Foreign Earned Income Exclusion
Foreign Earned Income Exclusion: When a U.S. person works overseas and meets the necessary IRS requirements, they may be able to exclude a portion of their foreign income and housing from their US taxes. There are very specific requirements in order to take advantage of this role.
One common misconception is that if a person qualifies, then they do not have to include the income on their tax return, but it is not as simple as just eliminating the foreign income from the tax return.
Rather, it requires establishing the elements of either the Physical Presence Test or the Bona-Fide Resident Test.
In addition, it requires the show that the person has a tax home outside of the United States and other specific requirements.
We will summarize the basics of the foreign earned income exclusion and explain why there is a higher risk of audit.
What is the Foreign Earned Income Exclusion?
When a person is a U.S. person who resides overseas and meets either the physical presence test or the bona fide resident test (and can prove the foreign country is their tax home), they may qualify to exclude a portion of their foreign income, using Form 2555.
In addition, a person may also be able to deduct a portion of their housing in accordance with the foreign housing deduction as well.
What if No Foreign Taxed Paid?
One nice thing about exclusion is that it does not matter if a person paid tax or not in a foreign country, as is required to claim a Foreign Tax Credit.
Unlike the foreign tax credit, a person may qualify for the foreign earned income exclusion even if they reside in the country and did not owe any foreign income tax.
As provided by the IRS:
“If you meet certain requirements, you may qualify for the foreign earned income exclusion, the foreign housing exclusion, and/or the foreign housing deduction. To claim these benefits, you must have foreign earned income, your tax home must be in a foreign country, and 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,
- 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, or
- A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
You can use the IRS’s Interactive Tax Assistant tool to help determine whether income earned in a foreign country is eligible to be excluded from income reported on your U.S. federal income tax return.
If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude your foreign earnings from income up to an amount that is adjusted annually for inflation ($103,900 for 2018, $105,900 for 2019, and $107,600 for 2020). In addition, you can exclude or deduct certain foreign housing amounts.
You may also be entitled to exclude from income the value of meals and lodging provided to you by your employer on their premises and for their convenience. However, such amounts are not foreign earned income. Refer to Exclusion of Meals and Lodging in Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, and Publication 15-B, Employer’s Tax Guide to Fringe Benefits for more information.”
Physical Presence Test (PPT)
In order to meet the PPT (Physical Presence Test), a person must reside outside of the U.S. for 330-days over a 12-month period. It is informally referred to as a “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.”
Bona-Fide Residence Test (BFR)
The Bona-Fide Residence Test is the more difficult of the two tests, and requires more than just counting days.
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.”
One of the absolute requirements for the Foreign Earned Income Exclusion is that the Taxpayer has a foreign country as a Tax Home.
As provided by the IRS:
“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. For this purpose, your period of physical presence is the 330 full days during which you were present in a foreign country, or countries, not the 12 consecutive months during which those days occurred.”
Do Government Employees Qualify?
Unfortunately, employees of the U.S. Government do not qualify.
“Income from working abroad as an employee of the U.S. Government does not qualify for either of the exclusions or the housing deduction. Don’t file Form 2555.”
Combat Zone Exception
The U.S. government has integrated an exception to the FEIE limitation, which is for service in a combat zone:
“Citizens or residents of the United States serving in an area designated by the President of the United States by Executive order as a combat zone for purposes of section 112 in support of the U.S. Armed Forces can qualify as having a tax home in a foreign country, even if they have an abode within the United States.
*For a list of IRS recognized combat zones, go to IRS.gov/ Newsroom/Combat-Zones.”
Can Both Spouses Claim the Exclusion?
Yes. If spouses file their tax returns Married Filing Jointly, they can still each claim the foreign earned income exclusion.
What about Housing?
You can claim a certain portion of the housing, which is summarized in a separate article.
We Specialize in Streamlined & Offshore Voluntary Disclosure
Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe. Our attorneys have worked with thousands of clients on offshore disclosure matters, including FATCA & FBAR.
Each case is led by a Board-Certified Tax Law Specialist with 20-years experience, and the entire matter (tax and legal) is handled by our team, in-house.
*Please beware of copycat tax and law firms misleading the public about their credentials and experience.
Less than 1% of Tax Attorneys Nationwide Are Certified Specialists
Our lead attorney is one of less than 350 Attorneys (out of more than 200,000 practicing California Attorneys) to earn the Certified Tax Law Specialist credential. The credential is awarded to less than 1% of Attorneys.
Recent Case Highlights
- We represented a client in an 8-figure disclosure that spanned 7 countries.
- We represented a high-net-worth client to facilitate a complex expatriation with offshore disclosure.
- We represented an overseas family with bringing multiple businesses & personal investments into U.S. tax and offshore compliance.
- We took over a case from a small firm that unsuccessfully submitted multiple clients to IRS Offshore Disclosure.
- We successfully completed several recent disclosures for clients with assets ranging from $50,000 – $7,000,000+.
How to Hire Experienced Offshore Counsel?
Generally, experienced attorneys in this field will have the following credentials/experience:
- 20-years experience as a practicing attorney
- Extensive litigation, high-stakes audit and trial experience
- Board Certified Tax Law Specialist credential
- Master’s of Tax Law (LL.M.)
- Dually Licensed as an EA (Enrolled Agent) or CPA
Interested in Learning More about our Firm?
No matter where in the world you reside, our international tax team can get you IRS offshore compliant.
We specialize in FBAR and FATCA. Contact our firm today for assistance with getting compliant.