Certain taxpayers can exclude or deduct income earned in foreign countries. However, the foreign earned income and housing exclusions and the foreign housing deduction do not apply to the income you receive as an employee of the U.S. Government.

If you are a U.S. Government employee paid by a U.S. agency to perform services in a foreign country, your pay is from the U.S. Government and does not qualify for the exclusions or the deduction. This is true even if the U.S. agency is reimbursed by the foreign government.

If you are an employee of an Armed Forces post exchange, officers' and enlisted personnel club, embassy commissary, or similar instrumentality of the U.S. Government, the earnings you receive are paid by the U.S. Government. This is true whether they are paid from appropriated or nonappropriated funds. These earnings are not eligible for the foreign earned income and housing exclusions or the foreign housing deduction.

If you are a U.S. citizen or resident employed abroad by the U.S. Government and you also receive income from a private employer or self-employment, you may qualify to claim the exclusions or the deduction based on this other income. To qualify, you must meet either the bona fide residence test or the physical presence test. Your spouse who is a U.S. citizen or resident alien may also qualify if he or she earns income in a foreign country that is paid by a private employer or is from self-employment. If you are not a U.S. Government employee, amounts paid by the United States or its agencies to you may also qualify for the exclusions or the deduction.

For more information on the foreign earned income and housing exclusions and foreign housing deduction, see Publication 54.

Pay differentials you receive as financial incentives for employment abroad are taxable. Your employer should have included these differentials as wages on your Form W–2, Wage and Tax Statement.

Generally, pay differentials are given for employment under adverse conditions (such as severe climate) or because the post of duty is located in a hazardous or isolated area that may be outside the United States. The area does not have to be a qualified hazardous duty area as discussed in Publication 3. Pay differentials include:

Certain foreign areas allowances are tax free. Your employer should not have included these allowances as wages on your Form W–2.

Tax-free foreign areas allowances are allowances (other than post differentials) received under the following laws.

These allowances cover such expenses as:

Allowances received by foreign service employees for representation expenses are also tax free under the above provisions.

If you are stationed outside the continental United States or in Alaska, your gross income does not include cost-of-living allowances (other than amounts received under Title II of the Overseas Differentials and Allowances Act) granted by regulations approved by the President of the United States. Cost-of-living allowances are not included on your Form W–2.

If you are a federal court employee, the preceding paragraph also applies to you. The cost-of-living allowance must be granted by rules similar to regulations approved by the President.

If you are an employee of the American Institute in Taiwan, allowances you receive are exempt from U.S. tax if they are equivalent to tax-exempt allowances received by civilian employees of the U.S. Government.

If you are a federal employee who is reemployed by a federal agency after serving with an international organization, you must include in income any reemployment payments you receive. These payments are equal to the difference between the pay, allowances, post differential, and other monetary benefits paid by the international organization and the pay and other benefits that would have been paid by the federal agency had you been detailed to the international agency.

See How To Report Business Expenses, later, for a discussion on whether a reimbursement or allowance for travel or transportation is included in your income.

If you are a principal representative of the United States stationed in a foreign country, you do not have to include in income the value of lodging (including utilities) provided to you as an official residence. However, amounts paid by the U.S. government for your usual costs of operating and maintaining your household are taxable. If amounts are withheld from your pay to cover these expenses, you can not exclude or deduct those amounts from your income.

If you are a Peace Corps volunteer or volunteer leader, some allowances you receive are taxable and others are not.

The following allowances must be included on your Form W–2 and reported on your return as wages.

Taxable allowances are considered received by you when credited to your account.

These generally include travel allowances and the part of living allowances for housing, utilities, food, clothing, and household supplies. These allowances should not be included on your Form W–2. These allowances are tax free whether paid by the U.S. Government or the foreign country in which you are stationed.

Income earned by any citizen or resident of the United States is not exempt from U.S. tax by any section of the Panama Canal Treaty. See Allowances, Differentials, and Other Special Pay, earlier.

If you have a gain from the sale of your personal property (such as an automobile or a home appliance), whether directly or through a favorable exchange rate in converting the proceeds to U.S. dollars, the excess of the amount received in U.S. dollars over the cost or other basis of the property is a capital gain. Capital gains are reported on Schedule D (Form 1040), Capital Gains and Losses. However, losses from sales of your personal property, whether directly or through an unfavorable exchange rate, are not deductible.

All or part of the gain on the sale of your main home, within or outside the United States, may be taxable. (Losses are not deductible).

You may be able to exclude from income any gain up to $250,000 ($500,000 on a joint return). Generally, you must have owned and used the home as your main residence for two of the five years preceding the date of sale.

For detailed information on selling your home, see Publication 523.

You are traveling away from home if you meet both of the following requirements.

You do not have to be away from your tax home for a whole day or from dusk to dawn as long as your relief from duty is long enough to get necessary sleep or rest.

If your assignment or job away from your tax home is temporary, your tax home does not change. You are considered to be away from home for the whole period, and your travel expenses are deductible. Generally, a temporary assignment in a single location is one that is realistically expected to last (and does in fact last) for one year or less.

However, if your assignment or job is indefinite, the location of the assignment or job becomes your new tax home and you cannot deduct your travel expenses while there. An assignment or job in a single location is considered indefinite if it is realistically expected to last for more than one year, whether or not it actually lasts for more than one year.

You must determine whether your assignment is temporary or indefinite when you start work. If you expect employment to last for one year or less, it is temporary unless there are facts and circumstances that indicate otherwise. Employment that is initially temporary may become indefinite due to changed circumstances. A series of assignments to the same location, all for short periods but that together cover a long period, may be considered an indefinite assignment.

If you are a federal employee participating in a federal crime investigation or prosecution, you may be able to deduct travel expenses even if you are away from your tax home for more than one year. This exception to the one-year rule applies if the Attorney General certifies that you are traveling for the federal government in a temporary duty status to prosecute, or provide support services for the investigation or prosecution of a federal crime.

You can generally deduct only 50% of the cost of your unreimbursed business-related meals and entertainment. However, the limit does not apply to expenses reimbursed under a U.S. Government expense allowance arrangement.

You can deduct a higher percentage of your unreimbursed business-related meal expenses if the meals take place during or incident to any period subject to the Department of Transportation's hours of service limits. The percentage increases to 80% by the year 2008, as shown in the following table.

Individuals subject to the Department of Transportation's “hours of service” limits include the following persons.

If your trip was entirely for business, your unreimbursed travel expenses are generally deductible. However, if you spend some of your time on nonbusiness activities, part of your expenses may not be deductible.

If your trip was mainly personal, you cannot deduct your travel expenses to and from your destination. This applies even if you engage in business activities while there. However, you can deduct any expenses while at your destination that are directly related to your business.

You generally cannot deduct travel expenses of your spouse, dependents, or other individuals who go with you on a trip.

The Foreign Service Act requires U.S. citizens who are members of the foreign service to take a leave of absence after completing 3 years of continuous service abroad. This period is called “home leave” and can be used to take care of certain personal matters such as medical and dental checkups, buying a new wardrobe, and visiting relatives.

The amounts paid for your travel, meals, and lodging while on home leave are deductible as travel or business expenses subject to the rules and limits discussed earlier. You must be able to verify these amounts in order to claim them. Amounts paid on behalf of your family while on home leave are personal living expenses and are not deductible.

See chapter 1 of Publication 463 for more information on travel expenses.

Whether you own or lease your car, you generally can use either of two methods to figure your business car expenses: actual expenses or the standard mileage rate.

If you use your car for both personal and business purposes, you must divide your expenses between business and personal use. To determine the business percentage, divide the business miles driven by the total miles the car was driven for the year.

Under this method, you figure deductible car expenses using the business percentage of your actual operating costs. These include depreciation or lease payments (subject to certain limits), gasoline, repairs, and similar expenses.

Under this method, you use a set rate per mile for each business mile you drive. The rate is adjusted periodically for inflation. See your tax form instructions to find the rate for the year you claim the deduction.

If you want to use the standard mileage rate for a car, you must choose to use it in the first year the car is available for use in your business. Then in later years, you can choose to use the standard mileage rate or actual expenses.

You cannot use the standard mileage rate if you:

You cannot deduct your transportation costs of going between your home and your regular business location. These costs are personal commuting expenses.

If you have one or more regular business locations but must work at a temporary location, you can deduct the costs of commuting to that temporary place of work.

If you work at two or more places in the same day, you can deduct your expenses of getting from one place of work to the other.

If your employment at a work location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary unless there are facts and circumstances that would indicate otherwise. If your employment at a work location is realistically expected to last for more than one year, the employment is not temporary, regardless of whether it actually lasts for more than one year. If employment at a work location initially is realistically expected to last for one year or less, that employment will be treated as temporary until the date after your expectation changes, and you determine the employment will last more than one year.

For more information on transportation expenses, see chapter 4 of Publication 463.

Membership dues you pay to professional societies that relate to your business or profession are deductible.

Subscriptions to professional publications that relate to your business or profession are deductible.

Generally, educational expenses are considered to be personal expenses and are not deductible. However, under some circumstances, educational expenses are deductible as business expenses.

You can deduct educational expenses as business expenses if the education:

You cannot deduct educational expenses as business expenses if the education:

These rules apply even if the education is required by your agency or it maintains or improves skills required in your work.

See Publication 970, Tax Benefits for Education, for more information on educational expenses.

Educational expenses that are not work related, such as costs of sending children to college, are personal expenses that you cannot deduct. However, you may be eligible for other tax benefits such as the Hope and lifetime learning credits, contributions to a Coverdell education savings account or qualified tuition program, deduction for student loan interest, and exclusion from income of certain savings bond interest. These benefits are explained in Publication 970, Tax Benefits for Education.

If you are an employee of the U.S. Foreign Service and your position requires you to establish and maintain favorable relations in foreign countries, you may receive a nontaxable allowance for representation expenses. If your expenses are more than the allowance you receive, you can deduct the excess expenses as an itemized deduction on Schedule A (Form 1040) if you meet one of the following conditions.

To deduct any expenses for travel, entertainment, and gifts, including those certified by the Secretary of State, you must meet the rules for recordkeeping and accounting to your employer. These rules are explained in Publication 463.

These are expenses that further the interest of the United States abroad. They include certain entertainment, gifts, costs of official functions, and rental of ceremonial dress. They generally do not include costs of passenger vehicles (such as cars or aircraft), printing or engraving, membership fees, or amounts a principal representative must pay personally to cover the usual costs of operating and maintaining an official residence.

Chapters 300 and 400 of the Standardized Regulations (Government Civilians, Foreign Area) provide more detail on what expenses are allowable as representation expenses. These regulations are available on the Internet at www.state.gov/m/a/als. Click on “Table of Allowances, Section 920”. Publication 463 and Publication 529, Miscellaneous Deductions, provide more detail on what expenses are allowable as ordinary and necessary business expenses.

If you are an employee with a physical or mental disability, you can deduct attendant-care services at your place of work and other expenses in connection with work that are necessary for you to be able to work. Attendant care includes a reader for a blind person and a helper for a person with a physical disability. These expenses are reported on Form 2106 or 2106–EZ and carried to Schedule A (Form 1040). They are not subject to the 2%-of- adjusted-gross-income limit on miscellaneous itemized deductions.

The conversion of U.S. dollars into foreign currency at an official rate of exchange that is not as favorable as the free market rate does not result in a deductible loss.

Records for proof of your expenses should be kept in an account book, diary, statement of expense, or similar record. They should be supported by other records, such as receipts or canceled checks, in sufficient detail to establish the elements for these expenses. You do not need to duplicate information in an account book or diary that is shown on a receipt as long as your records and receipts complement each other in an orderly manner.

Each expense should be recorded separately in your records. However, some items can be totaled in reasonable categories. You can make one daily entry for categories such as taxi fares, telephone calls, meals while away from home, gas and oil, and other incidental costs of travel. You may record tips separately or with the cost of the service.

Documentary evidence generally is required to support all lodging expenses while traveling away from home. It is also required for any other expense of $75 or more, except transportation charges if the evidence is not readily available. Documentary evidence is a receipt, paid bill, or similar proof sufficient to support an expense. It ordinarily will be considered adequate if it shows the amount, date, place, and essential business character of the expense.

A canceled check by itself does not prove a business cost. You must have other evidence to show that the check was used for a business purpose.

Record the elements for the expense in your account book or other record at or near the time of the expense. A timely-kept record has more value than statements prepared later when, generally, there is a lack of accurate recall.

You do not need to put confidential information relating to an element of a deductible expense (such as the place, business purpose, or business relationship) in your account book, diary, or other record. However, you do have to record the information elsewhere at or near the time of the expense and have it available to fully prove that element of the expense.

You must complete Form 2106 or 2106–EZ to deduct your expenses. Also, if your actual expenses are more than your reimbursements, you can complete Form 2106 or 2106–EZ to deduct your excess expenses. You must generally include all of your expenses and reimbursements on Form 2106 or 2106–EZ and carry your allowable expense to Schedule A (Form 1040). Your allowable expense is then generally subject to the 2%-of-adjusted-gross-income limit.

You may be able to use Form 2106–EZ instead of the more complex Form 2106 for reporting unreimbursed employee business expenses. You can use Form 2106–EZ if you meet both of the following conditions.

The move must be closely related, both in time and in place, to the start of work at the new location. In general, you must have incurred your moving expenses within one year from the time you first report to your new job or business.

A move generally is not considered closely related in place to the start of work if the distance from your new home to the new job location is more than the distance from your former home to the new job location. A move that does not meet this requirement may qualify if you can show that you must live at the new home as a condition of employment, or you will spend less time or money commuting from the new home to the new job.

Your new main job location must be at least 50 miles farther from your former home than your old main job location was. If you did not have an old job location, your new job location must be at least 50 miles from your former home.

If you are an employee, you must work full time for at least 39 weeks during the first 12 months after you arrive in the general area of your new job location.

Moving expenses that can be deducted include the reasonable costs of:

The cost of your meals is not a deductible moving expense.

The costs of moving household goods include the reasonable expenses of moving household goods and personal effects to and from storage. For a foreign move, the costs also include expenses of storing the goods and effects for part or all of the period that your new job location abroad continues to be your main job location.

You can deduct only those expenses that are reasonable for the circumstances of your move. For example, the costs of traveling from your former home to your new one should be by the shortest, most direct route available by conventional transportation.

A member of your household includes anyone who has both your former home and new home as his or her home. It does not include a tenant or employee unless you can claim that person as a dependent.

You can deduct the costs of moving to the United States when you permanently retire if both your former main job location and former home were outside the United States and its possessions. You do not have to meet the time test described earlier.

You can deduct moving expenses for a move to the United States if you are the spouse or dependent of a person whose main job location at the time of death was outside the United States and its possessions. The move must begin within 6 months after the decedent's death. It must be from the decedent's former home outside the United States, and that home must also have been your home. You do not have to meet the time test described earlier.

Use Form 3903 to report your moving expenses and figure your allowable deduction. Claim the deduction as an adjustment to income on Form 1040. (You cannot deduct moving expenses on Form 1040A or Form 1040EZ.)

Generally, you must include reimbursements of, or payments for, nondeductible moving expenses in gross income for the year paid. You must also include in gross income reimbursements paid to you under a nonaccountable plan. However, there is an exception for the tax-free foreign areas allowances described earlier under Allowances, Differentials, and Other Special Pay

For additional information about moving expenses, see Publication 521.

You can deduct contributions to qualified organizations created or organized in or under the laws of the United States or its possessions. You cannot deduct contributions you make directly to foreign organizations (except for certain Canadian, Israeli, and Mexican charities), churches, and governments. For more information, see Publication 526, Charitable Contributions.

If you receive a tax-free housing allowance, your itemized deductions for real estate taxes and home mortgage interest are limited. You must reduce the amount of each deduction that would otherwise be allowable by the amount of each expense that is related to the tax-free allowance.

If you receive a tax-free housing allowance as a member of the military or the clergy, you do not have to reduce your deductions for real estate tax and home mortgage interest expenses you are otherwise entitled to deduct.

If you receive a tax-free housing allowance and have real estate tax or home mortgage interest expenses, attach a statement to your tax return. The statement must contain all of the following information.

The statement must also indicate that none of the amounts deducted on your return are in any way attributable to tax-free income.

Your foreign tax credit is subject to a limit based on your taxable income from foreign sources. If you choose to figure a credit against your U.S. tax liability for the foreign taxes, you must generally complete Form 1116 and attach it to your U.S. income tax return.

You cannot claim a credit for foreign taxes paid on amounts excluded from gross income under the foreign earned income or housing exclusions. If all your foreign income is exempt from U.S. tax, you will not be able to claim a foreign tax credit.

If the foreign taxes you paid or incurred during the year exceed the limit on your credit for the current year, you can carry back the unused foreign taxes as credits to the 2 preceding years and then carry forward any remaining unused foreign taxes to the 5 succeeding tax years.

You can elect to not be subject to the foreign tax limit if you meet all the following conditions.

If you make the election, you can claim a foreign tax credit without filing Form 1116. However, you cannot carry back or carry over any unused foreign tax to or from this year. See the instructions for the appropriate line in the Tax and Credits section of Form 1040.

If you choose to deduct all foreign income taxes on your U.S. income tax return, itemize the deduction on Schedule A (Form 1040). You cannot deduct foreign taxes paid on income you exclude under the foreign earned income or housing exclusions.

The deduction for foreign taxes other than foreign income taxes is not related to the foreign tax credit. You can take deductions for these miscellaneous foreign taxes and also claim the foreign tax credit for income taxes paid to a foreign country.

You can deduct real property taxes you pay that are imposed on you by a foreign country. You take this deduction on Schedule A (Form 1040). You cannot deduct other foreign taxes, such as personal property taxes, unless you incurred the expenses in a trade or business or in the production of income.

The foreign tax credit and deduction, their limits, and carryback and carryover provisions are discussed in detail in Publication 514.

If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

Mail. Persons living outside the United States may contact the Taxpayer Advocate at:

Phone. You can call the Taxpayer Advocate at 877–777–4778. When outside the United States, call the Taxpayer Advocate at 01–787–622–8930, or call 787–622–8940 if you need to speak to someone in Spanish. You can also contact one of the IRS offices located abroad, listed earlier.

Fax. You can fax the Taxpayer Advocate at 787– 622–8933.