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If you are living and working in Afghanistan for a period of 330 days during a consecutive 12 month period, then you may claim the foreign earned income exclusion which is currently $87,600. You may also qualify to deduct certain foreign housing amount. However, you would still be responsible for taxes on any amount exceeding the $87,600 foreign income.
The Form 673 strictly allows your employer not to withhold taxes on the first $87,600 of your income. Any income you have over that amount, the employer is obligated to withhold taxes.
Hello again mechanic,
You will need to file your taxes on a calendar year basis. The tax return filings do not go according to your contract.
You are allowed the exclusion of $87,600 for each 12 month period that you meet the 330 day residency test.
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When did you first start working in Afghanistan and when did you return to the US?
When do you plan to return to Afghanistan?
If you just started working in Afghanistan on November 6th of this year, then you will not qualify for the foreign earned income exclusion for the tax year of 2008. Any earnings you have from November 6th to December 31st will be fully subject to tax, the same as if you were still here in the US.
However, the following year when you file your taxes for the year 2009, you will have then met the 330 day physical presence test, as you will have been in Afghanistan for 300 days in a 12 month consecutive period. The 12 months period does not all have to be in the same calendar year. So for the year 2009 you will be able to exclude $87,600 from your income before the rest may be taxable. In fact in 2009 the amount will probably be a little higher, as the amounts are generally adjusted upward each year.
If you are certain that you plan to fulfill your contract, then you should fill out the Form 673 and give that to your employer, which will allow him not to withhold tax from your paychecks until you have reached the $87,600 threshold. Once you reach that amount, then taxes would start being withheld. Just keep in mind that if for some reason your contract gets cut short or your come home early for any reason, then you may be subject to tax on your entire earnings if you do not meet the 330 day test.
The information you were given is not correct. In the US, as an individual you always file your taxes on a calendar year basis. Earnings that you have between January 1st and December 31st of any calendar year must be reported on a tax return for that calendar year.
The physical presence test is not 330 days out of a 365 day year. It is 330 days out of any consecutive 12 month period. This year you will not meet that test since you just went to Afghanistan on November 6th. So when you file your taxes for the year of 2008, you will only have been in Afghanistan a little less than 2 months. But if you finish out your contract and remain in Afghanistan until November of 2009, then when you file your taxes for 2009 you will have met the test, as you will have been in that country for 330 days, even though part of those days were the last half of 2008 -- it is still a consecutive 12 month period.
One thing I would like to add here. Even if you were allowed to file your taxes at the end of your contract as you were told (which you are not), but even then you would still only be allowed one exclusion amount of $87,600. So even though you are going to need to file 2 tax returns (one for 2008 and one for 2009) you will still get to claim the same exclusion on your second return for 2009, so you are still coming out the same. The only difference is that you will be reporting 2 months of your income on the 2008 return and 10 months on the 2009 return.
Filling out the Form 673 does not exempt you from tax on all of your earnings. It only exempts you on the part of your earnings which qualify for the foreign earned income exclusion, which is currently $87,600. Once you reach that limit, any earnings over that amount will have tax withheld.
Here are the exact instructions that the IRS gives to the employer who receives a Form 673 from an employee:
"Once you have received Form 673 completed by the employee, you may discontinue withholding of U.S. income tax on those wages that qualify for the exclusion."