I am a sole proprietor. I meet the test for tax home and physical presence test for foreign earned income. I am a sole proprietor operating outside the US in a South American city. My situation isn’t easily defined because I am not paid by a company in South America for my work. I maintain a home office and a full time paid assistant in South America. The work done is operating a retail internet business which targets the US market and other countries. The work is done in South America by phone, fax and e-mail where I arrange to buy merchandise and services and pay other businesses in the US to do fulfillment work in the US. I have no employees in the US. Mailbox only in the US and credit card sales paying into business checking accounts are in the US. I also manage from my South American office the importing of goods buying from a South American business for import and sale in the US. I need to be in South America to oversee the South American manufacturer. My income results from mainly US and some foreign buyers of the work I do in South America. Is it foreign earned income? Do I qualify for the tax exemption.

“My income results from mainly US and some foreign buyers of the work I do in South America. Is it foreign earned income?”----> Yes. It is your foreign earned income. I guess ( assume) you are either a US citizen or a US resident. Foreign earned income is income you receive for services you perform in a foreign country during a period your tax home is in a foreign country and during which you meet either the bona fide residence test or the physical presence test. As a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income ( I mean you are liable for taxes on both US source and your worldwide income.). However, you may qualify to exclude from income up to an amount of your foreign earnings that is now adjusted for inflation ( $91,500 for 2010, $92,900 for 2011). In addition, you can exclude or deduct certain foreign housing amounts. You also may be subject to foreign income tax credit on foreign income taxes that you paid to the S. American taxing authority on your US federal tax return. But I bet you can’t take tax deduction on your state level tax return; for instance, if you pay capital gain taxes overseas, then you can claim CG taxes on your federal return but you can’t claim CG tax credit on your state income tax return. As you maintain your home office, you can deduct your home office related expenses on your Sch C as part of your business operating expenses and you may qualify for the foreign housing exclusions and the foreign housing deduction(Your housing amount is the total of your housing expenses for the year minus the base housing amount. The computation of the base housing amount (line 32 of Form 2555) is tied to the maximum foreign earned income exclusion. Please keep this in mind; if you own or have authority over a foreign financial account, including your bank account in the S. American state, and the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year, then you MUST report it by filing the FORM TD F 90-22.1 on or before June 30 of the following the year that the account holder meets the $10,000 threshold.
“Do I qualify for the tax exemption.”---->Let me tell you only on FEIE ,foreign earned income exclusion; for 2011( or 2010), you may elect to exclude up to $91,500 ( for 2010) of your earned income from the S. American state. To qualify for the exclusion, you must either reside in the foreign nation for the entire year or be physically present in the foreign nation for 330 full days during a 12-month period. If you reside in the foreign nation only part of the year, then the exclusion must be prorated. Fo rinstancem assume that you resides in the foreign nation for the last 210days of 2009 and the first 300 days in 2010, the you meet the 330-day rule in a 12-month period requirement. 210+300=510>330.
Please visit the IRS website on it here; Foreign Earned Income Exclusion - Requirements