With growing globalization, US Citizens and Permanent resident aliens have been working outside the country more than ever. They often have a misconception that since they are working outside the country, they do not have US Source income so they do not need to file and pay taxes. However, this is not true. I have addressed this issue several times. Here it goes again….
If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are subject to tax on your worldwide income. However, you may qualify to exclude from income up to $87.600 for 2008 ($85,700 for 2007) of your foreign earnings. In addition, you can exclude or deduct certain foreign housing amounts.
You may also be entitled to exclude from income the value of meals and lodging provided to you by your employer.
To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, you must have foreign earned income, your tax home must be in a foreign country, and you must be one of the following:
1. A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year
2. 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 or countries for an uninterrupted period that includes an entire tax year, or
3. 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
The foreign earned income exclusion and the foreign housing cost amount exclusion are figured on Form 2555 (PDF), which must be attached to Form 1040 (PDF). However, if you claim only the foreign earned income exclusion, you may be able to use Form 2555-EZ (PDF) instead.
In case where you do not qualify for the exclusion discussed above, you will be able to claim foreign tax credit. Which means that, to some extent, you will be able to offset your tax liability in US with the foreign taxes you paid on that income to a foreign country. You will have to fill Form 1116 for this purpose and attach to Form 1040.