The Foreign Earned Income Exclusion (FEIE) is a handy money-saving provision that reduces the taxable income out of your earnings outside the USA. Therefore, if you are a US expat , you should definitely know if you qualify for the exclusion maximum amount that you can exclude from total income etc.Once you complete this guide , you will have fair idea about FEIE provisions under IRC .
What is Foreign Earned Income ?
Since the maximum exclusion is fixed to the quantum of your foreign earned income, it is better we start with an explanation about what constitutes foreign earned income. Section 911 of the 26 US Code defines Foreign Earned income as the amount received by an individual US citizen from sources within a foreign country or countries that constitute earned income attributable to services performed by such individual during the period for an uninterrupted period which includes an entire taxable year, or at least 330 full days in such period.
What income does not constitute the Foreign Earned Income definition?
The foreign earned income for an individual shall not include amounts—
- (i)received as a pension or annuity,
- (ii)paid by the United States or any agency thereof to an employee of the United States or any agency of USA,
- (iii)Any included in the gross income of beneficiary of the nonexempt trust or on account of section 403(c) (relating to taxability of beneficiary under a nonqualified annuity), or
- (iv)received after the close of the taxable year following the taxable year in which the services to which the amounts are attributable are performed
Foreign Earned Income Exclusion Meaning
The Foreign Earned Income Exclusion, or FEIE, means that an eligible US expat having foreign earn income can claim exclusion a certain amount from the taxable portion of his/her foreign-earned income while filing a tax return to IRS.
What Types of Foreign Income can be excluded?
Under the US taxation law, Income arising as a result of work or services rendered includes salary income, wages, commissions, bonuses, self-employment income, and professional fees as well as the value of any other compensation for services, such as food and travel allowances, professional training, relocation expenses, etc.
What Types of Income Can’t be excluded?
- Income like social security benefits, pension income, rents, dividend income, interest, gambling winnings, capital gains, annuities, and alimony payments are not eligible for exclusion because they are considered unearned income.
- Similarly, the following types of income can’t be excluded by ex-pats claiming the Foreign Earned Income Exclusion :
- – Payments received as a military or civilian employee of the U.S. Government
- – Payments received for services conducted in international waters
- – Payments received after the end of the tax year or other 365 days period being claimed for, even if the service was performed during that time
- Meals and lodging that are excluded from income for the convenience of the employer
What is Foreign Earned Income Exclusion Limit?
IRS announces every year the amount of the FEIE is adjusted for inflation. Sometimes, this can cause confusion since early projections of the new FEIE limit may underestimate or overestimate the allowed excludable amount.
The Foreign Earned Income Exclusion limits for 2022 & 2021 are $112,000 and $108,700.
Who Qualifies for the Foreign Earned Income Exclusion?
In order to qualify for the FEIE, you must be one of the following:
- A bona fide resident of a foreign country (or countries) for an entire tax year
- Physically presence in a foreign country (or countries) for at least 330 full days during any 12-month period
What is a Bona Fide Residence Test?
A bonafide residence test means satisfying three points :
- Expat must have Foreign Earned Income.
- Expat must have a “tax home” by having a work engagement expected to last a year or more, and retaining a personal residence in the US means you do not have a “tax home” in a foreign country.
- Expat must have bona fide residence in the foreign country for an entire tax year and that ex-pat must demonstrate the intent to stay in the foreign country indefinitely with no immediate plans to return to the US.
Is Having a Home in The US Affects Bona Fide Residence?
Since the rule for the Foreign Earned Income Exclusion has a tax home test, that requires that your tax home must be your regular or principal place of business, employment, or post of duty. It does not matter where your family residence resides. So, the IRS considers your ‘tax home’ where you primarily live and work, regardless of real estate or foreign rental income.
Your ‘abode’ is determined by where you manage your personal, family and economic ties. Where your family is can certainly play a role in determining your ‘abode,’ but if you show that you’ve established a residence in your host country by integrating into society, having a home and setting up a bank account, among other factors – your ‘abode’ could be your host country.
As far as your property back in the States, you could rent it out, let your family live in it, or even leave it vacant. You’ll want to keep accurate records of your home in your host country, also, since that can go a long way in helping prove you are integrated into the foreign society.
How Will You Qualify for the Foreign Earned Income Exclusion?
Before deciding which test you’ll use to qualify for the FEIE, it’s important to fully understand the difference between the bona fide residence and the physical presence test.
Often, your specific situation will determine which test is the best option for qualifying for the FEIE. For instance, if you are on a foreign assignment with a specified end date (but for at least 330 full days), you’ll likely need to use the physical presence test.
If you’re unsure, it’s a good idea to consult with an expat tax professional to better understand the requirements for your US expat taxes.
Which Form Do You Use for the Foreign Earned Income Exclusion?
Once you’re confident you qualify, you’ll need to complete and attach Form 2555 as part of your Federal Tax Return.
To complete Form 2555, you will need to include:
- Which test (bona fide residence or physical presence) you will use to qualify
- Dates you traveled internationally and to/from the US during the tax year
- Your prior year Form 2555 (if available)
- Documentation of your foreign earned income
Each expat is required to complete their own Form 2555. If you are married filing jointly, each spouse will need to complete their own Form 2555. You’ll then attach both forms to your joint US expat taxes.
Filing Form 2555 is obligatory!
You must file IRS form 2555 if you are claiming the foreign earned income exclusion. The tax form 2555 lets you figure out and claim the foreign earned income exclusion and housing exclusion or deduction.
What are the Common Foreign Earned Income Exclusion Mistakes?
1. Assumption that You Don’t Need to File
As per IRS, it is seen that the most common error among taxpayers who desire to claim FEIE is that taxpayers believe the income exclusion recuses them from filing requirements if their income is under the limit. This is not correct as per law because the law requires every claimant of FEIE must still file annual Federal Tax Returns, and in order to exclude this income, you must qualify and fill out the required Form 2555.
2. Failing to Prorate the FEIE When Needed
The rule for FEIE says that the full FEIE amount is for the full tax year. So when you stay in foreign countries for less days in a tax year, your claim to FEIE exclusion is only pro-rata basis . In other words, you must compute your maximum exclusion amount as under
The maximum excludable amount for the tax year x Number of your qualifying days/number of days in the year
For example, if you moved abroad in March 2022, the FEIE amount for the 2022 tax year should be computed as follows:
- $108,700 (FEIE limit in 2021) x 274 days (number of qualifying days) ÷ 365 (total number of days in the year) = $81,599
Can You Revoke Foreign Earned Income Exclusion?
Once you claim FEIE, you must use it every year and if you revoke the exclusion, you cannot use the FEIE for another 5 years. If you want to invoke FEIE within five years after revoking , you can do so only if IRS permits you to do.