IRS issues housing caps for expats

The IRS recently issued Notice 2020-13, which provides limitations on housing expenses for individuals working abroad. Section 911 of the Code allows US individuals working abroad to exclude from taxation a certain amount of foreign earned income each year, plus a housing amount.

The general housing limitation is set at 30% of the maximum foreign earned income exclusion for the year (indexed for inflation). However, individuals living in high cost of living areas are provided a greater limitation. The adjustments are made on the basis of geographic differences in hosting costs relative to housing costs in the United States. These revised amounts are listed in Notice 2020-13.

To qualify for the foreign earned income exclusion and related housing benefits, the U.S. citizen or resident must meet the definition of a qualified individual. A qualified individual is defined as:

• Individual is physically present in a foreign country for at least 330 days during any 12-month period or is a bona fide resident of a foreign country for an uninterrupted period that includes an entire taxable year, and
• Individual’s tax home is in a foreign country (i.e., principal or regular place of business).

The benefits under section 911 are only applicable for the period in which the taxpayer meets the foreign tax home requirement, while also meeting either the bona fide foreign resident test or the 330-day physical presence test. 

Section 911 allows a qualified individual to exclude from gross income their foreign earned income and housing costs up to a specified amount.

The maximum amount of foreign earned income that is eligible for the exclusion is adjusted annually for inflation. The chart below shows the indexed amounts for the most recent five years.

The maximum foreign earned income amount is also prorated for the number of qualifying days in a taxable year. For example, if John Doe met the definition of a qualified individual for the 2017 tax year, but only has 325 qualifying days, his maximum foreign earned income exclusion would be the 2017 maximum/indexed amount of $102,100 (see chart above) multiplied by 325/365.

The housing cost amount is generally the total of the housing expenses for the taxable year minus a base housing amount. The base housing amount is 16% of the limitation on foreign earned income for the year. This means that the base housing amount for 2020 would be $17,216 (16% x $107,600).

Housing expenses in excess of the base amount are eligible for the housing exclusion, but such expenses may not exceed a certain limit. The limit on housing expenses is tied to a taxpayer’s location.

For most locations, the housing limit is set at 30% of the maximum/indexed foreign earned income amount for the tax year. This means the general housing limitation for 2020 is $32,280 (30% x $107,600 limitation on foreign earned income for 2020).

However, as noted above, some locations are provided a greater limitation. For example, Notice 2020-13 provides that individuals living in Tokyo, Japan having a housing cap of $93,200 (instead of $32,280). This means a U.S. citizen living and working in Tokyo for the entire year will be eligible for a housing exclusion of $75,984 ($93,200 - $17,216 base housing amount for 2020).

Eligible housing expenses include:

• rent
• utilities
• property insurance
• rental of furniture and accessories

If a taxpayer claims the foreign earned income exclusion, the housing exclusion, or both, the individual must figure the tax on the remaining non-excluded income using the tax rates that would have applied had the individual not claimed the exclusions.

Taxpayers electing the foreign earned income and/or housing exclusion must file Form 2555, Foreign Earned Income, with the IRS. This form establishes the taxpayer’s status as a qualified individual, calculates the taxpayer’s foreign earned income, and determines the total amount of exclude income to be carried forward onto the taxpayer’s Form 1040.  

Tara Fisher has been practicing international tax for 20 years. Her professional background includes working for the US Congress Joint Committee on Taxation, the national tax practice of PWC, the University of Pittsburgh and American University in Washington, DC. She is a licensed CPA and holds undergraduate and graduate degrees in accounting from the University of Virginia.