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Does an American citizen (independent contractor) with American clients getting paid in an American bank account but working remotely abroad qualify for the foreign earned income exclusion credit if they pass the physical present test? I understand a self-employment tax would still be due but would an income tax?

http://www.irs.gov/Individuals/International-Taxpayers/Foreign-Earned-Income-Exclusion---Tax-Home-in-Foreign-Country

http://www.irs.gov/Individuals/International-Taxpayers/Foreign-Earned-Income-Exclusion---Physical-Presence-Test

UPDATE Please see my answer below for further information on research I've done.

I think the it's best to talk to an accountant as @littleadv makes some good points and I've read points on both sides. It would probably be best to get an accountant and be advised on your personal situation.

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Talk to an accountant if more than $2k in income is at stake. –  Jeff-Inventor ChromeOS Aug 11 at 0:36

2 Answers 2

I've also found this link which states so as long you physically worked out of the country you qualify. Perhaps it is left up to interpretation but it seems there is reason to believe based on research that income earned abroad no matter whence it comes is considered foreign-source.

U.S.-Source vs. Foreign-Source Income

Determination of whether income is U.S.-source or foreign-source governs whether or not exclusions are available. The source of income is not necessarily determined by where it is paid. For example, if a U.S. employer pays an employee via direct deposit to her U.S. bank account, but she conducts all of her work in Zaire, the income is foreign-source and not U.S.-source. Essentially, the source of the income is the place where work is actually done.

To cite another example, a client who is a U.S. taxpayer working abroad also works in the United States for 11 days during the year. The client has a gross income of $100,000. Because he worked in the United States for 11 days, not all of the income is foreign-source (i.e., tax free). By dividing the number of days worked in the United States by the total number of days worked during the year and multiplying that number by your client’s gross income, you can ascertain what portion of his income is U.S.-source (taxable), and what portion is foreign-source: 11 days worked in United States divided by 240 total days worked during the year multiplied by $100,000 gross income equals $4,583.33 of U.S.-source income.

http://www.americanbar.org/newsletter/publications/gp_solo_magazine_home/gp_solo_magazine_index/oct99zg.html

Also according to this questionnaire on the IRS website: http://www.irs.gov/Individuals/International-Taxpayers/Foreign-Earned-Income-Exclusion-Can-I-Claim-the-Exclusion-or-Deduction

You pay taxes to your "tax home".

Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual.

If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and your tax home is wherever you work.

Also on the IRS website itself: http://www.irs.gov/Individuals/International-Taxpayers/Foreign-Earned-Income-Exclusion---What-is-Foreign-Earned-Income

Source of Earned Income

The source of your earned income is the place where you perform the services for which you received the income. Foreign earned income is income you receive for performing personal services in a foreign country. Where or how you are paid has no effect on the source of the income. For example, income you receive for work done in France is income from a foreign source even if the income is paid directly to your bank account in the United States and your employer is located in New York City.

After consulting a tax professional specializing in expatriat american tax, her advice was also of this opinion:

If you work and live in a foreign country long enough to be considered a Bona Fide Resident or have Physical Presence that meet the IRS standard, it does not matter whether your employer, if you are indeed an employee on payroll, is a US based company or foreign based company.

If you are a self-employed independent contractor, then you don’t officially have any employer, US or foreign. If your clients or customers are US based or foreign based businesses, you can still qualify for the Foreign Income Exclusion is you meet one of the 2 aforementioned residency tests.

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If you consulted a tax professional who is duly certified (CPA/Attorney certified by any US State and not disqualified by the IRS, or a IRS-certified Enrolled Agent), and you got this opinion in writing - then you can use this advice and the tax professional's E&O coverage would kick in if you're found avoiding taxes by the IRS. If any of these conditions is incorrect - I'd consider avoiding taking this path. Note that only the person getting the CPA/EA's opinion and paying for it can rely on it when dealing with the IRS, not anyone else quoting rumors read on Internet forums. –  littleadv Aug 8 at 3:29
    
@littleadv please read "Source of Earned Income" at this link or see my updated answer: irs.gov/Individuals/International-Taxpayers/… –  sandy Aug 8 at 4:14
    
I'll be more comfortable with quotes from an authoritative text. Unfortunately, IRS instructions or web pages are not a legal authority and you cannot rely on them in the court of law. The only things you can rely on in the court of law in the US are the statute (which I quoted), relevant regulations as published in the CFR, and the precedences in the relevant Circuit Courts, the Tax Court or the SCOTUS. –  littleadv Aug 8 at 4:17
    
Just so you know, just this year the IRS pursued, and won, a case in court where it sued taxpayers that followed the official published IRS instructions to the letter. Why? Because the instructions were contrary to the law, and the IRS decided to go after the taxpayers since a lot of money was involved. –  littleadv Aug 8 at 4:19
    
I see. That is very unfortunate that the official IRS site may be providing incorrect information. I'll refrain from selecting an answer as it seems the answer is not straightforward. –  sandy Aug 8 at 4:22

This is an interesting (and for me, timely, thread). I am a US CPA (licensed in TX and NY) and have researched this issue for myself as I will have passed the residency test working a long term contract in Dubai. I DO plan to take the exclusion for this income based on what I've read in the guidance. However, 'littleadv' makes an EXCELLENT point - if the amount of tax your will avoid using this method is substantial, it is a good idea to get a licensed CPA 'on the hook' (make sure he actually HAS E&O liability insurance - many don't) for this advice. If you don't, you might consider setting aside an amount if you are successfully challenged by the service. Also - there are firms that have specialists in expat taxation - you would do well to use one of them if your regular tax adviser is not familiar with this area - most US CPAs are not. I was not - but as mentioned, I believe the position is sound and will take it myself - but not certain I would sign another person's return with this position without substantial additional research - - court decisions, USC, etc/etc.

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