If you’re a US expat, you need to know about the Foreign Earned Income Exclusion (FEIE).
The FEIE is an important IRS tax provision specifically for US expats that can shield Americans living abroad from double taxation. While many Americans living abroad aren’t even aware that they must continue to file US taxes, the fact is that filing an annual tax return with the US is typically obligatory. This obligation applies to Americans regardless of where they reside in the world.
In this article, we’ll go over the FEIE in-depth, addressing questions including, “What is foreign income exclusion,” “How much foreign income is tax-free,” and more.
Note: The recommendations in this article apply to filing the Foreign Earned Income Exclusion for the 2022 tax year (in other words, the taxes you file in 2023!).
What is the Foreign Earned Income Exclusion?
Often searched as the “foreign income exclusion,” the FEIE is an IRS exemption that American expats can claim when they file their US tax return from abroad. The provision, in many cases, allows expats to drastically reduce (or completely eliminate) their US tax bill. The FEIE allows expats to exempt a certain amount of their income from taxation. The precise amount increases a little bit each year to account for inflation, and the FEIE threshold for the 2022 tax year is $112,000.
Let’s consider how the Foreign Earned Income Exclusion works with different types of income:
Expats should note, however, that the FEIE can only be used to exclude earned income. Earned income is income that comes from work or services rendered. This includes:
- Salary or wages
- Self-employment income
- Professional fees
- The monetary value of certain benefits, like:
- Sick leave
- Benefits earned in a union strike
- Some disability benefits (if provided to you before the minimum retirement age)
- Reimbursements for work-related expenses (e.g. food/travel allowances for business trips, professional training, relocation expenses)
- Non-taxable combat pay (if you elect to treat it as earned income)
Unearned or passive income
This does not include unearned income, also called passive income.
Passive income is any income from any source other than work. Examples of passive income that cannot be claimed on the FEIE include:
- Social security benefits
- Pension income
- Dividend income
- Interest on investment
- Gambling winnings
- Capital gains
- Child support or alimony payments
- Trust fund payments
Other types of income
A few more types of income that are not FEIE-eligible include:
- Payments received as a military or civilian employee of the U.S. Government
- Payments received for services conducted in international waters
- Payments received after the end of the tax year or the 365-day period being claimed using the Physical Presence Test (even if the service was performed during that time)
- Meals and lodging that are excluded from income for the convenience of the employer
The FEIE does not exclude you from having to pay any state or local taxes you may be subject to, depending on where you most recently lived. If you have questions, you can consult the IRS website or seek professional assistance.
How to qualify for the Foreign Earned Income Exclusion
Before they can claim the FEIE, expats must demonstrate that their tax home is abroad by meeting one of two IRS tests.
The Physical Presence Test
The Physical Presence Test requires expats to prove that they were physically present for at least 330 full days outside the US in a 365-day period that does not need to coincide with the tax year.
The Bona Fide Residence Test
The Bona Fide Residence Test requires expats to prove that they are permanent residents in a foreign country through official documents like a permanent residency visa, foreign income tax records, or proof of housing rental/ownership and utility bills in the expat’s name. The bona fide residency must occur for a period that includes at least one calendar year, and that overlaps with the tax year filed.
Strategizing how to qualify for the FEIE
The right test for you depends on your situation.
For example, the Physical Presence Test is useful for expats who are moving between countries (such as digital nomads) or who can’t demonstrate permanent residence in any one foreign country. However, you will have to limit and carefully count the days you spend in the US in order to meet the requirements.
The Bona Fide Residence Test, on the other hand, is useful for expats who can demonstrate that their tax home is in another country and don’t want strict limits placed on the number of days they spend in the US each year.
What is the Foreign Housing Exclusion/Deduction?
If you qualify for the FEIE, earn over $112,000 (the FEIE threshold for tax year 2022), and rent a home abroad, you can exclude even more income from taxes by claiming the Foreign Housing Exclusion (FHE).
The FHE allows you to exclude additional foreign-earned income from the value of qualifying housing expenses, which include:
- Rent payments
- Utility bills (besides phone and TV bills)
- Fees for securing a leasehold
- Residential parking costs
- Occupancy taxes
- Property insurance
- Furniture rental
- Necessary repairs
A few things that do not count as qualifying housing expenses include:
- Mortgage payments
- Purchased furniture
- Domestic services (e.g. cleaning, cooking, or nannying services)
To calculate the amount you can exclude, you’ll subtract your base housing amount from your qualifying expenses. The maximum FHE amount you can claim in most countries is typically 30% of the FEIE limit — which again, for the 2022 tax year, is $112,000 — or $33,600 total.
To claim the FHE, fill out the relevant portions of IRS Form 2555 (not on IRS Form 2555-EZ, though), which we’ll go over in detail below. And keep in mind: the FHE is only for expats who work for an employer. Self-employed expats will instead claim the Foreign Housing Deduction (FHD), which functions similarly.
How to file the FEIE
To obtain the tax benefit of the Foreign Earned Income Exclusion, expats must file IRS Form 2555 along with their federal tax return.
The form has nine sections:
- Section I is where you’ll input personal details, your employer’s details (if applicable), and where your tax home is
- Section II is for expats who meet the Bona Fide Residence Test
- Section III is for expats who meet the Physical Presence Test
- Note: You only need to complete either Section II or Section III, depending on which one applies to you
- Section IV is for your earned income and expense details, which should correspond with the figures you enter in Form 1040
- Sections V & VI relate to the Foreign Housing Exclusion/Deduction
- Sections VII-IX are where you’ll enter the final figures used to calculate the total amount you’ll be excluding
Form 2555 is not the most straightforward form to complete, so if you have any queries or doubts, you can look up additional information on the IRS website or seek professional assistance. A reputable and experienced expat tax preparation specialist can help ensure that your tax return is filed to your utmost advantage.
Some expats may qualify for a simplified, shorter version of Form 2555, Form 2555-EZ. In order to qualify, expats must meet the following criteria:
- The period they are claiming for is a calendar year
- They don’t earn more than the FEIE threshold
- They have no self-employment income
- They have no business or moving expenses for that year
- They are not claiming the Foreign Housing Exclusion
Who should claim the Foreign Earned Income Exclusion in 2023?
We’ve talked about who can claim the FEIE — but who should claim it? The FEIE is particularly beneficial for expats who:
- Earn less than the annual FEIE threshold
- Only have earned income — not unearned/passive income
- Don’t pay foreign income tax
- Pay foreign income tax at a lower tax rate than the US
- Can prove that they live abroad according to the IRS criteria
This makes the FEIE a great option for digital nomads. Digital nomads can often avoid paying foreign income taxes entirely if they travel from country to country in short stints, provided that they spend at least 330 days a year abroad and don’t maintain a US household.
The FEIE may not be a good fit for expats who:
- Have large amounts of unearned income
- Earn over the annual FEIE threshold
- Pay foreign income taxes at a higher rate than the US
- Are unable to fulfill IRS criteria to prove that they live abroad
The Foreign Earned Income Exclusion versus the Foreign Tax Credit
Another major tax provision that can help expats avoid double taxation is the Foreign Tax Credit (FTC). The FTC allows expats to deduct the value of the income tax that they pay to a foreign government from what they owe in US income taxes.
If an expat lives in one of the many countries with a higher income tax than the US, they can not only eliminate their US tax bill but also be granted tax credits that can be applied to future US tax bills for up to ten years (or back one year, if they file amended returns for those years).
Furthermore, there’s no IRS limit set on the amount of tax credits that can be claimed, and the FTC can be applied to unearned income as well (so long as foreign income tax has been paid on it).
Expats can claim the FTC by filing Form 1116 along with their federal return.
Can I claim the Foreign Earned Income Exclusion and the Foreign Tax Credit?
Expats can claim both the Foreign Earned Income Exclusion and the Foreign Tax Credit, but they cannot apply them both to the same income. Take, for example, an individual residing full-time in France and working as a registered freelancer (autoentrepreneur). In this example, the freelancer has income from both US and French clients.
Because the freelancer in this example resides full-time in France, they pay taxes on all of their earnings in France (because France taxes on worldwide income). All of the income the freelancer earns, in this example, is taxed at a higher rate than it would be taxed in the US because France imposes higher taxes.
This freelancer could choose to apply the FEIE to their self-employment income earned in France. However, the French income tax paid on that income can not then be used as a Foreign Tax Credit on that same self-employment income. On the other hand, if French tax were paid on bank interest the freelancer has on an account there, the Foreign Tax Credit can be used for the bank interest, using the FEIE only on the self-employment income.