Foreign Earned Income Exclusion (Form 2555)

If you are a US citizen or resident living and working abroad, you might be eligible for a significant tax break called the Foreign Earned Income Exclusion. This allows you to exclude a portion of your foreign-earned income from US taxes– reducing your overall tax liability.

Curious if you qualify or how to claim this benefit? You've come to the right place! This page explains the Foreign Earned Income Exclusion in simple terms. We will cover what it is, who's eligible, the maximum limit for foreign earned income exclusion 2023, and how to report it on Form 2555.

What is Foreign Earned Income Exclusion?

Foreign Earned Income Exclusion (FEIE) is a tax break for U.S. citizens and residents who live and work abroad. It allows you to exclude a portion of your foreign income from your U.S. taxes. This means you only pay taxes on the remaining amount of your income. To qualify, you need to fill out Form 2555 with their tax return and meet certain requirements, such as living in a foreign country for a specific period or passing a physical presence test. The amount you can exclude changes each year.

Who Qualifies for the Foreign Earned Income Exclusion?

To qualify for the Foreign Earned Income Exclusion (FEIE), you must meet specific conditions set by the IRS. This exclusion allows you to exclude a certain amount of foreign earned income from your taxable income if you work and reside outside the US. Here's what you need to know:

1. Residency and Presence Tests

To claim the exclusion, you need to meet either:

• Physical Presence Test: You must be physically present in a foreign country for at least 330 days during any 12-month period.
• Bona Fide Residence Test: You need to be a resident of a foreign country for an entire tax year. This typically means you have established a home there and intend to stay for an extended period.

2. Foreign Earned Income

You need to have income earned from working in a foreign country. This can include wages from employment or earnings from self-employment. However, income from pensions, investments, or alimony is not considered foreign earned income.

3. Employment Types

• You must work outside the US as an employee or self-employed individual. This applies to both U.S. and non-US employers.
• Employees of the US government CANNOT claim the exclusion, but those working for a private company contracted by the US government may still qualify.

4. US Citizens Supporting Military or Combat Zones

US citizens or resident aliens supporting the US Armed Forces in designated combat zones may also qualify for the exclusion, even if their home is in the United States.

5. Foreign Housing Exclusion

If you live and work abroad, you may also qualify for a Foreign Housing Exclusion. To do this, you need to meet the requirements of either the Bona Fide Residence or Physical Presence Test. This exclusion covers certain housing expenses, such as rent, utilities, and repairs, but does not include costs like mortgage payments or home improvements.

Important Notes: If you are married, you and your spouse can each claim the FEIE if you both meet the eligibility requirements.

Qualifying Expenses for the Foreign Housing Exclusion

The following housing expenses are eligible for exclusion:

• Rent or lease payments for your foreign residence.
• Utilities such as electricity, gas, water, and sewage.
• Property taxes on your foreign residence.
• Homeowner's or renter's insurance.
• Mortgage interest on a foreign residence.
• Furniture and appliance rentals.
• Parking fees near your foreign residence.
• Maintenance and repair expenses for your foreign residence, but only for small, non-recurring repairs.

Expenses Not Covered by the Foreign Housing Exclusion

Certain expenses are excluded from eligibility for the Foreign Housing Exclusion, including:

• Domestic servants such as maids, gardeners, or cooks.
• Personal expenses such as food, clothing, and transportation.
• Lavish or extravagant housing expenses.
• The purchase of a foreign residence.
• Improvements to a foreign residence that increase its value or appreciably prolong its life.

Maximum Foreign Earned Income Exclusion Amount

You can exclude a certain amount of foreign income from your taxes, but there’s a limit. You can choose to exclude either your actual foreign wages or the annual maximum dollar limit—whichever is lower. Here are the latest maximum amounts for the foreign income exclusion, which are updated for inflation.

Example of Foreign Earned Income Exclusion

Let’s see how the Foreign Earned Income Exclusion works.

Sarah is an American who moved to Germany and lived in Berlin for most of 2023. She spent 355 days there, earning a salary of $250,000. Sarah paid $36,000 in rent for her apartment and $50,000 in German income tax. After all this, she calculated that she owed $80,000 in US income tax on her earnings.

Since Sarah is a US citizen who paid foreign taxes on her income while living in Germany for 355 days, she can use the Foreign Earned Income Exclusion to reduce her US taxable income.

For 2023, she can exclude up to $120,000 from her income. Additionally, she can claim a Foreign Housing Exclusion based on her housing costs. Her total housing expenses were $30,000, and the base amount for her area is $16,944. This means she can claim a foreign housing amount of $13,056 ($30,000 – $16,944).

Now, let’s break it down:

• Total Salary: $250,000
• Excluded Income: $120,000 (using the Foreign Earned Income Exclusion)
• Remaining Taxable Income: $130,000 ($250,000 – $120,000)

After using the exclusion, Sarah still has $130,000 that is taxable in the US However, she already paid $50,000 in foreign taxes, which allows her to claim a foreign tax credit of $50,000 against her US tax bill.

By filing Form 2555 to claim the Foreign Earned Income Exclusion and Form 1116 for the foreign tax credit, Sarah can avoid double taxation on her income.

How Do I Claim the Foreign Earned Income Exclusion?

To claim the Foreign Earned Income Exclusion, follow these five simple steps:

Step 1: Check If You Qualify: First, make sure you qualify for the exclusion. You need to have foreign earned income, which is money you earn while working in another country. Also, you should either be a permanent resident of that country or pass the physical presence test.

Step 2: Collect Your Documents: Gather all the necessary documents such as:

• Proof of foreign residency (e.g., rental agreements, utility bills, driver's license)
• Proof of foreign earned income (e.g., pay stubs, W-2 forms)
• Documentation of any foreign housing expenses (if applicable)

These will help you accurately report what you’ve earned and show that you live in a foreign country.

Step 3: Fill Out Form 2555: Next, complete Form 2555. This is the official form you need to use to claim the Foreign Earned Income Exclusion. On this form, you’ll provide information about your foreign income, your residency status, and how many days you were in the foreign country. Make sure to double-check your information to avoid mistakes.

Step 4: Attach the Form to Your Tax Return: Once you have filled out Form 2555, attach it to your Form 1040 (Individual Income Tax Return) or Form 1040-X (Tax Amendment)

Step 5: File Your Return on Time: Finally, make sure to file your tax return by the due date, usually April 15. The easiest way to do this is by using online tax filing software like eFile.com. It’s user-friendly and offers a variety of tax calculators. Plus, our Taxperts are always available to guide you every step of the way.

By following these steps, you can successfully claim the Foreign Earned Income Exclusion.

Foreign Earned Income Exclusion Extensions

To get an extension for claiming the Foreign Earned Income Exclusion, you need to file Form 2350– the Application for Extension of Time To File US Income Tax Return, with the IRS. Make sure to submit this form by your tax return's due date. If your tax home and residence are both outside the US, your filing deadline is June 15.

Remember, Form 2350 only gives you more time to file, not to pay taxes. If you don’t pay what you owe by the regular due date (April 15), you will face interest and possibly penalties.

Withholding Taxes from Foreign Income

When you earn money abroad, understanding how to handle tax withholding is essential. Here are three effective ways to manage withholding taxes on your foreign income:

1. Limit or Stop Tax Withholding

If you think you qualify for tax withholding exemptions under the bona fide residence test or the physical presence test, you can ask your employer to reduce or stop withholding taxes from your wages. Here’s how:

• Notify Your Employer: Let your employer know that you believe you meet the requirements for the exclusion.
• Provide Necessary Documentation: Be prepared to provide any required forms or evidence to support your claim.

2. Pension Payment Withholding

If you receive pension benefits or other retirement distributions from US payers, they typically must withhold income tax from these payments. To potentially avoid this withholding, consider the following:

• Claim Exemption: To claim an exemption from withholding, provide a US residence address to the payer.
• Certification Requirements: If you’re not a US citizen or resident alien, inform the payer of your status to help avoid unnecessary withholding.

3. Estimated Tax Payments

When working for a foreign employer, you might need to pay estimated taxes since they generally do not withhold US taxes from your wages. Here’s how to approach estimated tax payments:

• Calculate Your Estimated Tax: Your estimated tax should include your expected income tax and self-employment tax for the year, minus any anticipated withholding.
• Exclude Certain Income: When estimating your gross income, do not include any income you plan to exclude under the Foreign Earned Income Exclusion.
• Consider Housing Deductions: You can subtract your estimated housing deduction from your income to calculate your estimated tax liability. However, be cautious, as you may face penalties if your actual deduction or exclusion is lower than expected.

Tax Forgiveness for Deceased Taxpayers Affected by Terrorism or Military Action

If a US government civilian employee dies from injuries sustained while working for the government, their income taxes may be forgiven. This applies specifically if the injuries were caused by military action or terrorist attacks aimed at the US or its allies. The tax forgiveness covers the tax years from the year before the injuries occurred up to the year of the employee's death. If you filed jointly with your deceased spouse, only their portion of the tax liability will be forgiven.

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Related Resources

• Annual Withholding Tax Return for U.S. Source Income of Foreign Persons.
• Foreign Bank and Financial Account Reports (FBARs).
• Bona Fide Residence and Physical Presence tests.
• Claim Foreign Country Tax Credits, Breaks, or Exemptions
• File Your Past Year Tax Returns if You Lived or Worked Abroad.
• Learn if You Can Take the Foreign Tax Credit.

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