Overview of Foreign Earned Income Exclusion for 2023 Taxes

Foreign Earned Income Exclusion (FEIE)

The Foreign Earned Income Exclusion 

Because the United States follows a worldwide income tax model, it can lead to an unfair tax outcome, especially for taxpayers who work outside of the United States. This follows the concept of citizenship-based taxation, although that term is a misnomer because citizenship-based taxation is not limited to just US citizens but can also include lawful permanent residents along with foreign nationals who meet the substantial presence test – such as foreigners who are on work, travel. or investment visas. In order to try to level the playing field, the United States developed the foreign-earned income exclusion (FEIE) and IRS Form 2555. This particular law is designed to assist taxpayers who are working overseas so that they can equalize their U.S. tax returns by excluding a portion of their earned income. Unfortunately, it does require taxpayers to file certain forms each year in order to claim the exclusion. Let’s walk through the basics of how the Foreign Earned Income Exclusion works. 

Example of Foreign Earned Income Exclusion

Here is a typical Foreign Earned Income Exclusion example: Janine is a US taxpayer who resides in a foreign country. She does not work for the US government or as a contractor and is paid $100,000 (USD) a year. In the foreign country where Janine resides, there is no personal income tax for earned income by individuals. Unfortunately for Janine, since she’s a US person she is required to include the $100,000 a year on her U.S. tax return. If Janine can qualify for the foreign earned income exclusion, then she can exclude the $100,000 on her tax return by both including the income on her 1040 and then filing form 2555 which then allows her to exclude the income on the return as well.

2023 Foreign Exclusion Amount

“Exclusion amount. For 2023, the maximum exclusion amount has increased to $120,000.”

How to Qualify for the Foreign Earned Income Exclusion

Presuming that the taxpayer is not excluded from qualifying for FEIE, there are two main components to qualifying for the foreign earned income exclusion.

• • • “You qualify to exclude your foreign earned income from gross income if both of the following apply.

      • • You meet the tax home test

        • You meet either the bona fide residence test or the physical presence test (discussed later).”

Tax Home Test

• • • To meet this test, your tax home must be in a foreign country, or countries (see Foreign country, earlier), throughout your period of bona fide residence or physical presence, whichever applies.

As provided by the IRS:

• • • To qualify for the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, your tax home must be in a foreign country throughout your period of bona fide residence or physical presence abroad.

    • “Foreign Country

      • To meet the bona fide residence test or the physical presence test, you must live in or be present in a foreign country for the required time period.

      • A foreign country usually is any territory (including the air space and territorial waters) under the sovereignty of a government other than that of the United States. For purposes of the foreign earned income exclusion, “territorial waters” are those waters that are within 12 nautical miles of the foreign country. The term “foreign country” includes the seabed and subsoil of those submarine areas adjacent to the territorial waters of a foreign country and over which the foreign country has exclusive rights under international law to explore and exploit the natural resources.

      • The term “foreign country” does not include U.S. territories such as Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa. For purposes of the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction, the terms “foreign,” “abroad,” and “overseas” refer to areas outside the United States, American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, Puerto Rico, the U.S. Virgin Islands, and the Antarctic region. The term “foreign country” does not include international waters or airspace, nor does it include offshore installations that are located outside the territorial waters of any foreign country.

Tax Home

• • • • Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. Having a “tax home” in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes.

      • If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and your tax home is wherever you work.

Abode

• • • • “You are not considered to have a tax home in a foreign country for any period during which your abode is in the United States unless, for tax years beginning after December 31, 2017, you are serving in support of the Armed Forces of the United States in an area designated as a combat zone.

      • The location of your abode is based on where you maintain your family, economic, and personal ties. Your abode is not necessarily in the United States merely because you maintain a dwelling in the United States, whether or not your spouse or dependents use the dwelling. Your abode is also not necessarily in the United States while you are temporarily in the United States. However, these factors can contribute to you having an abode in the United States.

      • “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. “Abode” has a domestic rather than a vocational meaning and does not mean the same as “tax home.” The location of your abode often will depend on where you maintain your economic, family, and personal ties.”

Example 1

• • • You are employed on an offshore oil rig in the territorial waters of a foreign country and work a 28-day on/28-day off schedule. You return to your family residence in the United States during your off periods. You are considered to have an abode in the United States and do not satisfy the tax home test in the foreign country. You cannot claim either of the exclusions or the housing deduction.

Example 2

• • • Your employer transferred you to a foreign country for an indefinite period. You kept ownership of your home in the United States but rented it to another family. You placed your car in storage. In November of last year, you moved your spouse, children, furniture, and family pets to a home your employer rented for you in London.

    • Shortly after moving, you leased a car, and you and your spouse got driving licenses in the foreign country. Your entire family got library cards for the local public library. You and your spouse opened bank accounts with a bank in the foreign country. You joined a local business league, and both you and your spouse became active in the neighborhood civic association and worked with a local charity. Your abode is in the foreign country for the time you live there, and you satisfy the tax home test in the foreign country.

Temporary or Indefinite Assignment

• • • The location of your tax home often depends on whether your assignment is temporary or indefinite. If you are temporarily absent from your tax home in the United States on business, you do not qualify for the foreign earned income exclusion. If your foreign work assignment is for an indefinite period and your abode is not in the United States, your tax home is in a foreign country.

    • If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise. If you expect it to last for more than 1 year, it is indefinite.

    • If you expect your employment to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary (in the absence of facts and circumstances indicating otherwise) until your expectation changes.

Bona Fide Residence Test

 The Bona-Fide Resident Test (BFR) is typically the harder test to qualify for.

As provided by the IRS:

• • • To meet this test, you must be one of the following.

      • • “A 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).

        • 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).

        • Whether you are a bona fide resident of a foreign country depends on your intention about the length and nature of your stay. Evidence of your intention may be your words and acts. If these conflict, your acts carry more weight than your words. Generally, if you go to a foreign country for a definite, temporary purpose and return to the United States after you accomplish it, you aren’t a bona fide resident of the foreign country.

        • If accomplishing the purpose requires an extended, indefinite stay, and you make your home in the foreign country, you may be a bona fide resident. See Pub. 54 for more information and examples. Line 10. Enter the dates your bona fide residence began and ended. If you are still a bona fide resident, enter “Continues” in the space for the date your bona fide residence ended. Lines 12a and 12b. If you check “Yes” on line 12a, enter the type(s) of family member(s) and the date(s) they lived with you on line 12b. Acceptable entries for family members on line 12b include child, foster child, grandchild, parent, grandparent, brother, sister, aunt, uncle, nephew, niece, son, daughter, spouse, or other. If you check “No” on line 12a, leave line 12b blank or enter “None.” Lines 13a and 13b.

        • If you submitted a statement of nonresidence to the authorities of a foreign country in which you earned income and the authorities hold that you aren’t subject to their income tax laws by reason of nonresidency in the foreign country, you aren’t considered a bona fide resident of that country. If you submitted such a statement and the authorities haven’t made an adverse determination of your nonresident status, you aren’t considered a bona fide resident of that country.”

Just Living in a Foreign Country is Not Sufficient

• • • “You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for one year.

      • Example: If you go to a foreign country to work for a specified period of time, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for one tax year or longer. The length of your stay and the nature of your work are only two of the factors to be considered in determining whether you meet the bona fide residence test.”

      • Example 1: You are the Lisbon representative of a U.S. employer. You arrived with your family in Lisbon on November 1, 2021. Your assignment is indefinite, and you intend to live there with your family until your company sends you to a new post. You immediately established residence there. On April 1, 2022, you arrived in the United States to meet with your employer, leaving your family in Lisbon. You returned to Lisbon on May 1 and continue living there. On January 1, 2023, you completed an uninterrupted period of residence for a full tax year (2022), and you may qualify as a bona fide resident of a foreign country.

      • Example 2: Assume that in Example 1, you transferred back to the United States on December 13, 2022. You would not qualify under the bona fide residence test. Although your stay in the foreign country lasted more than a year, it did not include a full tax year. You may, however, qualify for the foreign earned income exclusion and the foreign housing exclusion or deduction under the physical presence test.

Physical Presence Test

The Physical Presence Test (PPT) is also referred to as the ‘counting days’ test.

As provided by the IRS:

• • • Physical Presence Test To meet this test, you must be a U.S. citizen or resident alien who is physically present in a foreign country, or countries, for at least 330 full days during any period of 12 months in a row. A full day means the 24-hour period that starts at midnight. To figure 330 full days, add all separate periods you were present in a foreign country during the 12-month period shown on line 16. The 330 full days can be interrupted by periods when you are traveling over international waters or are otherwise not in a foreign country. See Pub. 54 for more information and examples. Note. A nonresident alien who, with a U.S. citizen or U.S. resident alien spouse, chooses to be taxed as a resident of the United States can qualify under this test if the time requirements are met. See Pub. 54 for details on how to make this choice. Line 16. The 12-month period on which the physical presence test is based must include 365 days, part of which must be in 2023. The dates may begin or end in a calendar

    • You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during any period of 12 consecutive months including some part of the year at issue. The 330 qualifying days do not have to be consecutive.

    • The physical presence test applies to both U.S. citizens and U.S. residents within the meaning of Internal Revenue Code section 7701(b)(1)(A) and is based only on how long you stay in a foreign country or countries. This test does not depend on the kind of residence you establish, your intentions about returning to the United States, or the nature and purpose of your stay abroad. However, your intentions with regard to the nature and purpose of your stay abroad are relevant in determining whether you meet the tax home test, as explained under Chapter 4 of Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

330 Full Days

• • • “Generally, to meet the physical presence test, you must be physically present in a foreign country or countries for at least 330 full days during a 12-month period including some part of the year at issue. You can count days you spent abroad for any reason, so long as your tax home is in a foreign country.

    • You do not meet the physical presence test if you are not present in a foreign country or countries for at 330 full days in a 12-month period regardless of the reason for the failure, including illness, family problems, a vacation, or your employer’s orders. Also, if you are present in a foreign country in violation of U.S. law, you will not be treated as physically present in a foreign country while you were in violation of the law. Income that you earn from sources within such a country for services performed during a period of violation does not qualify as foreign earned income.

    • However, the minimum time requirement can be waived if you must leave a foreign country because of war, civil unrest, or similar adverse conditions in that country. Each year the IRS publishes a Revenue Procedure containing a list of countries for which the minimum time requirements are waived and the applicable date such waiver begins (visit IRS.gov and search “foreign earned income waiver”). You must be able to show that you reasonably could have expected to meet the minimum time requirements if not for the adverse conditions, that you had a tax home in the foreign country and that you were a bona fide resident of, or physically present in, the foreign country on or before the beginning date of the waiver.”

Full Day

• • • A full day is a period of 24 consecutive hours, beginning and ending at midnight. You must spend the full day in a foreign country or countries for that day to be counted. When you leave the United States to go to a foreign country or when you return to the United States from a foreign country, the time you spend on or over international waters does not count as time in a foreign country.

Example

• • • You leave the United States for France by air on June 10. You arrive in France at 9:00 a.m. on June 11. Your first full day in France is June 12.

Passing Over Foreign Country

• • • If, in traveling from the United States to a foreign country, you pass over a foreign country before midnight of the day you leave, the first day you can count toward the 330-day total is the day following the day you leave the United States.

Example

• • • You leave the United States by air at 9:30 a.m. on June 10 to travel to Spain. You pass over a part of France at 11:00 p.m. on June 10 and arrive in Spain at 12:30 a.m. on June 11. Your first full day in a foreign country is June 11.

Change of Location

• • • You can move about from one place to another in a foreign country or to another foreign country without losing full days; but if any part of your travel is not within a foreign country or countries and takes 24 hours or more, you will lose full days.

Example 1

You leave London by air at 11 p.m. on July 6 and arrive in Stockholm at 5 a.m. on July 7. Your trip takes less than 24 hours, and you lose no full days.

Example 2

You leave Norway by ship at 10 p.m. on July 6 and arrive in Portugal at 6 a.m. on July 8. Since your travel is not within a foreign country or countries and the trip takes more than 24 hours, you lose as full days July 6, 7, and 8. If you remain in Portugal, your next full day in a foreign country is July 9.

In United States While in Transit

• • • If you are in transit between two points outside the United States and are physically present in the United States for less than 24 hours, you are not treated as present in the United States during the transit. You are treated as traveling over areas not within any foreign country.

How to Figure the 12-Month Period

• • • There are four rules you should know when figuring the 12-month period:

      • A 12-month period can begin with any day of the month. It ends the day before the same calendar day, 12 months later.

      • A 12-month period must be made up of consecutive months. Any 12-month period can be used if the 330 days in a foreign country fall within that period.

      • You do not have to begin a 12-month period with your first full day in a foreign country or to end it with the day you leave. You can choose the 12-month period that gives you the greatest exclusion.

      • In determining whether the 12-month period falls within a longer stay in the foreign country, 12-month periods can overlap one another.

Example

You live, work, and have a tax home in New Zealand from January 1, 2022, through August 31, 2023, except that you spend 28 days in February 2022 and 28 days in February 2023 on vacation in the United States. You are present in New Zealand for at least 330 full days during each of the following two 12-month periods: January 1, 2022 – December 31, 2022, and September 1, 2022- August 31, 2023. Your qualifying 12-month period for 2022 is January 1, 2022 – December 31, 2022. For 2023, you may choose September 1, 2022 – August 31, 2023 as your qualifying period. Refer to Chapter 4, Figure 4-B in Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

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