The tax law permits certain U.S. taxpayers to exclude up to $80,000 per year of earnings from taxation if they live and work outside the U.S. for a year or more. However, it should not be a surprise that there are "strings" attached to that tax break and that the details are quite complicated. To claim this tax break, the taxpayer must complete Form 2555 (or 2555-EZ) and attach it to his or her tax return.
The Form 2555 is a three page form with four pages of instructions. The Form 2555-EZ is a two page form with about three pages of instructions.
The Form 2555 requires information about the source of employment, foreign residence information, certain income details relating to employment in a foreign country and information about the foreign housing exclusion.
This form should be submitted with the individual Form 1040 and sent to the same address as the Form 1040.
The IRS estimates that it takes an average of 2.5 hours to prepare and file this form. However, it should take less than an hour for tax preparers who use professional quality tax preparation software. These forms are available in all of the professional tax preparation programs and most of the consumer tax preparation programs. The Form 2555-EZ should take about half as much time as the regular Form 2555. However, in some cases, it could much longer to prepare this form.
Compliance with filing this form is only required for those who wish to take advantage of the substantial income exclusion available to those who live and work outside the U.S. for more than year.
To qualify for this exclusion, the taxpayer must satisfy either (1) a "Bona Fide Residence Test" or (2) a "Physical Presence Test". The physical presence test does not require relocation to a foreign country but does require that the taxpayer live and work outside the U.S. for at least 330 days in a year. The residence (relocation) test is more complicated but if it can be satisfied, the taxpayer does not need to be physically outside the U.S. for a specific number of days. If the taxpayer is eligible for a deduction for foreign moving expenses, Form 3903-F should be filed.
Note that Section 350 of S. 1054, the Jobs and Growth Tax Relief Reconciliation Act of 2003, as introduced and passed in the Senate, would have repealed the foreign earned income and housing expense exclusions (collectively, the "911 exclusion"). However, the House version and final version of the bill did not include the provision. The defeat may have been in large part due to the efforts of the AICPA. At this time it does not appear likely that this issue will surface again in the near future.