If you can establish that your tax home is outside the U.S. and satisfy either the “bona fide residence” test or the “physical presence” test, you may be able to exclude your foreign income from U.S. tax.
Bona fide residence test A U.S. citizen satisfies the bona fine residence test if you reside in a foreign country for an uninterrupted period that includes the entire tax year. However, just being in a foreign country for one full year does not automatically qualify you. For example, a person who relocates to a foreign country to work a particular job for a specified period of time will not be treated as a bona fide resident of the foreign country, even if they are present for more than one year fulfilling the work assignment. The length and nature of your stay overseas are just two factors the IRS will consider. Other factors include whether you purchased a home overseas, any declaration you may have made to the foreign authority indicating that you are not a resident of the country, and whether your family lives abroad with you.
Physical presence test You will qualify under the physical presence test if you are present in a foreign country for 330 full days during a period of 12 consecutive months. The 330 days do not need to be consecutive.
Foreign earned income exclusion If you are able to establish that your tax home is outside the U.S. and can satisfy either the bona fide residence test or the physical presence test, you can exclude from income a portion of your income earned overseas. The excludable amount is adjusted each year. For 2016, this amount was $101,300. To claim this exclusion, you must file a U.S. federal income tax return (Form 1040) and attach Form 2555. Certain nuances and limitations may apply in the case of married couples.
Foreign tax credit You can also claim a credit for foreign income taxes paid. However, certain foreign taxes may not qualify as income taxes for purposes of taking the foreign tax credit. The amount of foreign tax credits you may take are limited to the amount of your foreign source taxable income and cannot be used to offset U.S. source income. Aside from specific situations, to claim a foreign tax credit you must file Form 1116 with your U.S. federal income tax return.
Foreign housing exclusion/deduction You can also exclude or deduct from your gross income your housing costs in a foreign country, provided you qualify under the bona fide residence or physical presence tests. The exclusion applies whenever you have wages, including self-employment. There are certain limitations imposed on the amounts you can exclude, which vary from city to city and are based on the cost of living there. The IRS publishes the relevant limitations each year. To claim the foreign house exclusion/deduction, you must file Form 2555.