Foreign Earned Income Exclusion – All Your Questions Answered by Expat Tax Experts
Living and working abroad as a U.S. citizen or resident alien means your worldwide income is subject to U.S. taxation. This can lead to double taxation, as your foreign country may also tax your income. The Foreign Earned Income Exclusion (FEIE) offers a significant tax benefit by allowing you to exclude a portion of your foreign earnings from U.S. income tax, potentially saving you thousands of dollars.
To qualify, you must meet specific requirements, such as having a tax home in a foreign country. You must also meet the Bona Fide Residence Test or the Physical Presence Test. It’s important to note that income earned from the U.S. government or its agencies does not qualify for this exclusion.
Additionally, the Foreign Account Tax Compliance Act (FATCA) mandates that all American citizens report their foreign holdings and assets to the IRS. This further complicates the tax situation for expats. However, the FEIE can help mitigate the risk of double taxation and ease the financial burden of living abroad.
This article answers common questions about the Foreign Earned Income Exclusion, offering expert advice to help you understand and utilize this tax benefit effectively.
What is Foreign Earned Income?
The Foreign Earned Income Exclusion (FEIE) applies specifically to income earned from performing services as an employee or independent contractor. “Foreign earned income” includes wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered. This means that wages and self-employment income may qualify for the FEIE.
However, the exclusion does not apply to passive income, such as interest, dividends, capital gains, rental income, or retirement income. Only income earned through active work or services in a foreign country qualifies for this exclusion.
To learn how to claim FEIE, check out our comprehensive article on Form 2555.
5 Ways to Determine Your Foreign Earned Income Exclusion Eligibility
The FEIE helps American expats reduce their income tax by excluding some or all of their foreign-earned income. Here’s how to determine if you qualify:
1. You have foreign earned income
You may be eligible for the FEIE if you receive earned income for services performed in a foreign country. For example, you can be an American expatriate working in Canada and earning a salary there.
A U.S. citizen can have several kinds of foreign income, such as earned, unearned, or variable. However, only foreign-earned income is viable for this tax benefit. This means you can only deduct income from performing personal services from the total taxable income. This includes wages, salaries, professional fees, tips, self-employment income, etc.
TIP: Amounts included in your income because of your employer’s contributions to a nonexempt employee trust or to a nonqualified annuity contract are not considered foreign earned income.
2. You have a foreign tax home
In general, a tax home is considered the individual’s primary place of business or employment. It is the place where the individual regularly performs work and is the base of their operations. The tax home is not necessarily the same as the individual’s residence or legal domicile.
Jumping off from the previous example, if your primary place of business or employment is in Canada, that country generally becomes your tax home.
However, this only applies to those staying or working in that country for an extended period. This means you may not have a foreign tax home if you are only there temporarily, with your residency remaining in the U.S.
You must not have an abode in the U.S. to qualify for the FEIE. However, certain U.S. citizens or resident aliens, specifically contractors or employees of contractors supporting the U.S. Armed Forces in designated combat zones, are exceptions. In general, an abode is considered to be a place where an individual has a regular and consistent presence, maintains personal belongings, and intends to remain for an extended period of time. The specific factors that may be considered when determining whether a location qualifies as an abode can vary depending on the individual’s circumstances.
3. You are a U.S. citizen who is a bona fide resident of another country
U.S. citizens who are bona fide foreign country residents are eligible for the FEIE. In other words, you’ll need to be residing in the foreign country as a resident. You may have to go through certain tests to prove this eligibility requirement.
For example, you’ll have to prove that you are currently a resident of a foreign country for a full tax year with no interruptions. If you have been outside the country for an entire tax year and earning income elsewhere, you can claim an FEIE deduction.
TIP: The IRS does not consider U.S. possessions, such as Guam and Puerto Rico, as foreign countries. Therefore, you cannot claim the exclusion if you reside in these territories. Always verify your location’s eligibility for the FEIE to avoid unexpected tax liabilities.
4. You are a resident alien of a country with an income tax treaty with the U.S.
A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year may be able to claim the FEIE.
A resident alien is an individual who is not a U.S. citizen but is considered a resident of the U.S. for tax purposes. Resident aliens are subject to U.S. federal income tax on their worldwide income, similar to U.S. citizens.
There are two main ways an individual can be classified as a resident alien:
- Green Card Test: An individual is considered a resident alien if they are a lawful permanent resident of the United States (i.e., they have a green card).
- Substantial Presence Test: An individual is considered a resident alien if they meet the substantial presence test. This test considers the number of days the individual has been physically present in the United States during the current and two preceding calendar years.
5. You are physically present in a foreign country for at least 330 full days during any period of 12 consecutive months
Another way to qualify for the FEIE is to pass the Physical Presence Test. In this test, you must reside in a foreign country for 330 full days within 12 consecutive months.
During this time, pay close attention to the time. Every minute counts, with a full day starting its 24-hour count at midnight. Remember that any domestic visits to the U.S. will reset the day count, even for work assignments. Indicate the times and dates of your location, in and out of the U.S., to qualify for the test.
For example, your employer assigned you to their branch in Australia. You’ll have to stay there for 330 full, 24-hour days within 12 consecutive months to become eligible for the FEIE. If they ask you to return to the U.S. for some site work, your days in the U.S. will not count toward the 330 days and could make you ineligible for the Physical Presence Test.
How Does The Foreign Income Exclusion Impact Tax Rates?
Taxpayers claiming the foreign income exclusion will pay tax at the tax rates that would have been applied had they not claimed the exclusion.
In other words, the federal income tax is calculated by first calculating the amount of income tax on income without taking the foreign earned income exclusion into account and then subtracting the tax as calculated on the amount of foreign earned income excluded.
The result is the amount of the federal income tax liability. To facilitate this calculation, taxpayers use the Foreign Earned Income Tax Worksheet in the Instructions for Form 1040.
Special Extension To Qualify For The Foreign Earned Income Exclusion
Most taxpayers generally can only get an extension of up to six months, which is not subject to the discretion of the IRS. However, if you are residing outside of the United States and meet certain requirements, you may be able to get a special extension to qualify for the foreign earned income exclusion test.
You can get an extension of more than six months to file your tax return if you need the time to meet either the bona fide residence test or physical presence test. You can request this type of extension if you meet all three of the following tests:
- You are a U.S. citizen or resident alien.
- You expect to meet either the bona fide residence test or the physical presence test, but not until after your tax return is due.
- Your tax home is in a foreign country (or countries) throughout your period of bona fide residence or physical presence, whichever applies.
To request the extension, you must file Form 2350, “Application for Extension of Time to File U.S. Income Tax Return.” You must request it before the due date of your return. If your tax home and your abode are outside the U.S. and Puerto Rico on the regular due date of your return (April 15), the due date for filing your return is June 15.
If granted an extension, it generally lasts up to 30 days beyond the date you can reasonably expect to qualify for the exclusion under the bona fide residence test or the physical presence test.
What if You Don’t Meet the Bona Fide Residence or Physical Presence Test?
If unforeseen events make it impossible for you to qualify for the foreign earned income exclusion, you must pay interest on any tax due from the regular due date (April 15) until the tax is paid in full.
At Tax Samaritan, we can prepare and submit the required extension request to the IRS.
Need US expat tax advice? Book a consultation now!
Frequently Asked Questions About FEIE
1. I am self-employed, and my income is excluded under the Foreign Earned Income Exclusion. Why does my return show a balance due?
Even if the Foreign Earned Income Exclusion (FEIE) excludes all your income, self-employed taxpayers must still pay self-employment tax on their net business income. This is because the FEIE only exempts foreign earned income from income tax. It does not exempt self-employment taxes, which fund Social Security and Medicare.
For the 2024 tax year, the self-employment tax rates are as follows:
- Social Security Tax: 12.4% on the first $168,600 net earnings. This is because self-employed individuals pay both the employee and employer portions.
- Medicare Tax: 2.9% on all net earnings, with an additional 0.9% Medicare tax on earnings over $200,000 for single filers or $250,000 for married couples filing jointly.
Totalization Agreements
If you live in a country with a Totalization Agreement with the U.S., you might be exempt from paying U.S. Social Security taxes. These agreements ensure you do not pay Social Security taxes on the same income to both countries.
Estimated Quarterly Payments
To avoid interest and penalties, you must pay estimated self-employment taxes quarterly. This ensures that your tax liabilities are met throughout the year rather than as a lump sum at the end of the tax year.
Example Calculation for 2024
- If you have a net earnings of $100,000 and are self-employed, you would pay:
- Social Security Tax: $100,000 * 12.4% = $12,400
- Medicare Tax: $100,000 * 2.9% = $2,900
- Total Self-Employment Tax: $12,400 + $2,900 = $15,300
Even if you exclude $100,000 under the FEIE, you still owe $15,300 in self-employment taxes.
2. What tax rates apply if I exceed the Foreign Earned Income Exclusion?
When your foreign-earned income exceeds the Foreign Earned Income Exclusion (FEIE) limit, any amount above the exclusion is subject to U.S. federal income tax. For the tax year 2024, the FEIE limit is $126,500.
Calculation Method
The IRS computes the tax on your foreign earned income above the exclusion as if the exclusion was not claimed. This means your tax liability is calculated based on your total income, including the excluded amount, and then the tax on the excluded portion is subtracted. Your tax rate is based on the sum of your excluded and non-excluded income, which may place you in a higher tax bracket.
Tax Rates
For tax year 2024, the federal income tax rates for single filers are as follows:
- 10% on income up to $11,600
- 12% on income over $11,600 up to $47,150
- 22% on income over $47,150 up to $100,525
- 24% on income over $100,525 up to $191,950
- 32% on income over $191,950 up to $243,725
- 35% on income over $243,725 up to $609,350
- 37% on income over $609,350
For example, if your total income is $150,000 and you claim the FEIE of $126,500, you will pay taxes on the remaining $23,500. However, your tax rate will be based on a total of $150,000, potentially placing you in a higher bracket than if you were taxed only on the $23,500.
Note that your standard or itemized deductions and other deductions and credits will affect the actual tax amount owed. This can help further reduce your tax liability.
3. What is the foreign housing exclusion or deduction? Do I qualify?
The Foreign Housing Exclusion or Deduction allows U.S. citizens and resident aliens working abroad to exclude or deduct certain housing expenses from their taxable income, providing significant tax relief. To qualify, your tax home must be in a foreign country, and you must pass either the bona fide residence test or the physical presence test.
Housing Exclusion vs. Housing Deduction
- Housing Exclusion: This applies to housing expenses paid with employer-provided amounts, such as wages or salary. You can claim this by attaching Form 2555 to your tax return.
- Housing Deduction: This deduction applies to self-employed individuals who use their self-employment earnings to pay for housing. Like the exclusion, it is calculated using Form 2555.
Calculating the Exclusion or Deduction
Housing expenses can include rent, utilities (excluding phone, TV, and internet), insurance, and certain other expenses. The IRS limits the exclusion or deduction to the lesser of your actual housing expenses minus the base amount or the maximum limit set for your location. These limits vary by city due to differences in living costs. The base housing amount is 16% of the Foreign Earned Income Exclusion (FEIE). To claim the exclusion or deduction, your qualifying expenses must exceed this base amount.
To claim the Foreign Housing Exclusion or Deduction, complete Form 2555 and attach it to your Form 1040. The IRS instructions for Form 2555 provide detailed instructions for calculating and claiming the exclusion.
4. Should I take the Foreign Tax Credit or utilize the Foreign Earned Income Exclusion?
Choosing between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) depends on your financial circumstances and the specifics of your foreign income and taxes.
When to Choose the Foreign Earned Income Exclusion
The FEIE allows you to exclude up to $126,500 of your foreign earned income from U.S. taxation for the 2024 tax year. This exclusion is particularly beneficial if:
- Lower Foreign Taxes: If you work in a country with lower tax rates than the U.S., the FEIE can significantly reduce your U.S. tax liability.
- No Foreign Taxes Paid: If you did not pay any foreign taxes on your income, the FEIE is usually the better option since it allows you to exclude your foreign-earned income from U.S. taxes entirely.
- Student Loans: If you are on an income-driven repayment plan for U.S. student loans, the FEIE can reduce your Adjusted Gross Income (AGI), potentially lowering your monthly payments or reducing them to zero.
When to Choose the Foreign Tax Credit
The FTC allows you to claim a dollar-for-dollar credit on foreign income taxes paid, which can be beneficial if:
- Higher Foreign Taxes: If you are paying higher taxes in your country of residence than you would in the U.S., the FTC can eliminate any U.S. tax liability.
- Passive Income: If you have passive income streams (e.g., dividends, interest, capital gains), the FTC is more beneficial as it applies to both earned and unearned income.
- Family and Retirement Benefits: If you want to qualify for the Additional Child Tax Credit or make IRA contributions, the FTC is preferable since the FEIE reduces your taxable earned income, making you ineligible for these benefits.
TIP: Once you use the FEIE by filing Form 2555, you cannot switch back and forth annually. If you skip claiming the FEIE one year, you revoke your election and cannot claim it for the next five years unless you get IRS permission through a private letter ruling for a valid reason, like a change in marital status or country.
5. I left the U.S. during the middle of the year. Does the foreign earned income exclusion apply, and how is it calculated?
Yes, you can still qualify for the FEIE even if you left the U.S. mid-year. To qualify, you must meet either the Physical Presence Test or the Bona Fide Residence Test.
Proration of the Exclusion
If you only qualify for part of the year, the exclusion amount is prorated based on the number of qualifying days within the calendar year. The calculation is as follows:
(Maximum FEIE x Number of qualifying days in the tax year) / 365
For example, if you qualify for 180 days in 2024 and the maximum exclusion is $126,500, the calculation would be:
126,500 x (180 / 365) = 62,384
This prorated amount is the portion of your foreign earned income you can exclude from U.S. taxation​.
6. I am a U.S. citizen working outside of the United States. Do I still have a filing requirement?
Yes, as a U.S. citizen working outside the United States, you must file a U.S. tax return and report your worldwide income, regardless of where you live or how long you have been abroad.
Filing Requirements
The U.S. tax system is based on citizenship, meaning all U.S. citizens and resident aliens must file and pay taxes on their global income. This includes wages, investments, and other sources earned outside the United States​.
Tax Deadlines and Extensions
The filing deadline for U.S. citizens living abroad automatically extends to June 15. However, any tax owed is still due by April 15. If you need more time, you can request an additional extension to October by filing Form 4868.
7. I work directly for the U.S. government, so would I qualify for the foreign earned income exclusion?
If you work directly for the U.S. government, such as an embassy or consulate employee, you do not qualify for the Foreign Earned Income Exclusion (FEIE). This exclusion is designed explicitly for income earned from private-sector employment or self-employment while living abroad. Income earned from the U.S. government does not meet the criteria for this exclusion.
However, you might still be able to reduce your tax burden through other means like claiming tax credits.
TIP: Military and civilian employees of the U.S. government typically cannot exclude their pay under the FEIE. However, employees of international organizations like NATO might benefit from special agreements with the IRS.
8. Do I need to file a U.S. tax return if I earned less than the Foreign Earned Income Exclusion?
Yes, you must file a U.S. tax return to claim the Foreign Earned Income Exclusion (FEIE), even if your total income is below the exclusion limit and results in no tax liability. The IRS requires you to report all foreign earned income and claim the exclusion using Form 2555, which you must attach to Form 1040.
This is necessary because the exclusion is not automatic; you must elect it by filing the appropriate forms. Failing to file could mean missing out on the exclusion and potentially facing penalties for late filing if the IRS contacts you about unreported income.
TIP: Even if your foreign-earned income is below the FEIE limit, you must still file a U.S. tax return. By doing so, you can claim the exclusion and potentially exempt all qualifying income from U.S. taxation
9. Can I take a credit for taxes paid on foreign income excluded under the Foreign Earned Income Exclusion?
No, you cannot take either a credit or a deduction for foreign taxes paid on income that you exclude under the Foreign Earned Income Exclusion (FEIE) or the Foreign Housing Exclusion. The IRS stipulates that any income excluded from your U.S. tax return using the FEIE or the Foreign Housing Exclusion is not subject to double taxation and, therefore, ineligible for the Foreign Tax Credit.
Avoid Double Taxation With Foreign Earned Income Exclusion Today
With the current citizenship-based tax system in the U.S., American expats draw the short end of the stick. You are prone to double taxation, which you can incur from your tax home country and the U.S., reducing your take-home pay.
However, there is still hope. The foreign earned income exclusion tax benefit can help reduce the taxable income you owe to the IRS. All you need to do is prove your eligibility, and our team at Tax Samaritan is here to assist you.
Tax Samaritan aims to provide our clients with the best counsel, advocacy, and personal service. We are not only expat tax preparation and representation experts but strive to become valued business partners. Tax Samaritan understands our clients’ unique needs; every tax situation requires a personal approach to providing realistic and practical solutions.