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