Faculty Scholarship 1994 - Present

New Tax Rules on Foreign Tax Credit and Foreign Housing Cost Exclusion

A U.S. expatriate with foreign-source income is subject to U.S. taxation on worldwide income. However, in order to alleviate the burden of double taxation, the taxpayer is given the rights to claim either a foreign tax credit against the U.S. tax liability or the foreign earned income exclusion plus foreign housing cost exclusion from gross income. On May 17, 2006, the U.S. Congress enacted the Tax Increase Prevention and Reconciliation Act (the �Act�) under which the tax rate bracket in determining the tax liability on any foreign-source income in excess of the exclusion amount has been changed. The Act also sets the limit on the foreign housing cost exclusion. On October 23, 2006, the IRS issued Bulletin 2006-43 (the �Bulletin�) that modifies that limit by taking into account the housing cost at different geographical locations in the world. These new tax rules have far-reaching consequences on U.S. citizens working abroad. This article demonstrates how to determine the U.S. tax liability and the foreign tax credit when claiming foreign earned income exclusion. It further explains how much of the foreign housing cost allowance is excludible from and how much is includible in gross income. In addition, this article also offers a strategy in making a choice between foreign tax credit and foreign earned income exclusion, and gives a great number of examples.