If you have not heard of the Foreign Earned Income Exclusion (FEIE) and are a US taxpayer residing in a foreign country, you’re in for a treat. Sometimes colloquially referred to as the foreign earned tax exclusion, the FEIE is an essential IRS tax provision and is one of the top two most valuable tax breaks for US expats living and working abroad.
By claiming the Foreign Earned Income Exclusion, Americans with foreign-sourced income can exclude a substantial amount of their earnings from US taxation. In this article, we’ll go over the FEIE in-depth, addressing questions like “How does the Foreign Earned Income Exclusion work?” “What does the Foreign Earned Income Exclusion mean?” “Do I qualify for the Foreign Earned Income Exclusion?” and more.
Note: The recommendations in this article apply to filing the Foreign Earned Income Exclusion for the 2023 tax year (in other words, the taxes you file in 2024!).
What is the Foreign Earned Income Exclusion?
Let’s start with the basics: What is the FEIE, exactly? As we mentioned above, the Foreign Earned Income Exclusion, sometimes searched for as the “foreign income exclusion,” is an IRS benefit that American expats can claim when they file their United States tax return.
Thankfully, the FEIE allows those who qualify for it to drastically reduce — and in some cases, even eliminate — their US tax bill. That’s because the FEIE allows expats to exempt a certain amount of their income from taxation. The FEIE threshold for the 2023 tax year is $120,000. However, as you can see below, the precise amount increases each year to account for inflation.
Earning below the FEIE threshold does not mean that you don’t have to file US taxes. But, it does mean that you can exempt all qualifying, foreign-earned income from taxation. Score!
Foreign Earned Income Exclusion Amounts
|Return Filing Year
Let’s consider how the Foreign Earned Income Exclusion works with different types of income.
What is considered earned income?
There is a crucial callout here: Per the provision’s name, expats should note that the FEIE can only be used to exclude earned income. Earned income comes from work or personal services rendered, including:
Other earned income also extends to:
- The monetary value of certain taxable benefits, including:
- Sick leave
- Benefits earned in a union strike
- Some disability benefits, if provided to you before the minimum retirement age
- Non-taxable combat pay, if you elect to treat it as earned income
- Professional fees for services rendered abroad
- Self-employment income (more on this in a bit)
Unearned or passive income
However, the FEIE cannot be applied to unearned income, also known as passive income.
Passive income refers to any income derived from a source other than work. A few examples of income that cannot be claimed on the FEIE include:
- Social Security benefits
- Pension income
- Rental income
- Interest from investments
- Gambling winnings
- Capital gains
- Child support
- Alimony payments
- Trust fund payments
Other types of income that do not qualify for the FEIE
A few more types of income that are not FEIE-eligible include payments received as a military or civilian employee of the US government, including those for services conducted in international waters.
- Payments received after the end of the tax year or the 365-day period being claimed using the Physical Presence Test do not qualify (even if the service was performed during that time)
- Meals and lodging that are excluded from income for the convenience of the employer
Foreign Earned Income Exclusion eligibility
To claim the FEIE, expats must demonstrate that their tax home is in a foreign country by meeting one of two IRS tests.
The Physical Presence Test
The Physical Presence Test requires expats to prove that they were physically present in a foreign country for at least 330 full days in a consecutive 365 day period, which does not need to coincide with the tax year.
The Bona Fide Residence Test
The Bona Fide Residence Test requires expats to prove permanent residence in a foreign country through official documents like a permanent residency visa, foreign income tax records, or proof of housing rental/ownership and utility bills in the expat’s name.
Note: The IRS states that this bona fide residency must occur in foreign countries “for an uninterrupted period that includes an entire tax year.”
Which FEIE test to choose
So, which test should you select when planning your time abroad and filing your US tax return?
The answer depends on your situation.
The Physical Presence Test is useful for location-independent US taxpayers who are moving between countries (such as digital nomads). It is also helpful when you cannot demonstrate permanent residence in any one foreign country. That said, this test requires that you limit and carefully count the days you spend in the US in order to meet its requirements.
The Bona Fide Residence Test, on the other hand, is useful for expats who can demonstrate that they officially reside in another country and don’t want strict limits placed on the number of days they spend in the US each year.
The FEIE and the Foreign Housing Exclusion
There’s more — those who qualify for the FEIE and earn above the FEIE threshold (again, $120,000 in tax year 2023) can further exclude amounts related to certain qualified housing expenses by using the Foreign Housing Exclusion (FHE). This includes expenses like rent, utilities, occupancy taxes, and more.
Note: If you are a self-employed expat, you will claim the Foreign Housing Deduction instead of the Foreign Housing Exclusion.
Who should claim the Foreign Earned Income Exclusion in 2023?
We’ve talked about who can claim the FEIE — but who should claim the FEIE?
The FEIE is especially beneficial for expats who:
- Earn less than the annual FEIE threshold
- Only have earned income (not unearned/passive income)
- Don’t pay foreign income tax
- Pay foreign income tax at a lower tax rate than the US
- Can prove that they live abroad according to the IRS criteria
Again, this makes the FEIE a viable option for digital nomads, who can often avoid paying foreign income taxes entirely if they travel from country to country in short stints. However, to qualify, they must spend at least 330 days a year abroad and not maintain a US tax home.
The FEIE might not suit expats who:
- Have large amounts of unearned income
- Earn over the annual FEIE threshold
- Pay foreign income taxes at a higher rate than the US
- Are unable to fulfill IRS criteria to prove that they live abroad
The FEIE for self-employed expats
As mentioned earlier, the FEIE can be applied to foreign-earned self-employment income. There are a couple of important caveats worth noting, however.
For one, the FEIE can only be applied to your gross income (aka the total amount you earn), not your net income (aka the amount you earn after expenses and deductions).
The FEIE only excludes your foreign-earned gross income from federal income taxes. This means that self-employed expats may still be liable for US self-employment taxes.
Unless they pay social security taxes in a country with a totalization agreement with the US, self-employed expats must pay a 15.3% self-employment tax: 12.4% of which goes toward Social Security, and 2.9% of which goes toward Medicare.
How to claim the FEIE
To receive the tax benefit of the Foreign Earned Income Exclusion, expats must file IRS Form 2555 with their federal tax return.
What is Form 2555?
Form 2555 is the IRS paperwork required to claim the FEIE. The form has nine sections:
- Section I is where you’ll input personal details, your employer’s details (if applicable), and where your tax home is
- Section II is for expats who meet the Bona Fide Residence Test
- Section III is for expats who meet the Physical Presence Test
- Section IV is for your earned income and expense details, which should correspond with the figures you enter in Form 1040
- Sections V and VI relate to the Foreign Housing Exclusion/Deduction
- Sections VII-IX are where you’ll enter the final figures used to calculate the total amount you’ll be excluding
Form 2555 is not the most straightforward form to complete. For example, you will only complete Section II or Section III, not both. Additionally, effective tax year 2019, it is no longer possible to claim the FEIE via the simplified Form 2555-EZ. When in doubt, be sure to reference the IRS website, or seek assistance from an expat tax professional.
Can I claim the FEIE late?
The IRS rules allow some leeway for expats in this situation. They stipulate that the Foreign Earned Income Exclusion can be claimed as part of a:
- timely filed return, including any extensions
- return that is amending a timely filed return
- late-filed return filed within one year of the original due date of the return (not counting any extensions)
After a year though, expats may still file a late return and claim the Foreign Earned Income Exclusion so long as they do so before the IRS discovers the absence of the return and contacts them.
A cautionary legal case: The Redfield decision
Expats waiting until the IRS contacts them before filing late returns should not expect leniency from the IRS. This precedent was set by a 2017 decision involving a US Marine veteran, Damon Redfield.
Following his return to civilian status in 2010, he worked as a civilian contractor in Afghanistan briefly before returning to the US. He didn’t file a tax return relating to time spent as a civilian abroad until the IRS contacted him in 2014, at which point he filed a late return and claimed the Foreign Earned Income Exclusion.
The IRS disallowed his late claim, as they had already contacted him, and a court confirmed their decision, leaving Redfield liable to pay not just tax on the income he earned in 2010, but interest and penalties too.
This example highlights the importance of making timely filings and elections, particularly, taking action to rectify delinquent situations before the IRS contacts you.
The Foreign Earned Income Exclusion vs. the Foreign Tax Credit
As a resident of a foreign country, another major tax provision that can help expats avoid double taxation is the Foreign Tax Credit (FTC). The FTC allows expats to claim a dollar-for-dollar tax credit for foreign income taxes accrued or paid. It cannot be used to offset self-employment taxes, however.
The FTC is useful when an expat lives and pays taxes in one of the many countries with a higher income tax than the US. In these cases, the FTC can not only eliminate their US tax bill but also grant them excess tax credits that can be applied to future US tax bills for up to ten years (or back one year, by filing an amended return).
Furthermore, there’s no IRS limit set on the amount of tax credits that can be claimed, and the FTC can be applied to unearned income as well (so long as foreign income tax has been paid on it).
Can I claim the Foreign Earned Income Exclusion and the Foreign Tax Credit?
Expats can claim both the Foreign Earned Income Exclusion and the Foreign Tax Credit, but they cannot apply them both to the same income.