The Internal Revenue Service has provided new limitation amounts for the foreign earned income and housing exclusions under section 911. The maximum foreign earned income exclusion for 2012 is $95,100, up from $92,900 in 2011, and the maximum foreign housing exclusion is $28,530 (less a non-excludable floor of $15,216). However, in the new Notice the IRS has provided higher allowable housing amounts in dozens of high-cost locations. The foreign housing exclusion, along with the foreign earned income exclusion, is claimed by most employees of U.S. companies who are assigned overseas, and is a key component in determining pay and benefits for such employees, usually called “expats,” during their assignments, and in tax normalization calculations.
The Full Story:
Today’s tax quote: “Our tax code is so long it makes War and Peace seem breezy.” Steven LaTourette
One of the more valuable portions of the tome that is the Code is section 911, which is hidden near the middle and is hardly breezy to read, but provides significant benefits to employees of U.S. companies assigned overseas, and to their employers.
The Internal Revenue Service on February 13, 2012, provided new limitation amounts for the foreign housing exclusion under section 911. See Notice 2012-19. The foreign housing exclusion, along with the foreign earned income exclusion, is claimed by most employees of U.S. companies who are assigned overseas, and is a key component in determining pay and benefits for such employees, usually called “expats,” during their assignments, and in tax normalization calculations.
Both the foreign income and housing exclusions are limited in amount. However, the limitations are adjusted each year for inflation.
According to the IRS, for 2012, the foreign earned income limitation is $95,100 for the full year. That is the maximum earned income in the foreign country that may be excluded from tax on the U.S. tax return. (For 2011, the limit was $92,900).
The maximum foreign housing exclusion is calculated as a percentage of the earned income limit, in a two-step process. First, a “floor” is calculated, and only costs that exceed the floor are excludable. The floor is 16% of the maximum earned income exclusion, or $15,216 for 2012. Then a maximum exclusion is calculated, which is 30% of the earned income exclusion, or $28,530 for 2012. The result of this exercise is that no matter how much the actual housing cost is for an expat in 2012, the maximum that the expat may exclude is $13,314 ($28,530 minus the $15,216 floor).
However, the law gives the Treasury Department the authority to provide higher maximum housing amounts for high cost locations, and the Treasury has exercised this authority in a series of issuances, of which Notice 2012-19 is the latest. In the Notice, Treasury provides some 17 pages of locations and housing amounts in those locations that are allowable, beginning with Angola at $84,000 and ending with Ho Chi Minh City in Vietnam, at $42,000. In many countries, there are many different cities listed. The Notice also provides daily amounts that can be used by expats not in the locale for an entire year.
As in years past, the highest amounts listed are for Tokyo at $128,000 and Hong Kong at $114,300. Moscow also exceeds $100,000, coming in at $108,000, while Paris is $84,800 and London is $83,600.
For all of the cities and localities listed, the maximum amount an expat may exclude is determined by subtracting the floor amount of $15,216 from the amount listed for the particular location.
Of course, in the tax law nothing is ever simple. In 2006 Congress made a fundamental change in the way U.S. tax liability is calculated for those claiming the foreign earned income or foreign housing exclusions. Although the amounts excluded under section 911 are not taxable, they are added back to U.S. taxable income for purposes of calculating the tax on other income that remains taxable, such as spouse income, interest, dividends, or foreign income in excess of the section 911 exclusion amount, and the Alternative Minimum Tax. This has the effect of increasing the taxpayer’s tax rate by moving his or her other income into a higher bracket. For example, if a taxpayer would only be in the 15% tax bracket after the 911 exclusion, but would be in the 28% bracket if the amount excluded under section 911 was taxable, then the taxpayer’s tax is calculated at 28%, not 15%.
Companies with employees assigned overseas must become familiar with these rules, and will want to incorporate the increased earned income and housing exclusion limits, including the special rates listed in Notice 2019-12, into their salary, benefits, and tax normalization calculations for 2012. The Notice may not be a breeze to read, but doing so will prove to be highly rewarding.
Posted by Peter K. Scott