Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion (FEIE) is a provision in the United States tax code that allows U.S. citizens and resident aliens who live and work abroad to exclude a certain amount of their foreign earned income from their U.S. taxable income. This tax benefit is designed to prevent double taxation on the income earned in another country.

Overview of Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion allows qualifying individuals to exclude a maximum amount of their foreign-earned income from U.S. taxation. As of 2022, the limit stands at $112,000 per qualifying individual. This amount is subject to annual adjustments for inflation, so it is essential to check for the most current exclusion limits.

To qualify for the exclusion, individuals must meet specific requirements set by the Internal Revenue Service (IRS). The FEIE is particularly beneficial for Americans residing in countries with high-income tax rates since it helps to alleviate the burden of double taxation.

Requirements for Eligibility

1. Tax Home

To qualify for the FEIE, an individual must have a tax home in a foreign country. The IRS defines “tax home” as the general area of an individual’s main place of business, employment, or post of duty, regardless of where the family home is maintained. If an individual does not have a regular or main place of business because of the nature of the work, the tax home is the place where they regularly live.

2. Foreign Residence

In addition to establishing a foreign tax home, an individual must either:

Bona Fide Residence Test

To meet the bona fide residence test, an individual must be a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. This test is more qualitative, assessing factors such as:

Physical Presence Test

To meet the physical presence test, an individual must be physically present in a foreign country or countries for at least 330 full days during a period of 12 consecutive months. This test is quantitative and does not consider the intent behind the stay.

Foreign Housing Exclusion / Deduction

In addition to the foreign earned income exclusion, taxpayers may also qualify for the foreign housing exclusion or deduction. This provision allows certain housing expenses incurred in a foreign country to be excluded or deducted from taxable income. These expenses include rent, utilities (excluding telephone), and other reasonable housing costs. The amount that can be excluded or deducted is subject to limitations and varies depending on the location of the foreign residence.

Calculation and Filing

Form 2555

Individuals who qualify and wish to claim the FEIE must file IRS Form 2555, Foreign Earned Income. This form will require details about:

Earned Income

Earned income includes wages, salaries, professional fees, and other amounts received as compensation for personal services rendered. It does not include passive income such as interest, dividends, capital gains, alimony, etc.

Proration

If you qualify for the FEIE for only part of the year, the exclusion will be prorated based on the number of days you were eligible during the year.

Example: If you were eligible for 180 days in the tax year, the exclusion amount would be ($112,000 / 365 days) * 180 days.

Housing Exclusion/Deduction Calculation

To calculate the allowable housing exclusion or deduction, first determine the total housing expenses. Then, the IRS provides a base amount that is not eligible for exclusion or deduction. The difference between the actual expenses and the base amount, up to a specified limit, can be excluded or deducted from your gross income.

Foreign Tax Credit

Another important tax relief provision is the Foreign Tax Credit (FTC), which is different from the FEIE. The FTC allows a taxpayer to apply taxes paid on foreign income to offset U.S. tax liability. However, if you claim the FEIE, you cannot take a credit or deduction for taxes on the income that is excluded.

Choice Between FEIE and FTC

Taxpayers need to evaluate their specific circumstances to decide whether to claim the FEIE, the FTC, or both. Since the FEIE and FTC have different benefits and limitations, careful planning and potentially consulting with a tax professional may be beneficial.

Revocation of the Exclusion

Once an individual chooses to use the FEIE, they are not required to do so every year. However, if they revoke the exclusion, they may not claim it again for the next five years without IRS approval.

Impact of State Taxes

It’s essential to remember that while the FEIE excludes income from U.S. federal taxes, state taxes are another matter. Some states follow federal tax rules, while others have different regulations. Taxpayers must consult with state tax authorities or a tax professional to understand the implications of claiming the FEIE on state taxes.

Summary of Key Points

  1. Income Limit: As of 2022, up to $112,000 of foreign-earned income is excludable.
  2. Eligibility: Establish a tax home in a foreign country and pass either the bona fide residence test or the physical presence test.
  3. Housing Exclusion/Deduction: Additional exclusion/deduction available for qualified housing expenses.
  4. Form 2555: Use to claim the exclusion and housing benefits.
  5. Foreign Tax Credit: An alternative to the FEIE that might be more beneficial in certain circumstances.
  6. Revocation: Revoking the FEIE prevents claiming it again for five years without IRS approval.
  7. State Taxes: State tax impacts should be reviewed separately.

For more in-depth details, individuals should refer to the IRS Publication 54, “Tax Guide for U.S. Citizens and Resident Aliens Abroad,” and the instructions for IRS Form 2555 available on the IRS website here.