Because the US taxes based on citizenship, American expats have to file US taxes from abroad, reporting all of their global income.
Many Americans also have to file foreign taxes too, depending on the rules in the country (or countries where they live).
Americans also often have to report their foreign registered bank and investment accounts, businesses, and assets.
The US has signed tax treaties with over 60 other countries, however with very few exceptions these don’t prevent Americans living abroad from having to file.
There are ways for most American expats not to pay US taxes from abroad in 2020 though. In this article we look more closely at one of these ways, the Foreign Earned Income Exclusion.
About the 2020 Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion allows qualifying expats to exclude $105,900 of their earned income from US taxation for 2019 (for filing in 2020, or £107,600 for tax year 2020 filing in 2021).
It’s a great solution for expats whose only income is earned and whose total income was below the threshold.
Earned income refers to any income that is compensation for services actively provided, including salaries, wages, bonuses, tips, and self-employment and freelance income.
Unearned or passive income on the other hand such as income from rents, dividends and interest can’t be excluded using the Foreign Earned Income Exclusion.
“To claim the foreign earned income exclusion, you must have foreign earned income, and your tax home must be in a foreign country.” – the IRS
It doesn’t matter where in the world the income is sourced or paid, so long as it is earned and the taxpayer lives abroad.
$105,900 is the Foreign Earned Income Exclusion maximum for 2019 tax year for filing in 2020 – the figure for 2020 tax year, for filing in 2021, is $107,600.
To claim the Foreign Earned Income Exclusion, expats must file IRS Form 2555 when they file their federal tax return. Some expats with very simple circumstances may be able to use Form 2555-EZ.
Expats who earn over the threshold and who rent their home abroad may be able to also claim the Foreign Housing Exclusion, also on Form 2555.
Qualifying for the Foreign Earned Income Exclusion in 2020
When claiming the Foreign Earned Income Exclusion on Form 2555, expats have to prove that they live abroad in one of two ways.
The Bona Fide Residence Test requires them to demonstrate permanent residence in another country. Proof might include a permanent residency visa, or proof of foreign income tax paid, or proof of having and maintaining a home.
Alternatively, expats can use the Physical Presence Test, which requires them to prove that they spent at least 330 days outside the US in a relevant tax year (or, if they moved abroad or back to the US mid year, in the subsequent or previous 365 day period respectively).
The Physical Presence Test is often used by expats who have less of a permanent base, such as Digital Nomads.
Is the Foreign Earned Income Exclusion the only way for expats to avoid double taxation in 2020?
Many expats who live abroad and pay foreign taxes benefit more from claiming the US Foreign Tax Credit.
The Foreign Tax Credit lets expats claim a $1 US tax credit for every dollar equivalent of foreign income tax that they’ve paid. For expats who pay foreign tax at a higher rate than the US income tax rate, this should eliminate their US tax bill, and there’s no income limit. Expat parents who claim the Foreign Tax Credit can also claim the US Child Tax Credit, which can result in a tax refund even if no tax was due. The Foreign Tax Credit can be claimed on IRS Form 1116.
Some expats can claim both the Foreign Tax Credit and the Foreign Earned Income Exclusion, however they can’t be applied on the same income.
Expats who are behind with their US tax filing because they didn’t know that they have to file from abroad can catch up without facing penalties under an IRS amnesty program called the Streamlined Procedure, so long as they do so voluntarily before the IRS contacts them.