# Severance pay - does it count for the Foreign Earned Income Exclusion?



## ldnxpat

Hi,

I'm a US citizen living in UK. The company I worked for for 10 yrs has made me redundant on Dec 30 2016. I worked 4yrs in USA then 6 yrs in UK for this company. They are going to pay me a severance payment later in January. I'm trying to understand how redundancy/severance payments fit in the IRS Foreign Earned Income Exclusion.

According to the "Figuring the Foreign Earned Income Exclusion" page on the IRS website ("Amounts Earned Over More Than 1 Year" section) it seems that the severance payment should be split into 10 parts and one tenth of it should be subjected to taxes for a given yr.

Not sure if it works that way. Or perhaps the entire severance payment is considered as earned in 2016 and is added to salary in 2016 to see if it falls under the 2016 amount for the Foreign Earned Income Exclusion? (I believe it is $101,300 for 2016.)

If anyone has any advice or insight on this I would greatly appreciate it.
Thanks...ldnxpat


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## Bevdeforges

There are a couple of factors to take into consideration here. As far as I know, severance pay isn't considered to be earned over the time that you worked for the employer. It's (usually, at least here in Europe) a mandatory payment paid out at the end of your service to the company. Even if it is based on your years of service, if it's paid out in a lump sum, then it is considered paid in the year that payment is made.

So, technically speaking, if you aren't getting your severance until January, 2017, it's an item for your 2017 tax return, not for 2016. Actually, the IRS has a Publication 4128 on Job Loss that states that severance is taxable in the year it is received. 

I would include it as "earned income" for FEIE purposes, too. (In fact, I think I did exactly that when I got French severance pay.) Obviously, you won't have a W-2 for the amount, but it is payment received from your employer (ok, past employer) based on services rendered, so I'd take the FEIE for it. (If they have a problem with this, they'll be in touch. But don't hold your breath.)
Cheers,
Bev


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## ldnxpat

Bev, thanks very much for your response. These issues can be very confusing for a lot of people.
To clarify...
- If I add up my salary and bonus for 2016 and these fall under the FEIE amount for 2016 ($101,300) then I should not have to pay US taxes on them.
- The redundancy/severance payment (and payment in lieu of notice for first 3 months of 2017) should be considered as earned in 2017 and if they are less than FEIE amount (which they are) then I should not pay US taxes on them.

Would you say the above points are correct/true?

My employer seems to be trying to apply US taxes of 25% to my redundancy/severance payment and that does not seem correct to me.

Thanks again...ldnxpat


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## Bevdeforges

It will depend if you remain in the UK or if you're planning on returning to the US in 2017. If you are no longer resident outside the US, then you will have to apportion your FEIE that you can apply to the severance payout. I suppose that's the devil in the details.

Take a look at that publication I pointed you toward. Worse possible case, however, is if your employer withholds US taxes from the severance, then you claim them back as a refund when you file your 2017 US taxes. However, if you pack up and move back to the US early in the year, that could reduce your FEIE.
Cheers,
Bev


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## ldnxpat

I live full time in England now (I'm originally from England) and I won't be returning to US in 2017 (I have kids at school here in England). I guess that means the 2 points I made based on your post are true/correct?

I looked at IRS Publication 4128...it doesn't seem to mention anything about foreign earned income or anything like that, so I'm wondering if the rules it contains might be different for expats.

One other question I'm wondering if anyone can help with...I worked 4 years for the company in USA (before moving to UK) and the severance payment is based on a 10 year service. Does that mean that there is some federal/state tax due on the portion (4/10) of the severance payment that could be considered as having been earned in USA (even though it is being paid to me here in UK now)? Or does that fact not matter now, and it's all just considered a lump sum paid in UK and subject to UK tax and FEIE rules?

Thanks...ldnxpat


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## Bevdeforges

> I looked at IRS Publication 4128...it doesn't seem to mention anything about foreign earned income or anything like that, so I'm wondering if the rules it contains might be different for expats.


There is remarkably little (if any) tax law or guidance for "foreign" income of any sort in the IRS code. Basically, you have to interpret and "roll your own" depending on where you are (tax treaties) and rough equivalents to how things work in the US. However, look at what pub 4128 has to say about severance - it's clearly taxable when paid and not "when earned."


> I worked 4 years for the company in USA (before moving to UK) and the severance payment is based on a 10 year service. Does that mean that there is some federal/state tax due on the portion (4/10) of the severance payment that could be considered as having been earned in USA (even though it is being paid to me here in UK now)? Or does that fact not matter now, and it's all just considered a lump sum paid in UK and subject to UK tax and FEIE rules?


Income taxes for individuals in the US are based on the "cash basis" - which means when they are paid, not when they are earned. Corporations have to match revenue and expense, but for individuals, you calculate your taxes based on when you were paid. (There is a big deal in the US about deferring the receipt of income into the next tax year because income is cash based. In some companies, you can elect to receive your December pay in the next year January and that defers it into the next tax year.
Cheers,
Bev


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## ldnxpat

Thanks Bev, that helps.
Regards...ldnxpat


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## ldnxpat

Hi,

I spoke with an "official" (expensive) tax adviser today. He said that only 1/10 of the severance pay is excludable under FEIE rules (the part for last year). There would be US tax due on the rest of it.

Does that make sense? Paying US tax on 9/10 of the gross severance amount, as well as the UK taxes that are due on it, would seem to make such that I am being double taxed. I cannot understand how that can be the case.

Appreciate if anyone has any insight. 
Thanks...ldnxpat


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## celticweb

I would stay clear from taking the word of "one official tax advisor". they make the rules in some cases.

I actually investigated this myself last year when my firm was making a lot of redundancies and severance payments as part of a reorganisation. It didn't happen to me in the end but I wanted to know the implications if it did. 

Redundancy and severance payment are actually two different things. redundancy is based on length of service. Severance payment can be given to an employee with a mutual agreement to terminate the employment, the job could still exist. the payment could be made out of appreciation of past performance, sort of like a bonus in some cases. or it could be to stop the employee from suing for unfair dismissal. How i understood it, severance payment definitely counts toward the FEIE in the year it's paid.
Redundancy might be a grey area and I can see where a tax advisor might come up with a 1/10 scenario here. Have a look at this, it clearly says severance payment counts toward the FEIE. 
https://www.taxesforexpats.com/articles/expat-tax-rules/expat-taxes-after-losing-job.html

I haven't used these people btw. Of course someone with more experience could come along and say I am talking complete rubbish here. but I learned to interpret things how I see fit within the obscure laws that exist especially when no clear guidance is given or anything written in the tax code.


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## celticweb

also to be clear, i said "I can see where a tax advisor might come up with a 1/10 scenario for redundancy" payments. I didn't say I agree with this interpretation.

for example if the redundancy is to be £10,000. the £1000 for year one is not wages that were due to be paid 10 years ago that never got paid that year. the £1000 is part of a settlement package for this year based on past length of service and should rightly be able to be claimed on the FEIE providing it doesn't take you over the exclusion amount.


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## ldnxpat

Hi celticweb,

Thanks for the response. Good advice about the "official tax advisor", so much of this seems very open to interpretation.

Regarding severance/redundancy pay, I can def see the distinction you make. However, in practice there does not seem to be any difference and the terms seem to be used interchangeably. (Both terms were used in emails/docs I received from my UK employer.)

The IRS website def says severance pay qualifies for FEIE. Since the US doesn't use the term "redundancy" it seems reasonable to interpret redundancy pay (as used in UK) as severance pay (per the US term).

The tax advisor seemed to be interpreting rules that said something like ...
income can only be excluded if it is earned either this yr or the yr prior...something like that. I guess it comes down to the interpretation of "severance pay". Is it something that's attributable for several years (10 in my case) or is it a one off payment.

It seems that in either case, if all the amounts were below the FEIE threshhold for the years in question then there should not be a problem (no US tax). But my (ex) employer is attempting to withhold a large amount of US tax from the payment, in addition to UK tax, and that does not seem right.


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## ldnxpat

Thanks for that 10K illustration, it really does help lay out why interpreting this the way the tax adviser did makes no sense at all. I agree, it's not money that was due to be given 10 yrs ago but they're only getting around to it now, instead it's a payment made NOW and thus qualifies for FEIE. Cheers.


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## celticweb

When dealing with the IRS (and even tax advisors), things are rarely logical. 

I also interpret the words as being interchangeable. earned income is wages and includes severance payments and IRS taxes severance payments as wages too, and yes on the IRS website under Foreign Earned Income Exclusion Requirements it does clearly say this

t also may include severance pay, sick leave pay and vacation pay. Foreign earned income can also include noncash income such as the fair market value of lodging, a car, or employer provided meals. 

If you must use a tax advisor, try to find that supports your interpretation of things. 

Good luck!


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## Bevdeforges

As you said, the term "redundancy" doesn't have any real meaning in the US.

If your employer insists on withholding US taxes on your severance, then you just file your 2017 returns claiming the FEIE for the whole thing and claim a refund of the amounts over-withheld. OK, you have to wait for your money, but that throws it squarely in the IRS' court and lets them decide. Remember, US income tax is calculated on a cash basis, not accrual.
Cheers,
Bev


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## ldnxpat

Bevdeforges said:


> Remember, US income tax is calculated on a cash basis, not accrual.


Thanks. Just so I'm clear, I think "income tax is calculated on a cash basis" means that you pay tax on the income/money in the year you receive it, not the year you did the work to earn the money?

In my case, even though I did the work for bonus in 2016, since I'm not getting the money in 2017 it becomes a matter for 2017 tax yr (i think).

Cheers...ldnxpat


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## Bevdeforges

ldnxpat said:


> Thanks. Just so I'm clear, I think "income tax is calculated on a cash basis" means that you pay tax on the income/money in the year you receive it, not the year you did the work to earn the money?
> 
> In my case, even though I did the work for bonus in 2016, since I'm not getting the money in 2017 it becomes a matter for 2017 tax yr (i think).
> 
> Cheers...ldnxpat


Correct - cash basis means you declare and pay taxes in the year you receive the money, not in the year you "earned" it. 
Cheers,
Bev


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## ldnxpat

I google this but cannot find an answer...
Does anyone know WHY the FEIE only goes back 2 years. I know these things are usually to do with big earners shifting money to this year and that year etc, but I can't find any explanation as to the limited look back of the FEIE. Thanks.


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## Bevdeforges

Ultimately, you're supposed to take the FEIE when you're entitled to it, and not "backfile" to get it. They have to make some allowances, however, for those who move somewhere mid-year and thus don't qualify for the FEIE when their first year returns are due. While the usual course of action is to extend your filing deadline until you have your first full year abroad done, it is also possible to file the return without the FEIE, and then amend after you fulfill the physical presence test to claim the refund. Two years gives you just enough time for that.

The threat has always been that, if the IRS audits you (a real long shot these days) for failure to file, you don't have the option to take the FEIE retroactively.

But, frankly, it's really rare that any of these "oddities" of tax law are explained anywhere.
Cheers,
Bev


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## LC3622

Bevdeforges said:


> Ultimately, you're supposed to take the FEIE when you're entitled to it, and not "backfile" to get it. They have to make some allowances, however, for those who move somewhere mid-year and thus don't qualify for the FEIE when their first year returns are due. While the usual course of action is to extend your filing deadline until you have your first full year abroad done, it is also possible to file the return without the FEIE, and then amend after you fulfill the physical presence test to claim the refund. Two years gives you just enough time for that.
> 
> The threat has always been that, if the IRS audits you (a real long shot these days) for failure to file, you don't have the option to take the FEIE retroactively.
> 
> But, frankly, it's really rare that any of these "oddities" of tax law are explained anywhere.
> Cheers,
> Bev


I thought you can take the exclusion any time if you do not owe any tax after the exclusion...

This is from the website:

The foreign earned income exclusion is voluntary. You can choose the foreign earned income exclusion and the foreign housing exclusion by completing the appropriate parts of Form 2555. Your initial choice of the exclusions on Form 2555, Foreign Earned Income or Form 2555-EZ, Foreign Earned Income Exclusion generally must be made with:

•a timely filed return (including any extensions),


•a return amending a timely filed return, or


•a late-filed return filed within 1 year from the original due date of the return (determined without regard to any extensions).


You can choose the exclusion on a return filed after the periods described above, provided you owe no federal income tax after taking the exclusion into account.


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## Bevdeforges

It comes down the matter that, if the IRS finds you before you have "elected" the FEIE - either on a timely filed return or on an amendment to a prior return - they will disallow the election and calculate your taxes due based on no FEIE. That, from the Paris tax office - though they all got sent home, so who really knows?
Cheers,
Bev


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## liquiduty

I'm a bit late to this particular party... I took a severance package from my US-based employer in 2010 - the entire amount was eligible for the FEIE.

As far as your UK taxes go I can share my own situation... I worked for that company for 22 years. 4.5 were in the US, 3 in the UK where I was considered not ordinarily resident and then the remainder where I was considered ordinarily resident. This meant that roughly 7.5/22 of the severance pay in the UK was not taxed as it fell under foreign service relief. First the £30K UK exclusion was deducted and then only 14.5/22 of what was left was exposed to UK tax.

UK tax law might have changed in the interim but probably worth exploring.


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