U.S. Contractor Abroad Tax Guide

By Ines Zemelman, EA

Who Should Use This Guide?

Any U.S. person who already is, or is considering working as a contractor outside of the U.S.

Why Use This Guide?

Understanding your tax obligations as a contractor is vital prior to accepting a job offer abroad. Safety in a conflict zone is priority number one. However you want to make sure that you are fairly compensated for the risks you are taking; therefore awareness of tax implications is something you must be aware of before taking the job.

How To Use This Guide?

Apply the considerations we discuss below when weighing job offers. More salary as a contractor may not necessarily be better from a financial position than accepting a lower paying job as a salaried employee. Read this guide as a tool to aid your job search and as a reference point to negotiate any potential job offers.

Can contractors utilize the Foreign Earned Income Exclusion (FEIE) to exclude up to $100k of income?

Yes - contractors can certainly qualify for the Foreign Earned Income Exclusion (FEIE). However, in general, the nature of contractor employment terms does not allow using the Bona Fide Residence Test. Therefore, civilian contractors working abroad are limited to the Physical Presence Test. Therefore you must closely track your time spent in the U.S. (whether for personal or business reasons) in order to secure the ability to exclude up to $100K from taxable income. Depending on your home state, you may also be able to exclude your earnings at the state level.

Can contractors utilize the Foreign Housing Exclusion and Foreign Tax Credit (FTC)?

Generally, no. If the contractor is living on employer provided premises, they simply do not pay out of pocket housing expenses and do not qualify for the Foreign Housing Exclusion.

As far as Foreign Tax Credit (FTC) - U.S citizens abroad are able to utilize any tax paid to a foreign government towards their U.S. tax obligations. However, contractors almost never pay tax in the country of foreign employment, thus they do not have the ability to utilize the Foreign Tax Credit (FTC) mechanism to reduce tax on earnings remaining after exclusion of first $100K.

Can contractors utilize the Foreign Housing Exclusion and Foreign Tax Credit (FTC)?

You work in a war zone. Do you automatically qualify for the foreign earned income exclusion?

No. You need to have been in the country and expected to qualify for the exclusions before the area was declared a war zone in order to qualify for a residency waiver due to adverse conditions in the foreign country. See Rev. Proc. 2006-28 for how this waiver applies. While this Revenue Procedure concerns individuals leaving Haiti in 2005, prior rulings are consistent with the findings in this Procedure.

You should also note that this waiver only applies to individuals who expected to qualify as a resident of the foreign country (bona fide residence test, or BFR). In most of the cases we see, the individual could not have expected to qualify for the exclusions under BFR even after arrival. See further discussion on this page relating to claiming the exclusions in a war zone.

Don’t ignore your state returns

Unlike other expats, the biggest, most often ignored, and most expensive issue is that they must always file a State Tax Return unless their home of record is in tax-free U.S. state. Civilian contractors always file as full-year residents of the state that is indicated as their home of record on Form W-2.

Civilian contractors with compensation reported on Form 1099-Misc (independent contractors) are also obligated to file state return, even if home of record is not shown on Form 1099-Misc. Most often this is the state where their family (spouse and children) remained. If single, they file state return with the state where they lived and filed prior to working overseas.

What are the tax deadlines for contractors? What if I work in a combat zone - do I get an automatic extension?

Even when working in a war zone, you are still subject to normal tax filing deadlines and if they are abroad on April 15 they have an automatic 2 month extension until June (FBAR is due April 15th as of 2017, but there is an automatic extension until Oct 15 this year).

However, there is a penalty waiver available for Civilian Contractors working in direct support of military operations in the combat zones designated by an Executive Order from the President - http://www.irs.gov/uac/Combat-Zones. If qualified, one can obtain an extension of time to pay federal taxes for the period of service in the combat zone, plus 180 days after the last day in the combat zone. If you have outstanding tax due (any tax due is owed by Apr 15; interest accrues from then on) - we can file for a penalty waiver to have this removed.

Training

I spent 3 months in the U.S. for job-related training ahead of my upcoming deployment. Can I still qualify for the foreign earned income exclusion?

You may be able to use partial foreign earned income exclusion if you had 12 consecutive months overlapping two years where you met the 330 days abroad requirement for the Physical Presence test. If consecutive 12 months period cannot be established then you will not be able to use the Foreign Earned Income exclusion. Months spent in the U.S. on job-related training cannot be included in the selected 12 months period.

If your spouse and children reside in the U.S. you can still file jointly even though you are working abroad.

You have the right to file jointly (MFJ) or separately (MFS). Even if you file separately (MFS) hoping to utilize the Earned income Credit (EIC), this will not work because the MFS status does not allow use of the Earned Income Credit. Your spouse cannot use the Head of Household status as long as you are officially married and not legally separated. Moreover, if your spouse lives in a community property state like California, half of your income will be counted as her income. For the majority of taxpayers, the overall family economic benefit will be higher if they file jointly.

My contract ended early because of job-related injury. I had to return to the U.S. after 10 months abroad to get treatment in a hospital. Can I claim partial foreign earned income exclusion based on the qualifying life event?

The minimum time requirement can be waived if you must leave a foreign country because of war, civil unrest, or similar adverse conditions in that country. You must be able to show that you reasonably could have expected to meet the minimum time requirements if not for the adverse conditions. Unfortunately any other unexpected events including family or health related issues do not qualify for the time requirement waiver.