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) from US tax using the Foreign Earned Income Exclusion (FEIE).
To qualify for the FEIE, a person needs to both work and live outside the US, and to meet either the Bona Fide Residence test, or the Physical Presence test.
The Physical Presence test requires that you must be physically outside the US and in another country for a minimum of 330 days in a 12 month period. The rules are specific: days traveling between countries don’t count, while a day is the whole of a 24 hour period. There is flexibility about when the 12 month period starts though, so Americans who move abroad (or back to the US) mid-year can claim the FEIE for the 12 month period after they move abroad (or before they return to the States).
The Bona Fide Residence test requires you to prove that you are a resident in another country, for example paying taxes there, having official residence status there, or having a permanent home there.
If you qualify for the FEIE, you are eligible to exclude up to $107,600 (in 2020 – the figure is adjusted for inflation each year) of earned income from US tax.
The FEIE allows you to exclude foreign earned income solely from the federal income tax, not state taxes, and neither Social Security nor Medicare taxes.
What is ‘earned income’?
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. Passive income though, such as rent, dividends, benefits, or interest, can’t be excluded.
How can expats claim the Foreign Earned Income Exclusion?
The FEIE is elective (i.e. voluntary), rather than applied automatically. To claim it, expats should file Form 2555 attached to their federal income tax return. Once having claimed the FEIE, it continues through into subsequent years until revoked (although Form 2555 must be filed annually. Once revoked though, it can’t be claimed again for five years.
Can you claim the Foreign Earned Income Exclusion as well as other allowances?
Yes – if you quality for the Foreign Housing Exclusion, you can claim it as well as the FEIE to increase the maximum amount of income that can be excluded. Some expats meanwhile benefit from claiming the Foreign Tax Credit, either instead of or as well as the FEIE (although it can’t be applied to the same income).
Filing US taxes from abroad can be complex. Expats often also have to report any foreign bank accounts, investments, assets, and business interests they may have, besides filing Form 1040 and claiming the FEIE or the Foreign Tax Credit. To stay compliant and also minimize tax in each individual’s best interests, it’s always worth seeking advice from a US expat tax specialist. Expats who are behind with their US filing may be able to catch up without facing penalties under the Streamlined Procedure amnesty program.