What’s New About the Foreign Earned Income Exclusion in 2019?
Living abroad is an incredible experience, so it’s easy to understand why over nine million Americans have made the move overseas.
The American tax system is unusual though, in that expats are still required to file a US federal tax return, reporting their worldwide income, regardless of whether they are also filing foreign taxes or not.
Expats are also often subject to further reporting requirements, such as reporting any foreign bank accounts or investments they may have by filing a Foreign Bank Account Report (FBAR), and reporting their foreign financial assets, if the values meet minimum reporting thresholds.
There are two main ways that expats can avoid double taxation (to both the US and another country), and both of them involve claiming IRS exemptions (rather than through a tax treaty for example – US tax treaties with other countries don’t provide this).
One of these exemptions is called the Foreign Tax Credit, and it involves claiming US tax credits for the same value as foreign taxes already paid. Alternatively, a more flexible option for many expats is the Foreign Earned Income Exclusion.
The 2019 Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion allows expats to exclude the first around $100,000 of their income from US taxation.
One advantage of the Foreign Earned Income Exclusion is that it doesn’t matter whether an expat is paying foreign taxes or not, so expats who don’t pay foreign taxes, such as those living in zero income tax jurisdictions, or Digital Nomads who freelance while roaming between countries without establishing tax residence anywhere, can still claim it and avoid paying US taxes (up to the threshold).
“Typically, if you are a U.S. citizen or a U.S. resident alien, you’re taxed on your worldwide income. However, certain taxpayers can exclude some or all foreign wages from tax under the foreign earned income exclusion.” – Forbes
To claim the Foreign Earned Income Exclusion, expats must file form 2555 with their federal tax return.
Form 2555 requires expats to prove that they live abroad in one of two ways.
The first is called the Bona Fide Residence Test, and it requires expats to provide evidence that they are a permanent resident in a foreign country. This may be through foreign tax information, or through utility bills in their name.
The second way is called the Physical Presence Test, and it requires expats to prove that they spent at least 330 days outside the US in a 365 day period that coincides with the tax year. Expats who can’t prove permanent residency in a foreign country should ensure that they fulfil this second criteria by not travelling back to the States too much, to ensure they can still claim the Foreign Earned Income Exclusion.
What’s new about the Foreign Earned Income Exclusion in 2019?
The maximum amount of income that expats can exclude from US taxation has risen for 2018 tax year (so for tax filing in 2019), and is now $103,900 (up from $102,100 for year 2017).
The other main change for expats filing the Foreign Earned Income Exclusion in 2019 is that contractors working in support of the armed forces in combat zones, who previously were unable to claim it, now can due to a recent change in law.
Is the Foreign Earned Income Exclusion the best option in 2019?
Determining which IRS exemption is most beneficial depends on each expat’s individual circumstances, including how much they earn, where they live, what types of income they have, where their income is sourced, whether they rent or own their home, and whether they pay foreign taxes or not.
Choosing the right exemption can make a significant impact on expats’ present and future finances, and expats in any doubt should contact an expat specialist accountant.
Expats who are behind with their US tax filing because they weren’t aware of the rules can catch up without facing penalties (and still claiming the most beneficial exemption in retrospect) under an IRS amnesty program called the Streamlined Procedure.
The IRS has the ability to look into expats’ finances globally, so we recommend that expats who are behind with their federal filing take steps to catch up at their earliest convenience.