One of the novel aspects of living in Kuwait was no taxes. We’re talking no income tax, no sales tax - nothing. While there were enthusiastic chants from Parliament on taxing foreigners, the unpopular idea never gained traction; maybe due to the mass exodus that would ensue. 

As United States citizens living in a foreign country, we are responsible for reporting world-wide income to the Internal Revenue Service. With that said, there is some relief for those living and working abroad.

Please note that the following information is for entertainment purposes only. Seek a professional accountant for support should you wish to make any changes to your tax reporting status with the IRS. 

First and foremost, there is the foreign income exclusion provided by 26 CFR § 1.911-3. For tax year 2022, an individual that lives and works abroad can exclude up to $108,700 from taxable income. To reap the benefits, you must:

• have foreign earned income, 

• your tax home must be in a foreign country, 

• and be a resident (for tax purposes) of a foreign country/countries for an uninterrupted period that includes an entire tax year. 

Simple enough? The foreign earned income is pretty straight forward, but the whole tax home, bona fide resident, and uninterrupted period can get confusing. 

The second component is setting up your tax home in a foreign country - given you are living and working abroad. All that really means is filling out a form saying a) to what foreign country you moved and b) the dates you lived outside the USA. 

The third component can be resolved by meeting one of two tests - the bona fide resident or physical presence test. For your sanity, I am not going to get into the bona fide resident test; it is very fact and circumstance driven. Under the physical presence test, you just have to exist outside of the United States for 330 days during a 12-month period - to put it simply. This might require you to file for a tax return extension to accumulate the days, but it will be worth the work. Publication 54 was a huge help in navigating the information and establishing residency abroad. 

From our experience, we were able to exclude our entire teaching salaries while living in Kuwait. We moved to Kuwait in August 2016; living and working in California from January to August of the same year. We used the physical presence test (Form 2555, Part III) to establish residency abroad. That required us to file for extension of our 2016 tax return; we filed the tax return in October 2017 instead of April. To maintain the 330 days in a 12-month period, we were only able to visit the United States for no more than 15 days in the summer of 2017 because we visited California for Christmas (2016). Please note that the Federal income exclusion provided relief for foreign earned income only; we were still responsible for tax on income earned prior to moving abroad. After filing the initial tax return and changing our tax status to non-resident, year-to-year filing is relatively simple. All of this is dependent upon little to no ties back in the USA like a private residence or certain other investments.      

Please note that not all states conform to the Federal income exclusion. For example, we were audited by the State of California Franchise Tax Board in 2018. The FTB claimed that since California does not conform to the federal foreign income exclusion, California tax would be calculated on total income prior to the Federal income exclusion. Long story short, the audit was dropped because a) we have no physical presence in California and b) the income was not California sourced - earned in California. FTB Publication 1031 Section G provides guidelines for determining residency and helped me provide a rebuttal to the proposed assessment. 

To be fair, we continued to file both Federal and state returns the entire time we lived in Kuwait. Our continued filing of Federal returns (which is required) provided us with uninterrupted stimulus payments during the pandemic. While there was no actual State requirement, we filed them due to my wife’s student loans and other licensing requirements.