The Foreign Earned Income Exclusion (FEIE) is a tax provision that allows U.S. citizens and resident aliens working in foreign countries to exclude a certain amount of their income earned abroad from their income tax.
To qualify for the FEIE, an individual must have a tax home in a foreign country, meet the physical presence test, and have foreign earned income.
The IRS defines tax home as the individual’s regular place of business or employment, and the physical presence test requires the individual to be physically present in a foreign country for at least 330 full days during a 12-month period.
Additionally, the foreign housing exclusion and deduction can be used to further exclude certain housing expenses from income tax.
Passive income, such as investment income, does not qualify for the FEIE. The FEIE is updated each tax year based on inflation rates.
Do I Have To Pay U.S. Taxes on Foreign Income?
If you are a U.S. citizen or resident alien, you have to pay taxes on all of your income regardless of where it was earned. This includes foreign income and interest from offshore bank accounts.
However, there is a foreign earned income exclusion that allows you to exclude a certain amount of your foreign earned income from U.S. taxes.
To qualify for this exclusion, you must meet certain requirements such as living in a foreign country for a minimum of 330 days in a 12-month period.
You must also file IRS Form 2555 to claim the exclusion. It’s important to note that the exclusion only applies to earned income, which includes wages, salaries, and self-employment income.
Unearned income, such as dividends and interest, is not eligible for the foreign earned income exclusion and is subject to foreign income tax as well as U.S. income tax.
Who Qualifies for the Exclusions and the Deduction?
To qualify for the exclusions and deductions related to foreign housing, taxpayers must meet certain requirements.
In order to qualify for the foreign housing exclusion, taxpayers must have a tax home in a foreign country and meet either the bona fide residence test or the physical presence test.
Additionally, they must have paid for qualified foreign housing expenses out of their own pocket. The foreign housing exclusion allows taxpayers to exclude a portion of their foreign earned income to cover the cost of housing in a foreign country.
Taxpayers who qualify for the foreign earned income exclusion may also qualify for the foreign housing exclusion, which means they can exclude both their earned income and housing expenses from their taxable income.
Overall, the qualifications and rules surrounding housing exclusions and the foreign earned income exclusion can be complex, but can provide significant tax benefits for those who qualify.
What foreign income can you exclude with the FEIE?
The Foreign Earned Income Exclusion (FEIE) is a provision in the U.S. tax code that allows taxpayers to exclude a portion of their foreign income from taxation.
This exclusion applies to income earned in a foreign country, including wages, salaries, and self-employment income.
Additionally, investment income, such as interest and dividends, earned from a foreign source may also be eligible for the FEIE.
However, the income must be earned income, meaning it must be derived from work performed in a foreign country.
The FEIE does not apply to taxes on foreign income, only to the income itself. Overall, the FEIE provides a useful benefit for individuals working overseas and can potentially help to reduce their tax liability in the United States.
How much foreign income can I exclude?
If you earn foreign income while living and working abroad, you may be eligible for the foreign earned income exclusion (FEIE) to reduce or eliminate your tax liability.
The FEIE allows U.S. citizens and resident aliens to exclude a portion of their foreign earned income from their taxable income in the U.S. To qualify for the FEIE, you must pass either the bona fide residence test or the physical presence test.
For the physical presence test, you must be physically present in a foreign country for at least 330 full days during a consecutive 12-month period.
The maximum exclusion amount in 2022 is $110,600. However, this amount may vary depending on the year and your individual circumstances.
It’s important to note that the FEIE only applies to foreign earned income, not to other types of income such as pensions, dividends, or capital gains.
Which is more advantageous: the Foreign Earned Income Exclusion or the Foreign Tax Credit?
The choice between the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) depends on various factors, including the taxpayer’s income level and the countries they have earned income from.
The FEIE allows taxpayers to exclude a certain amount of foreign earned income from US tax, while the FTC allows taxpayers to claim a credit for taxes paid to a foreign country.
The FEIE is more advantageous for taxpayers with lower worldwide income because it reduces their taxable income.
However, the FTC is more beneficial for taxpayers with higher worldwide income and who pay a substantial amount of foreign tax.
In general, taxpayers should consult with a tax professional to determine which option is better for their specific situation.
Can I take both the Foreign Earned Income Exclusion and the Foreign Tax Credit?
Yes, it is possible to take both the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit, but it cannot be on the same income.
The FEIE allows individuals who satisfy certain requirements to exclude up to a certain amount of foreign earned income from US federal income tax.
On the other hand, the Foreign Tax Credit allows eligible taxpayers to reduce their US tax liability on a dollar-for-dollar basis for every dollar paid in foreign income taxes.
In order to take advantage of both benefits, taxpayers should carefully consider which one would be more beneficial based on their individual circumstances.
For example, if an individual’s foreign taxes exceed the amount of income they can exclude under the FEIE, then it may be more advantageous to use the foreign tax credit to reduce their US tax liability.
It is important to note that taxpayers are not allowed to use the foreign tax credit to reduce US tax liability on income that they have already excluded under the FEIE. So, if an individual chooses to use the foreign tax credit, they must ensure that they are not using it for income that they have already excluded.
Ultimately, in order to make the most informed decision, it is important to consult with a tax professional and carefully review the requirements and limitations of both the FEIE and the foreign tax credit.
2022 updates may affect the calculation of tax, so it’s always a good idea to stay up-to-date on recent regulations that may affect your income tax.
Individuals should also consider the use of the foreign tax credit on alternative minimum tax (AMT) liability as it cannot be used against the AMT as an exclusion and the foreign tax credit can be a significant tax savings tool.
As a last point, expat taxpayers are advised to use the foreign tax credit rather than the shared responsibility payment.
In summary, both the FEIE and the foreign tax credit can be used, but not simultaneously on the same income.
Taxpayers should take the time to understand which credit will provide them with the maximum tax benefit before filing their return.
Foreign Housing Exclusion or Deduction
Foreign Housing Exclusion or Deduction is a tax provision that allows individuals who are paying foreign housing expenses while living in a foreign country to exclude or deduct a certain amount of those expenses from their taxable income.This can result in a significant tax savings for those who qualify.
The Foreign Housing Exclusion applies to both employees and self-employed individuals who use the foreign housing as their primary place of residence.
The exclusion amount is determined based on the taxpayer’s foreign earned income and the cost of housing in the foreign country.
The Foreign Housing Exclusion is sometimes referred to as the housing exclusion or deduction and is part of the Foreign Earned Income Exclusion (FEIE) provisions.
This tax benefit is designed to provide relief for individuals living abroad who are subject to additional living expenses in a foreign country.
Physical Presence Test
The Physical Presence Test is an essential requirement for expats who wish to avail of the Foreign Earned Income Exclusion.
To qualify, you must be physically present in a foreign country for at least 330 full days in a 12-month period. The test is crucial because it determines if you’re eligible to exclude a portion of your income from US tax.
Your tax home is necessary to determine your eligibility for the Physical Presence Test. To be deemed as present in a foreign country, you must be physically present in a foreign location or locations for a minimum of 24 hours.
The test applies to all citizens, regardless of their status in a specific foreign country.
Meeting this criterion allows expats to avoid being taxed twice, which helps prevent double taxations.
What Is A Bona Fide Resident?
A bona fide resident of a foreign country or countries is a person who has established a legal and permanent residence in a specific location.
This term is often associated with taxes and immigration laws, as it is used to determine a person’s tax liability or immigration status.
To be considered a bona fide resident, an individual must meet certain requirements that vary depending on the country or state in which they are residing.
Generally, a person must have a physical presence in the location for a specific period of time which includes an entire tax year, and their intention must be to remain there permanently.
Proof of residence, such as a lease agreement or utility bill, may also be required.
Being a bona fide resident can have important implications for taxes, as it may allow individuals to qualify for certain deductions or exemptions.
Example of Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion is a tax provision for eligible taxpayers to exclude a portion of their foreign earned income from their taxable income.
For the tax year 2022, the maximum exclusion amount is $108,700. To qualify for this exclusion, the taxpayer must have a tax home in a foreign country and meet either the physical presence test by spending at least 330 days in a foreign country or the bona fide residence test.
This exclusion does not affect the taxpayer’s eligibility for the foreign tax credit, which allows them to offset their US tax liability by the foreign taxes paid on this income.
If the taxpayer’s foreign income exceeds the exclusion amount, they must still report it on their income tax return, but they may be able to reduce their US tax liability by claiming the foreign tax credit.
In addition to the exclusion, the taxpayer may also deduct certain foreign housing expenses from their taxable income.
Married Filing Jointly – Double Exclusion
Married couples who file tax returns jointly have the opportunity to double their tax exclusion through the Foreign Housing Exclusion.
The IRS allows taxpayers to claim both the foreign earned income exclusion and the foreign housing exclusion on their tax return.
To qualify, the couple must meet certain criteria, including living abroad for at least 330 days in a given year.
The Foreign Housing Exclusion involves a deduction for expenses related to the foreign housing like rent, utilities, and furniture rental.
By claiming both exclusions, married couples can save a considerable amount of money on their taxes.
However, it is essential to understand the requirements and properly document all expenses to avoid any issues with the IRS.
When to consult with a tax professional?
Consulting with a tax professional can be beneficial in several situations, particularly when dealing with complex tax issues.
One of the critical decisions to seek the advice of a tax professional is when trying to understand the tax codes’ nuances.
A few examples of when tax consulting is vital include filing a business tax return, preparing a complicated tax return, to claim tax deductions or credits, or dealing with foreign earned income exclusions.
Individuals who live in a foreign country and qualify for the foreign earned income exclusion should seek tax professional help to understand the legalities and regulations surrounding expat taxes.
With a tax specialist’s guidance, taxpayers can quickly and accurately navigate tax laws and codes and avoid mistakes that might result in penalties or fines.
If you are an expat and are just learning about this deduction, you may be able to amend past returns and get some of your overpaid taxes back as a refund.
We are experts in Foreign Earned income Exclusion and have helped many clients over the years. Give us a call today for a free 15 minute consultation at 877-860-373.