Foreign Earned Income Exclusion – U.S. Expats | Example Calculation
A Taxpayer may avoid U.S. Tax on Income they earned abroad with the IRS Foreign Earned Income Exclusion.
If a U.S. Person qualifies for the Foreign Earned Income Exclusion (FEIE) using IRS Form 2555, they may be able to legally reduce their taxable income by more than $100,000 annually.
Common Foreign Earned Income Exclusion questions we receive, include:
- What is the Foreign Earned Income Exclusion
- Do I have to still file taxes?
- How much can I exclude?
- What if I paid foreign taxes?
- What if I didn’t file the return in prior years?
Foreign Earned Income Exclusion
The foreign earned income exclusions is applied to each person, not each IRS tax return. There if a married couple is filing Married Jointly (MFJ), each person is entitled to use the Foreign Earned Income Exclusion to reduce their respective income.
In other words, if two people are working together outside of United States, and are married, they may both qualify for the exclusion, and effectively exclude upwards of $200,000 from their taxable income.
Thus, when a person resides in a foreign country in which the tax rate is low or personal income is not taxable, and they qualify for the exclusion, they may be able to (legally) significantly reduce their U.S. tax liability.
Foreign Earned Exclusion Example
Qualifying for the Foreign Earned Income Exclusion is not easy. With the IRS agreeing to allow individuals to exclude upwards of $100,000 dollars of their individual foreign earned income, you can better believe the IRS will take you to task to ensure that you are properly taking the exclusion.
The following is an example of how to ,make a preliminary determination as to whether you qualify for FEIE. Of course, each person’s facts and circumstances are different, and if you are considering taking exclusion, then you may consider speaking with an experienced tax professional first before filing any paperwork with the IRS.
David is a US citizen who’ve began working for a company outside of the United States. In 2017, David worked for the company the entire year and only travel back to the United States twice for one week at a time.
Tax Home Test
As provided by the IRS:
“To meet this test, your tax home must be in a foreign country, or countries throughout your period of bona fide residence or physical presence, whichever applies.
For this purpose, your period of physical presence is the 330 full days during which you were present in a foreign country, not the 12 consecutive months during which those days occurred. Your tax home is your regular or principal place of business, employment, or post of duty, regardless of where you maintain your family residence.”
“If you don’t have a regular or principal place of business because of the nature of your trade or business, your tax home is your regular place of abode (the place where you regularly live). You aren’t considered to have a tax home in a foreign country for any period during which your abode is in the United States. However, if you are temporarily present in the United States, or you maintain a dwelling in the United States (whether or not that dwelling is used by your spouse and dependents), it doesn’t necessarily mean that your abode is in the United States during that time.”
What Does The IRS Mean by “Tax Home Test?”
With the IRS is saying, is that in order to qualify for these benefits, your tax home must be a foreign country. Therefore, if you meet the 330 day test or otherwise qualifies a bona fide resident chances are you will meet the test. If you happen to work overseas and the United States coming than it is very important to show that your tax home is the foreign country, even if you come back and visit the United States intermittently. Conversely, if your main home is the United States but you have to travel outside of United States for periods of time to work, then your abode would be the United States and you would not qualify.
Does David Qualify?
Since David was outside of United States for 350 days with the foreign country being his tax home, David would presumably meet the Tax Home Test.
Physical Presence Test
In practice, the physical presence test is typically the way to go if you can qualify. That is because essentially, in order for David to prove this portion of the analysis he must simply show that he was physically present in either one or more foreign countries for at least 330 days during any 12 month period. In other words, it does not need to be January 1 first through December 31 – it could be February through February, March through March, etc — and it can be more than just one country.
Does David Qualify?
Since David was outside of United States for 350 days with the foreign country being his tax comment David would meet the Physical Presence Test.
3rd Bona-Fide Resident Test
If David was unable to meet the physical presence test he could try to meet the bona fide resident test. The bona fide resident test is different, and before moving any further it is very important to note that David does not need to meet both tests to qualify for the exclusion. Rather, David must meet one of the two tests (Physical Presence Test or Bona-Fide Resident Test), in addition to meeting the tax home contest.
In order to meet this test, the IRS is not only concerned with the number of days in which a person was outside United States, but the applicant must be able to also show he/she is a bona fide resident of before country (s).
As provided by the IRS: “U.S. citizen who is a bona fide resident of a foreign country, or countries, for an uninterrupted period that includes an entire tax year (January 1–December 31, if you file a calendar year return), or A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country, or countries, for an uninterrupted period that includes an entire tax year (January 1–December 31, if you file a calendar year return). See Table 3 at IRS.gov/individuals/ international-taxpayers/tax-treaty-tables for a list of countries with which the United States has an income tax treaty in effect.
What Does The IRS Mean by “Bona-Fide Residence Test?”
Essentially, the bona fide residents test is based on the facts and circumstances of each person’s situation to determine whether they are bona fide. For example:
- Do they have a local Driver’s License?
- Do they shop at local stores?
- Do they live in local housing
- Are they part of local community organizations
- How often do they travel back to the United States?
Note: the rules are different for a U.S. citizen versus a U.S/ resident. If a person is a US resident, then they can usually only use this test if they are citizen or a national of a country that has an income tax treaty and the fact with United States.
Additional Foreign Earned Income Exclusion Tips
Presuming that you were able to meet the above referenced tests, you may qualify for the exclusion. But with that said, there are various pitfalls to avoid, for example:
If you also pay foreign tax and therefore have foreign tax credits that you can apply to your U.S. taxes, you have to be careful to not double dip. In other words, you cannot claim both a foreign tax credit and foreign earned income exclusion for the same dollar – although you may be able to claim both for the same category of income — using a hybrid FEIE/FTC analysis
You may be entitled to housing deduction in addition to your Foreign Earned Income Exclusion. With that said, it is important to note that you cannot double up on the housing exclusion for married couples, and you may be limited by the amount of deduction depending on where you live.
The analysis is unnecessarily complex, but essentially there is an initial portion which cannot be excluded, followed by a portion that can be excluded — while any subsequent amount above the maximum amount of the exclusion is disallowed (aka not deductible).
For example, is a person had $50,000 in foreign housing, then usually the first $15,000 or so is not excluded, and the next $15,000 or so is excluded — and then the next $20,000 is above the maximum amount that can be excluded, and therefore disregarded.
U.S. Workers Abroad
If you work for the US government, but you work abroad then under most circumstances you are prohibited from taking exclusion as to the income earned from the US government.
Also Have Undisclosed Account, Assets or Business?
If you have not properly disclosed foreign income come assets common investments, or accounts then you may be subject to excessively high fines and penalties for noncompliance with offshore related money.
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