The Foreign Earned Income Exclusion (FEIE) is a great method for US taxpayers to significantly reduce their US tax liability. The problem is that many people do not qualify for this exclusion but try to claim the exclusion anyway – resulting in significant tax liability, fines and penalties.
*The Taxpayer should consult with an experienced International Tax Lawyer/Enrolled Agent to evaluate the situation and prepare the tax return.
What is the Foreign Earned Income Exclusion?
U.S. taxpayers (U.S. Citizen, Legal Permanent Resident, Foreign Nationals subject to U.S. tax) are required to pay tax to the United States on their worldwide income. If a US taxpayer works overseas and has already paid tax in a foreign country they will usually be entitled to either take a foreign tax credit or claim the foreign earned income exclusion to avoid U.S. Taxation on the foreign income.
Unlike the Foreign Tax Credit, the foreign earned income exclusion upwards of $99,200 of overseas earnings from any tax liability – along with roughly $15,000 of housing expense.
How do I Qualify for the Foreign Earned Income Exclusion?
In order to qualify for Foreign Earned Income Exclusion, there are a few main requirements:
- The taxpayer must be employed or generate self-income (in other words, the taxpayer cannot be employed by the US government).
- The taxpayer must have employment income (unlike the foreign tax credit, the Foreign Earned Income Exclusion refers to “earned” income – as opposed to passive income)
- The taxpayer must meet either the bona fide residence test or the physical presence test.
- The taxpayer must call the foreign country his or her tax home.
What are the Bona-Fide Resident and Physical-Presence Tests?
A Taxpayer must meet one of the two tests listed below.
Physical Presence Test
- When it comes to qualifying for the Foreign Earned Income Exclusion, the physical presence test is the easier of the two tests and simply requires “presence” in foreign countries for a specific time-period. To qualify for the physical presence test the taxpayer must reside overseas (not necessarily in one foreign country) for at least 330 days in any 12-month period; it is a mere “Physical Presence Test.”
- Thus, if the taxpayer resided overseas from May 2014 through May 2015, he or she could qualify for the Foreign Earned Income Exclusion for that time-period. (it does not need to be January through December). If a taxpayer qualifies for the physical presence test they generally will meet the exclusion requirements.
Bona-Fide Resident Test
For taxpayers who do not meet the 330-day test, they may try and qualify for the “bona-fide resident of a foreign country or countries test”. As you may imagine, this test is much more difficult to meet and requires more of a “totality of the circumstances” analysis.
It is important to keep in mind that the Internal Revenue Service is very strict when it comes to the bona fide residence test. If you are an overseas contractor who does not meet the 330 day physical presence test it will be extremely difficult if not impossible to qualify to be a bona fide resident. (Overseas contractors are the group of taxpayers who get themselves in the most trouble in trying to take this exclusion.)
- For example, you work for a US company and/or reside in housing that is provided to you by the company, shop at stores owned or recommended by the company, do not have a local drivers license, voter registration card, bank account, etc. then the IRS is not going to grant you the exclusion. Essentially, you must “immerse” yourself into the culture of the country you are working in.
What if I am audited for taking the Foreign Earned Income Exclusion?
Being audited for the Foreign Earned Income Exclusion is a big deal. That is because you have essentially avoided paying tax on upwards of $115,000 of income and housing allowance which if disallowed will cost you tens of thousands of dollars of taxes due – and it could be for multiple years. In addition, you will have interest and penalties ,which could bring your tax amount to a staggering total.
Our international tax attorneys have extensive experience with Foreign Earned Income Exclusion and can assist you with either tax planning, un-filed tax returns, and audit representation.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)