IRS Tax Tips for the Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion is an IRS provision that allows expats to pay less (and often no) US tax.
All Americans have to file US taxes on their worldwide income, wherever in the world they reside or work, even if they have to pay foreign income taxes in another country, too or if a tax treaty exists between the US and their country of residence.
Expats who pay foreign taxes abroad can claim the US Foreign Tax Credit by filing IRS Form 1116 when they file their US federal return. If the foreign tax rate is higher than the US rate, this will reduce their US tax bill to zero.
Many expats either live and pay tax in a country with lower income tax rates than the US though, or live and work abroad without paying foreign taxes (such as Digital Nomads), or those who live in countries with no income taxes.
These expats can claim the Foreign Earned Income Exclusion when they file their US tax return by filing IRS Form 2555 to reduce their US tax bill. Here are some top tax tips for expats claiming the Foreign Earned Income Exclusion.
1 - Exclude your earned income
The Foreign Earned Income Exclusion lets US expats exclude solely their earned income, and solely up to a threshold of around $105,000 of income. The exact figure rises each year based on inflation. So the FEIE expats can exclude any income earned by actively providing a service, but not passive income such as rental, interest, winnings, or dividend income.
2 - Demonstrate that you live abroad
When claiming the Foreign Earned Income Exclusion, expats have to demonstrate that they live abroad, either by proving that they are a permanent resident in another country (this is called the Bona Fide Residence Test), or by proving that they spent at least 330 days outside the US in a year (this is called the Physical Presence Test).
3 - Don’t forget to file
To claim the Foreign Earned Income Exclusion, expats have to file IRS Form 2555 every year. If they don’t file this form along with Form 1040, the IRS assumes that they owe tax on their worldwide income.
4 - The Streamlined Procedure lets you claim the FEIE retrospectively
Expats who are behind with their US tax filing because they weren’t aware that they have to file can retroactively claim the Foreign Earned Income Exclusion if they catch up under an IRS amnesty program called the Streamlined Procedure, often meaning they won’t owe any back taxes or penalties.
5 - Seek advice
Filing as an expat from abroad is more complicated, as expats not only have to claim the Foreign Tax Credit or Foreign Earned Income Exclusion to reduce their US tax bill, but they also often have to report foreign financial accounts and assets. Always seek advice from an expat tax specialist to ensure you not only stay compliant but file in as efficient a manner as possible.