Publication 553 (3/2007), Highlights of 2006 Tax Changes

7. Foreign Issues

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Table of Contents

2006 Changes

Foreign Earned Income Tax Worksheet

If you claim the foreign earned income exclusion or the foreign housing exclusion on Form 2555 or Form 2555-EZ, your must figure your tax using the Foreign Earned Income Tax Worksheet found in the Instructions for Form 1040.

Exception From the Filing Requirement for Nonresident Aliens

Generally, the requirement to file a return has been eliminated for nonresident aliens who earn wages effectively connected with a U.S. trade or business that are less than the amount of one personal exemption ($3,300 for 2006). For more information, see Notice 2005-77, 2005-46 I.R.B. 951. You can find Notice 2005-77 on page 951 of Internal Revenue Bulletin 2005-46 at
www.irs.gov/pub/irs-irbs/irb05-46.pdf.

Foreign Earned Income and Housing Exclusions

The following changes to the foreign earned income and housing exclusions went into effect for 2006. For more information, see Form 2555, Foreign Earned Income, and its instructions.

Exclusion amount. The maximum foreign earned income exclusion has increased to $82,400.

Housing expenses—maximum amount. The amount of qualified housing expenses eligible for the housing exclusion and housing deduction is now limited. The amount of the limit depends on the location of your foreign tax home. A complete table of the adjusted limitations on housing expenses for 2006 starts on page 5 of the latest revision of the 2006 Instructions for Form 2555, Foreign Earned Income. To view these instructions, go to
www.irs.gov/pub/irs-pdf/i2555.pdf.

Housing expenses—base amount. The base housing amount (Form 2555, line 32) has increased to $36.12 per day, or $13,184 for an entire calendar year.

Determination of tax on income not excluded. If you claim the foreign earned income exclusion, the housing exclusion, or both, you must determine the tax on your nonexcluded income using the tax rates that would have applied had you not claimed the exclusions. See the instructions for Form 1040 and complete the Foreign Earned Income Tax Worksheet to determine the amount of tax to enter on Form 1040, line 44. If you must attach Form 6251 to your return, use the Foreign Earned Income Tax Worksheet provided in the instructions for Form 6251.

Source of Compensation for Labor or Personal Services

If you are an employee and perform services partly inside and partly outside the United States, new rules apply in determining the source of your compensation for labor or personal services. Under the new rules, compensation (other than fringe benefits) is sourced on a time basis. Fringe benefits (such as housing and education) are sourced on a geographical basis. Or you may be able to use an alternative basis to determine the source. For more information, see the following publications.

Publication 514, Foreign Tax Credit for Individuals.
Publication 519, U.S. Tax Guide for Aliens.
Publication 570, Tax Guide for Individuals With Income From U.S. Possessions.

2007 Changes

Foreign Earned Income and Housing Exclusions

Exclusion amount. The maximum foreign earned income exclusion has increased to $85,700.

Housing expenses—base amount. The base housing amount has increased to $37.57 per day, or $13,712 for an entire calendar year.

Foreign Tax Credit

Income categories eliminated. For tax years beginning after 2006, the following categories of income will be eliminated for purposes of computing the foreign tax credit limit. Income that previously fell in these categories will fall in either the passive income category or the general limitation income category.

High withholding tax interest.
Financial services income.
Shipping income.
Dividends from a domestic international sales corporation (DISC) or former DISC.
Certain distributions from a foreign sales corporation (FSC) or former FSC.

High withholding tax interest and shipping income will fall in the passive income category or general limitation income category, depending on the circumstances. Financial services income will fall in the general limitation income category if you are predominantly engaged in the active conduct of a banking, insurance, financing or similar business. Dividends from a DISC or former DISC and certain distributions from a FSC or former FSC will fall in the passive income category. See Publication 514 for more information on the foreign tax credit for individuals.

Recharacterization of overall domestic loss. If you have an overall domestic loss for any tax year beginning after 2006, you must recharacterize a portion of your U.S. source taxable income in succeeding years as foreign source taxable income for purposes of the foreign tax credit.

In a tax year you choose to claim the foreign tax credit, the overall domestic loss is the domestic loss for that tax year to the extent it offsets foreign source taxable income for that tax year or for any preceding tax year (in which you chose to claim the foreign tax credit) because of a carryback. If you do not choose to claim the foreign tax credit for a tax year, the overall domestic loss is the domestic loss for that tax year to the extent it offsets foreign source taxable income for any preceding tax year (in which you chose to claim the foreign tax credit) because of a carryback.

For more information, see Internal Revenue Code section 904(g).