What is the Foreign Earned Income Exclusion (FEIE)?
The foreign earned income exclusion is a handy money-saving provision. If you are an expatriate, you definitely want to get acquainted with it. Taxes US residents and citizens on their worldwide income. Citizens and residents who live and work outside the United States may be entitled to the foreign earned income exclusion.
The foreign earned income exclusion is a tax benefit that allows you to exclude a certain amount of foreign earned income from U.S. taxation, one of the ways that the Internal Revenue Service allows expats to double taxation on their foreign-sourced income. Helps to avoid The IRS assumes that your foreign earned income will be taxed in your country of residence, allowing you to exclude this income from US taxation using the Foreign Earned Income Exclusion.
You are liable to pay income tax, regardless of where that income was earned, if you are a lawful permanent resident or US citizen. However, taxpayers who live elsewhere may qualify for FEIE, which allows them to exclude all or part of their foreign source self-employment and wage income from U.S. federal income tax. Those who qualify by completing the physical presence or actual resident test may be able to exclude up to $112,000 in foreign earned income in tax year 2022.
The Foreign Earned Income Exclusion (FEIE) is one of the biggest tax benefits available to you as an expatriate. FEIE is available only for self-employment or wage income earned for services performed outside the United States. Its purpose is to prevent double taxation by excluding income tax from US taxation in another country. The exclusion is claimed on IRS Form 2555.
Key Facts of Foreign Earned Income Exclusion
- The purpose of FEIE is to prevent double taxation from US taxation by excluding income tax in any other country.
- To qualify for the credit, you must be a US citizen who has been a bona fide resident of a foreign country for an uninterrupted period, which includes an entire tax year.
- The foreign housing amount represents the housing cost you paid abroad with the foreign earned income. It should be more than 16% of the maximum exclusion amount.
- If you reside in the other country for an uninterrupted period that includes the entire tax year, you are considered a bona fide resident of a foreign country.
- Special rules apply to military personnel and foreign service.
Who Eligible for the Foreign Earned Income Exclusion ?
If you meet certain requirements, you may qualify for foreign earned income. If you are a United States resident alien and you live abroad or are a US citizen, you are taxed on your worldwide income. In addition, you can deduct or exclude certain foreign housing amounts. To claim FEIE benefits, your tax home must be in a foreign country and you must have foreign earned income.
You can use the Internal Revenue Service's Interactive Tax Assistant tool to determine whether income earned in a foreign country can be excluded from income reported on your US federal income tax return.
How to Qualify for the Foreign Earned Income Exclusion ?
To qualify from the foreign earned income exclusion, a taxpayer must meet one of the following criteria :
- Must be an actual resident of a foreign country for the entire tax year. Which is known as bona fide residency test.
- Must be physically present in a foreign country for at least 330 days during any 12 month period. Which is known as physical appearance test.
Physical Presence Test to Qualify for the FEIE
The Physical Presence Test (PPT) is a method by which Americans working overseas can qualify for the Foreign Earned Income Exclusion. Counting of days for Physical Attendance Test requires separate assessment for each day. The IRS clarifies in Publication 54 that, each day can be in a period exceeding 12 months. A 12 month period can start on any day of any month. To pass the PPT test, you must have the following :
1) Foreign Earned Income :
This would include bonus, salary, self-employment or wage income. Note that this does not include interest, dividends, capital gains or pension distributions.
2) A Tax Home in Abroad :
A tax house is one where a person is employed either permanently or indefinitely, irrespective of their personal residence. To set up a tax home, you must have a work engagement lasting at least one year. If you have held a private residence in the US, you cannot be considered a tax home in a foreign country.
3) Be physically present in a foreign country for the required time frame :
This time frame is 330 days out of a 12 month period. You will have to spend a full 330 days abroad, as the partial days spent on the trip do not count. To qualify, the two-year period may be adjusted as needed, not necessarily on a calendar-year basis.
Bona Fide Residence Test to Qualify for the FEIE
An alternative to qualifying with the Physical Presence Test is to use the Bona Fide Residence Test (BFT). The Actual Residence Test is not available to a resident alien unless he is a citizen of a country with which the US Income Tax Treaty is in effect. If the taxpayer declares to the foreign government that they are not tax residents of that country, the test is not completed. Such a declaration can be made on a tax return or visa application. Some tax treaties may affect eligibility for the exclusion. To use the bona fide residency test, you must have the following :
1) Foreign Earned Income :
It is the same requirement as in PPT, you must have earned income abroad to pass the test.
2) A Tax Home in Foreign Country :
It is the same requirement as in PPT to qualify. You must set up a tax home with the expectation of working for a year or more and maintaining a personal residence in the US means you do not have a tax home in a foreign country.
3) Be a Bona Fide Resident for the Specified Time :
You must be a bona fide resident of a foreign country for the entire tax year. You must demonstrate an intention to remain abroad indefinitely without immediate plans to return to the United States.
How Does Having a Home in the US Affect Bona Fide Residence ?
The government classifies your tax home as where you work and primarily live, regardless of foreign rental income or real estate. Your residence is determined by where you manage your family, personal and financial relationships.
What Is Foreign Earned Income ?
Foreign Earned Income Exclusion only allows foreign earned income to be excluded from US expat taxes. It is therefore important to understand what income is earned and qualified as foreign.
1) Foreign vs. US Earned Income :
The Internal Revenue Service categorizes income by where it is earned. So if you are working and living abroad, your income is considered foreign earned income, even if it is being paid for by a US company.
If you are working in the United States, your earnings are considered US earned income regardless of who pays your salary, whether it is a US company or a foreign company.
2) Earned vs. Passive Income :
Earned income is the income that you have earned by working. Income from wages and wages is considered accrued.
On the other hand, passive income includes dividends, interest, rental property income, capital gains, retirement income and so on.
Exemption Due to Unfavorable Circumstances
If you are forced to leave abroad due to adverse circumstances such as war or civil unrest, the minimum time requirements for both the physical presence test and the actual residence may be waived. If these adverse circumstances would not have interrupted your term of residence, you should be able to prove that you have met the time requirements.
Impact on Tax Calculations
Even though this exclusion reduces your taxable income, you still pay tax at the rate that would have been applicable if you had not claimed the exclusion. In other words, your tax bracket remains the same, even if the exclusion eventually moves your income into the lower bracket. If you need help, use the Foreign Earned Income Tax Worksheet found in the instructions for Form 1040.
How Much is the Foreign Earned Income Exclusion ?
Every year, the amount of Foreign Earned Income Exclusion is adjusted for inflation. Sometimes, this can cause confusion because early estimates of the new FEIE limit may exceed or work out the allowed exclusion able amount. The maximum exclusion for each person is $120,000 for the tax year 2023. Married couples who both work overseas and satisfy the requirements for physical presence or bona fide residence may elect to exclude foreign earned income separately. When combined, they can deduct up to $240,000 from taxes in 2023.
|
Tax Year |
FEIE Amount |
|
2022 (filed in 2023) |
$112,000 |
|
2021 (filed in 2022) |
$108,700 |
|
2020 (filed in 2021) |
$107,600 |
|
2019 (filed in 2020) |
$105,900 |
|
2018 (filed in 2019) |
$103,900 |
|
2017 (filed in 2018) |
$102,100 |
There is a foreign housing amount and a statutory maximum exclusion amount that limits the exclusion. If the number of qualifying days in a foreign country is less than a full tax year, it is done pro-rata. The foreign housing amount is the one you have paid with foreign earned income, which exceeds 16% of the maximum exclusion amount. The maximum exclusion of this amount is the maximum limit of 30% of the amount. The foreign accommodation amount is taken as an exclusion by the employees and as a deduction by the self-employed persons.
How to Claim the Foreign Earned Income Exclusion ?
A taxpayer must file IRS Form 2555 to claim Foreign Earned Income Exclusion and attach this form to a US personal income tax return (IRS Form 1040). To complete Form 2555, you must include the following in the form:
- Which test are you using to qualify. (actual residence or physical presence)
- The dates you traveled internationally and to the US during the tax year.
- Previous Year Form 2555 (if available).
- Foreign earned income documentation.
Common Mistakes When Claiming the Foreign Earned Income Exclusion
One of the most common misconceptions about FEIE is that FEIE automatically applies or doesn't require you to report foreign pay on your federal tax return and that U.S. expats assume that if their income is Foreign Earned. They are not required to file a tax return if the income does not exceed the exclusion limit.
Frequently Asked Questions
What are the requirements for the FEIE ?
In order to be eligible for the foreign income exclusion, a migrant must meet all four of the following requirements :
- Must have foreign earned income
- Should have a tax home abroad
- Either meet the bona fide residence test or the physical presence test
- Make a lawful choice to exclude foreign earned income.
Which foreign income can you exclude from FEIE ?
Foreign Earned Income Exclusion can help reduce US taxes on foreign income earned while working overseas, but it does not apply to all sources of income. All income must be earned in a foreign country to count as foreign earned income. This exclusion is available only for earned income and does not apply to investments or passive income such as dividends and interest. Foreign earned income includes wages, bonuses, commissions, salaries and self-employment income.
Can I claim both the Foreign Tax Credit and the Foreign Earned Income Exclusion?
Yes, you can claim both the FTC and the FEIE. However, you cannot use the foreign tax credit on account of earned income that you have excluded using FEIE.
What happens if you don't report foreign income?
If the Internal Revenue Service finds that you knowingly failed to disclose foreign income or foreign accounts, the penalties can be severe. (civil or criminal)
How Does the Internal Revenue Service Know Your Foreign Income?
There are several ways for the IRS to learn about your foreign income, the primary way being information reporting to the US by foreign financial institutions worldwide through the Foreign Account Tax Compliance Act.