U.S. Tax Preparation Worldwide James Maertin CPA
Tax Guide, Americans Abroad
Foreign Unearned Income
Foreign unearned income includes:
Dividends
Interest
Capital gains
Gambling winnings
Alimony
Social security benefits
Pensions
Annuities
Some types of income are not easily identified as earned or unearned income. These types of income -specifically, income from sole proprietorships, partnerships, and corporations, stock options, pensions and annuities, royalties, rents, and fringe benefits.
Income from a sole proprietorship or partnership.
Earned Income: If you are a sole proprietor or partner and your personal services are also an important part of producing the income, the part of the income that represents the value of your personal services will be treated as earned income.
Unearned Income: Income from a business in which capital investment is an important part of producing the income may be unearned income.
Capital a factor. If capital investment is an important part of producing income, no more than 30% of your share of the net profits of the business is earned income. If you have no net profits, the part of your gross profit that represents a reasonable allowance for personal services actually performed is considered earned income. Because you do not have a net profit, the 30% limit does not apply.
Example 1. You are a U.S. citizen and meet the bona fide residence test. You invest in a partnership based in Cameroon that is engaged solely in selling merchandise outside the United States. You perform no services for the partnership. At the end of the tax year, your share of the net profits is $80,000. The entire $80,000 is unearned income. Example 2. Assume that in Example 1 you spend time operating the business. Your share of the net profits is $80,000; 30% of your share of the profits is $24,000. If the value of your services for the year is $15,000, your earned income is limited to the value of your services, $15,000.
Example 1. You are a U.S. citizen and an officer and stockholder of a corporation in Honduras. You perform no work or service of any kind for the corporation. During the tax year you receive a $10,000 “salary” from the corporation. The $10,000 clearly is not for personal services and is unearned income. Example 2. You are a U.S. citizen and work full time as secretary-treasurer of your corporation. During the tax year you receive $100,000 as salary from the corporation. If $80,000 is a reasonable allowance as pay for the work you did, then $80,000 is earned income.
You may have earned income if you disposed of stock that you got by exercising a stock option granted to you under an employee stock purchase plan. If your gain on the disposition of stock you got by exercising an option is treated as capital gain, your gain is unearned income. However, if you disposed of the stock less than 2 years after you were granted the option or less than 1 year after you got the stock, part of the gain on the disposition may be earned income. It is considered received in the year you disposed of the stock and earned in the year you performed the services for which you were granted the option. Any part of the earned income that is due to work you did outside the United States is foreign earned income. See Pub. 525, Taxable and Nontaxable Income, for a discussion of the treatment of stock options.
Royalties.
Royalties from the leasing of oil and mineral lands and patents generally are a form of rent or dividends and are unearned income.
Royalties received by a writer are earned income if they are received: (1) For the transfer of property rights of the writer in the writer's product, or (2) Under a contract to write a book or series of articles.
Rental income.
Generally, rental income is unearned income. If you perform personal services in connection with the production of rent, up to 30% of your net rental income can be considered earned income. Example. Larry Smith, a U.S. citizen living in Australia, owns and operates a rooming house in Sydney. If he is operating the rooming house as a business that requires capital and personal services, he can consider up to 30% of net rental income as earned income. On the other hand, if he just owns the rooming house and performs no personal services connected with its operation, except perhaps making minor repairs and collecting rents, none of his net income from the house is considered earned income. It is all unearned income.
Use of employer's property or facilities.
If you receive fringe benefits in the form of the right to use your employer's property or facilities, the fair market value of that right is earned income. Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being required to buy or sell, and both having reasonable knowledge of all the necessary facts. Example. You are privately employed and live in Japan all year. You are paid a salary of $6,000 a month. You live rent-free in a house provided by your employer that has a fair rental value of $3,000 a month. The house is not provided for your employer's convenience. You report on the calendar-year, cash basis. You received $72,000 salary from foreign sources plus $36,000 fair rental value of the house, or a total of $108,000 of earned income.