Thus, for 2006, the base amount will be $13,184(1).

Housing Exclusion Limit – A new provision has been added that limits the housing exclusion to 30% of the taxpayer’s earned income exclusion for the year, less the base amount. Thus, for 2006 the maximum housing allowance exclusion will be $11,536(1) ($24,720 – $13,184).

Marginal Tax Rates – Previously, an individual’s tax rates on other income was based on his or her taxable income after the allowable exclusions. However, beginning in 2006, the excluded income will be included for purposes of determining the marginal tax rates applicable to the other income. Caution: For taxpayers with substantial other income, this can create a significant increase in tax and may require adjusting withholding amounts or estimates to compensate for the increase.

(1) The amounts shown are for a full year. Taxpayers only qualifying for a partial year will be prorated by the day.