IRS Form 2555 – The Foreign Earned Income Exclusion
The foreign earned income exclusion, or FEIE, is one of the tax breaks available for US expats to eliminate or reduce any US tax liability on income earned from living and working abroad. This article gives you an overview of what the FEIE is, who can claim it, and how you can claim it through IRS Form 2555.
What is the FEIE?
The foreign earned income exclusion is a special deduction that US expats living and working abroad can use to reduce, or exclude, the amount of their foreign wages that are subject to US tax. Simply put, if you earned $100,000 of foreign wages, you can choose to “exclude” that $100,000 of wages from being subject to US tax. From a US tax perspective, the FEIE works by excluding your foreign wages (up to a limit) as wages that are subject to US tax. Find out if you are eligible to claim the FEIE.
How much of my foreign wages can be excluded?
The maximum exclusion amount for 2020 is $107,600 per person. If you are married to a US citizen or green card holder, and both you and your spouse are working and living abroad, then both of you may be eligible to individually exclude up to $107,600 by using the FEIE.
Who can claim the FEIE?
The FEIE has strict (and annoying) eligibility rules, or “tests” in order to claim it.
Tax home test
- First of all, you must have a tax home that is located outside of the US. Your tax home is generally the area of your main place of employment, regardless of where you maintain your family home. If you expect your employment away from the US to last more than a year, then your tax home is generally considered to be in that foreign country. Most expats who live and work in a foreign country will be considered to have a tax home in that foreign country. Many expats maintain a home and family in the US but are still considered to have a tax home in a foreign country.
- Secondly, your tax home must be located outside of the US during your period of either bona fide residence or physical presence abroad. In other words, you must have a tax home abroad and meet either the bona fide residence test, or the physical presence test, either or!
Bona fide residency test
To meet the bona fide residence test, you must have established your “residency” in a foreign country. Typically, you begin your bona fide residence period the day you moved abroad. Your bona fide residence ends the day you move back to the US. You must have been a bona fide resident of a foreign country for an entire tax year, so if you established bona fide residency in or before 2019, and are still a resident of a foreign country in 2021, then you are considered a bona fide resident because you were outside of the US for a full calendar year (2020). You remain a bona fide resident until establishing residency back in the US. For example, if you moved abroad during 2020, then you will not qualify as a bona fide resident unless you continue to live abroad through the end of 2021.
Physical presence test
The physical presence test is best for US expats working and living abroad temporarily. The physical presences test does not require you to live abroad for a full calendar year. The only requirement is that you spend 330 out of 365 days abroad over a 12 month period. Note, this 12 month period does not have to be a calendar year, the 12 month period can be any period that either begins or ends in the tax year you want to qualify for the physical presence test!
Finding out which test is best for you can be complicated, so we built Expatfile to automatically recommend what you should choose just by answering a few simple questions about your life abroad! Find out now whether you qualify for the physical presence test.
How do you claim the FEIE?
To claim the FEIE, you need to file IRS Form 2555 and attach this to your filed expat tax return. If you are married to a US citizen or green card holder, and both you and your spouse are working and living abroad, then both of you must fill out a separate Form 2555 in order to claim the exclusion.
IRS Form 2555 can be complicated to an expat that is starting from scratch – so we built Expatfile to immediately determine and fill out Form 2555 for you! Answer a few questions and Expatfile’s expat tax software does the rest.
Do you have an example of how the FEIE works?
Here’s a simplified example of how the FEIE works:
- You’re filing your 2020 US federal tax return and your filing status is “single”.
- You earned foreign wages of $120,000 while living and working in Singapore.
- Let’s assume you would owe $40,000 in US federal taxes on this income.
- On your foreign wages, you actually paid $20,000 in Singapore taxes.
Of the $120,000 of your foreign wages, you can exclude up to $105,900 from being subject to US taxes. This brings your wages subject to US tax down to $14,100. The 2019 standard deduction for a taxpayer claiming the “single” filing status is $12,400 (everyone gets this), meaning your taxable income would be $1,700. You would pay US federal taxes on the $1,700, and not the full amount of your foreign wages of $120,000. However, since you paid foreign taxes too, you will still be able to claim a foreign tax credit and reduce your US federal tax bill down to $0.
What type of foreign income can the FEIE be used for?
The FEIE (Form 2555) can be used to exclude “foreign earned income” from being subject to US tax. What this means for most expats is that they can use the FEIE to exclude foreign wage income or foreign self-employment income, from being subject to US tax.
The FEIE can even be used to exclude wages paid to you by a US employer, subject to meeting the eligibility tests described earlier!
The FEIE can not be used to exclude foreign income from interest, dividends, or capital gains.
Does the FEIE work against self-employment tax?
Good question! US expats who are self-employed and living abroad are subject to the additional self-employment tax. The self-employment tax is levied on your self-employment net income, and is an additional tax to regular US tax. The FEIE can be used to eliminate or reduce your regular US tax, however the self-employment tax cannot be reduced by claiming the FEIE unfortunately.
I am paid by a US employer but I live and work abroad, does the FEIE still work for me?
Yes, absolutely. The source of your wages is not the decisive factor in determining your eligibility to claim the FEIE. Many US expats are still on the payroll of US companies. In fact, many US expats are subject to US tax withholding. The good news is, if you meet the eligibility requirements described above, you can get a refund for US tax withholding!
Note: if you are paid by a US employer, they will still withhold Medicare and social security taxes from your paychecks. These amounts can not be refunded to you, even if you claim the FEIE.
Should I always use the FEIE, or should I claim the foreign tax credit (the FTC)?
If you live and work abroad in a country where the foreign tax rate is higher than the US federal tax rate, then you are usually better off by claiming the FTC. Claiming the FTC is a much more simple process than claiming the FEIE, and it also opens you up to other tax breaks in the US like the child tax credit.
Generally, if you live in a country where the foreign tax rate is lower (or zero) than the US federal tax rate, then you are usually better off by claiming the FEIE.
Some benefits of claiming the FTC over the FEIE include:
- If you claim the FEIE in a given year and you want to switch to FTC in a future year, you may not be able to claim the FEIE for 5 years unless you receive special persmissiom from the IRS to do so.
- If you paid more foreign taxes than US federal taxes, you can carry forward these as a credit to future years.
- If you claim the FEIE, you cannot claim the Additional Child Tax Credit (a refundable tax credit of up to $2,000 per child per year). If you claim the FTC, you are allowed to take this credit.
Can I claim both the FTC and the FEIE?
Yes, you can. The main limitation to claiming both the FTC and the FEIE is that you can’t claim a FTC on income that you excluded from US tax by claiming the FEIE.
In other words, the FEIE limitation in 2019 is $107,600 – if you take this full exclusion then you will not be able to claim a FTC on the amount of this exclusion. Using both the FTC and the FEIE really only comes in handy when you are living in a country that has a lower tax rate than the US and you earned more than the FEIE amount of $107,600.
Check out our article why it’s often better to claim FTC than FEIE.
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Latest update: January 12, 2020