What is it?
US citizens and green card holders who live and work outside the US may be able to exclude part or all of their foreign earned income (both wages and income from self-employment income) from being taxable using the Foreign Earned Income Exclusion, or FEIE. To qualify for the FEIE, a person needs to both work and live outside the US, and meet either the Bona Fide Resident test or the Physical Presence test.
The Bona Fide residence test means you can prove that you are resident in another country, for example paying taxes there, having official residence status there, and having a permanent home there.
If you qualify, you are eligible to exclude up to $100,800 (in 2015) of foreign earned income annually, depending on the year. The figure is lower for previous years.
The FEIA allows you to exclude foreign earned income solely from the federal income tax, not state taxes, and neither from Social Security or Medicare taxes.
On what sort of income does the Foreign Earned Income Exclusion apply?
The Foreign Earned Income Exclusion applies only to income arising from services performed either as an employee or as an independent contractor. "The term 'earned income' means wages, salaries, or professional fees, and other amounts received as compensation for services rendered. Thus, wages and self-employment income may qualify for the FEIE. Other types of income cannot be excluded using it.
No. People claiming the FEIE pay tax at the same rates that they would had they not claimed it. In other words, federal income tax is calculated by first calculating the amount of income tax on income regardless of the FEIE, and then subtracting the tax as calculated on the amount of foreign earned income that is excluded. The result is the amount of the federal income tax due.
How can you claim the Foreign Earned Income Exclusion?
The first point to make is that the FEIE is elective (voluntary). To claim it you should use a form 2555 attached to a your annual federal income tax return. Once it's been claimed, it continues through into subsequent years until you revoke it. Once revoked it can't be claimed again for 5 years.
Can you claim both the Foreign Earned Income Exclusion as well as other allowances?
Yes - if you quality for the Foreign Housing Allowance, you can claim it in tandem with the FEIE.