US expats are required to file US taxes, reporting their worldwide income, regardless of the fact that they live abroad. Many expats are also required to file taxes in the country where they live, too, raising the possibility of double taxation on the same income. To avoid this scenario, the IRS has put in place a number of exemptions that expats can claim when they file to avoid (or mitigate) paying US taxes on their income.
The most effective exemptions are the Foreign Tax Credit, allowing US expats to claim a $1 US tax credit for every dollar of tax that they’ve already paid abroad, and the Foreign Earned Income Exclusion.
The Foreign Earned Income Exclusion lets expats exclude the first around $100,000 of income (the exact figure rises a little each year) that they have actively earned while living abroad from US taxation.
This takes expats who are working abroad but not paying taxes abroad (such as Digital Nomads moving between foreign countries) and who are earning less than around $100,000 out of taxation liability entirely – although they still have to file a US tax return to claim the Foreign Earned Income Exclusion.
To claim the Foreign Earned Income Exclusion, expats must also prove that they live abroad in one of two ways.
The Bona Fide Residence Test requires proof that they are a permanent resident in another country. This may include rent and utility statements, or perhaps foreign tax statements or a permanent residence visa.
The Physical Presence Test meanwhile requires expats to prove that they spent at least 330 says outside the US in a 365 day period that overlaps with the tax year. If this period isn’t the tax year itself (such as for expats who moved abroad in the middle of a year), they can only claim the Foreign Earned Income Exclusion for the days that do fall within the tax year.
How to claim the Foreign Earned Income Exclusion?
“If both you and your spouse qualify for, and choose to claim, the Foreign Earned Income Exclusion, figure the amount of the exclusion separately, then each complete separate forms 2555-EZ” – the IRS
To claim the Foreign Earned Income Exclusion, expats must file form 2555 when they file their federal income tax return.
Expats get an automatic filing extension to June 15th, and they can claim a further extension until October 15th too, should they need to. This further extension may be useful for expats claiming the Foreign Earned Income Exclusion for a 365 day period that started midway through a tax year.
Some expats however may use the shorter form 2555-EZ .
Who can use form 2555-EZ to claim the Foreign Earned Income Exclusion?
Form 2555-EZ is available for expats with straightforward circumstances who want to claim the Foreign Earned Income Exclusion. In particular:
– Their total income must be less than the Foreign Earned Income Exclusion limit (around $100,000)
– All their earned income must be from wages, rather than having any from self-employment
– They must be claiming for an exact calendar year, rather than for an overlapping 365 day period
– They can’t also claim the Foreign Housing Exclusion or Deduction
– Their tax home (i.e.the place where they work) can’t have been in the US for any of the year that they are claiming the Foreign Earned Income Exclusion for.
Expats who meet all of the above conditions can use form 2555-EZ, rather than the longer, more complex form 2555, to claim the Foreign Earned Income Exclusion.
Penalties for not filing US taxes and FBARs for US expats can be steep, and the IRS has access to global banking and much foreign tax information, so we strongly recommend that expats who are behind with their US tax filing catch up at the earliest opportunity.