Foreign Earned Income vs. Unearned Income

Foreign Earned Income

This is income you receive for services you perform in a foreign country during a period that your tax home is in a foreign country and you meet either the bona fide residence test or the physical presence test.  This income can be received in a number of forms outside of the traditional paycheck and includes any and all of the following:

·        Salaries and wages

·        Commissions

·        Bonuses

·        Professional fees

·        Self-employment income

·        Tips

·        The fair market value of property or facilities provided by your employer for lodging, meals, car and other items

·        Allowances or reimbursements for cost of living, overseas differential, family expenses, education, home leave, quarters, moving and other miscellaneous expenses

All of these types of income are considered foreign earned income.

Unearned Income

Unearned income is basically investment income and includes interest, dividends, annuities, some royalties, capital gains, rents unless such income is derived in the ordinary course of a trade or business and gross income from a passive trade or business.  Unearned income is not excludable from US tax.

Sole Proprietor or Partnership                                                                                      

If you operate a small business in a foreign country, you will usually have two elements that go into producing income – capital investment and your personal service.  If capital investment is an important part of producing the income, that income is considered “unearned”.  However, the IRS will let you treat part of the income as “earned” if your personal services are also an important part of the production of income.  No more than 30% of your share of the net profits can be treated as foreign earned income.