Expat taxes aren’t easy. They depend on what you do for a living. They depend on where you do it, what taxes the local government charges, where you hold investments, which passports you hold and much more. For Americans who live overseas, however, the foreign earned income exclusion is a critical part of your annual filings.Here’s how it works. Given the complexity of expat taxes, it’s only prudent to work with a financial advisor on your taxes.
What Is the Foreign Earned Income Exclusion?
As American expatriates will tell you, the U.S. does things a little differently from many Western nations. Americans owe taxes on their income no matter where they earn it worldwide. This contrasts, say, with many EU nations, which only levy taxes on income that citizens earn while working domestically.
There’s a catch, however. While you owe the government taxes on all income earned worldwide, you can qualify to exclude income earned overseas from your income taxes. This is called the foreign earned income exclusion, and, along with the foreign housing deduction and the foreign housing exclusion, it is one of the major tax breaks which inure to U.S. citizens who live and work abroad.
This exclusion allows qualifying taxpayers to exempt a portion of their income from U.S. federal income taxes altogether. In 2023, you may claim it for up to the first $120,000 (up from $112,000 in 2022) that you earn. This means that if you earn $120,500, say, you would pay federal income taxes on a total of: $120,500 (your income earned) – $120,000 (the maximum exclusion) = $500.
Like the foreign tax credit, the purpose of the foreign earned income exclusion is to prevent double taxation. It makes sure that you aren’t taxed twice (once by the local government and once by the U.S. government) on the same income.
Claiming the Foreign Earned Income Exclusion
As noted above, the foreign earned income exclusion functions as a tax deduction. It allows you to deduct all of your qualifying, foreign-earned income from your U.S. taxable income.
You may claim this exclusion under three circ*mstances:
- You are a U.S. citizen who was a resident of a foreign country or countries for the entire taxable year (the bona fide residence test);
- You are a U.S. citizen or a U.S. resident alien who was physically present in a foreign country or countries for at least 330 complete days during a period of 12 consecutive months (the physical presence test);
- Or you are a U.S. resident alien who is a citizen or national of a foreign country with which the U.S. has an income tax treaty and who resided in that country for the entire taxable year.
On the first category, establishing bona fide residence is a case-specific test. Per the IRS:
It is determined by the facts of your situation and may include such factors as your intention or purpose for being in the foreign country, your activities in the foreign country, and whether you paid taxes to the foreign country, among other things. The IRS decides whether you qualify as a bona fide resident of a foreign country largely on the basis of facts you report onForm 2555, Foreign Earned Income. The IRS cannot make this determination until you file Form 2555.
On the second category, it’s important to note that you don’t need to live abroad for 330 consecutive days. You can come home from time to time, just so long as you live abroad for at least 330 days out of 12 consecutive months. It also does not need to apply to the same taxable or calendar year. You can qualify for the physical presence test even if the 12 consecutive months bridge two separate years.
If you qualify based on one of these three tests, you may deduct up to the maximum amount (again, $120,000 in 2023) from your taxable U.S income. This can only apply to money earned while working overseas. Any money that you earned while working or living in the U.S., most money earned off of investments or any money in excess of the cap, is not subject to the deduction.
Exceptions to the Exclusion
Pay received as part of the military or a civilian employee of the U.S. government does not qualify for this deduction. This is in part because you generally will not be taxed by local governments (and if you are, you likely may claim the foreign tax credit). However, it can apply to working spouses of foreign-based employees of the U.S. government. Further, self-employed workers should note that like all tax deductions this does not apply to your self-employment tax. It only applies to the personal income tax.
You can only claim this deduction for earned income. The IRS has a more complete guide on its website here, but earned income generally includes wages, salaries, professional fees and tips. It does not include categories such as dividends and interest, capital gains or gambling winnings. Depending on your individual circ*mstances business income can qualify, and most self-employed people or freelancers will qualify for this deduction.
As a final note it is essential to understand that this applies only to federal income taxes. If you are still a legal resident of the United States you are legally required to maintain a state or territory of residence. Unless you change that state of residence, it will typically remain the last state or territory in which you paid taxes. You must continue to comply with all tax laws of your state of residence.
Bottom Line
There are a number of tax issues that Americans working or living abroad should be aware of. One of the most important is the foreign earned income exclusion, which is a tax deduction that allows American citizens or legal residents to deduct from their federal tax returns income they earned while living and working overseas. In 2023 it allows you to deduct a maximum of $120,000 of your earnings from federal income taxes.
Tips on Taxes
- Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s tax calculator can show you what you might owe this year.
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Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
FAQs
This exclusion allows qualifying taxpayers to exempt a portion of their income from U.S. federal income taxes altogether. In 2023, you may claim it for up to the first $120,000 (up from $112,000 in 2022) that you earn.
Who qualifies for foreign earned income exclusion? ›
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.
What is the FEIE for 2023? ›
The FEIE limit is adjusted for inflation every year. The 2023 FEIE limit is $120,000, up from $112,000 in 2022, which is the largest increase in recent years.
Is $112000 foreign earned income exclusion? ›
The Foreign Earned Income Exclusion (FEIE) is a US tax benefit that allows you to exclude from taxation a certain amount of foreign-earned income over $100,000. The maximum foreign-earned income exclusion for the 2022 tax year is $112,000.
What is foreign income exclusion? ›
The Foreign Earned Income Exclusion can help reduce or eliminate U.S. taxes on foreign income earned while working abroad, but it doesn't apply to all sources of income. This exclusion is only available for earned income and doesn't apply to passive or investment income such as interest and dividends.
How can I avoid US tax on foreign income? ›
The Foreign Earned Income Exclusion (FEIE, using IRS Form 2555) allows you to exclude a certain amount of your FOREIGN EARNED income from US tax. For tax year 2022 (filing in 2023) the exclusion amount is $112,000.
How does foreign tax exclusion work? ›
Limit on Excludable Amount
The maximum foreign earned income exclusion amount is adjusted annually for inflation. For tax year2021, the maximum foreign earned income exclusion is the lesser of the foreign income earned or $108,700 per qualifying person. For tax year2022, the maximum exclusion is $112,000 per person.
What are the benefits of FEIE? ›
The Foreign Earned Income Exclusion, or FEIE, is also known as Form 2555 by the IRS. This expat benefit allows you to avoid double taxation by excluding up to a certain amount of foreign earned income from your US taxes. In 2023, for the 2022 tax year, you can exclude up to $112,000 of foreign earned income.
What is the maximum foreign earned income exclusion for 2023? ›
For this purpose, the base housing amount for the taxable year is limited to an amount that is tied to the maximum foreign earned income exclusion amount of the qualified individual, which is $120,000 for 2023.
What is the 2023 foreign income exclusion? ›
In 2023, you may claim it for up to the first $120,000 (up from $112,000 in 2022) that you earn. This means that if you earn $120,500, say, you would pay federal income taxes on a total of: $120,500 (your income earned) – $120,000 (the maximum exclusion) = $500.
If you cannot find what you are looking for on this page, please email us at info@palazzotax.com or give us a call at 866-272-9224. *The following states do not allow the foreign earned income exclusion to be included on the state return: Alabama, California, Hawaii, Massachusetts, New Jersey, and Pennsylvania.
What is the physical presence test for FEIE? ›
Generally, to meet the physical presence test, you must be physically present in a foreign country or countries for at least 330 full days during a 12-month period including some part of the year at issue. You can count days you spent abroad for any reason, so long as your tax home is in a foreign country.
Can you take both foreign tax credit and foreign income exclusion? ›
You cannot claim both the Foreign Tax Credit (Form 1116) and the Foreign Earned Income Exclusion (Form 2555) on the same dollar of income. If you exclude the income form your tax return, you cannot also claim a credit on that same income.
Can IRS track foreign income? ›
Yes, eventually the IRS will find your foreign bank account. When they do, hopefully your foreign bank accounts with balances over $10,000 have been reported annually to the IRS on a FBAR “foreign bank account report” (Form 114).
Do I have to pay U.S. taxes on foreign income? ›
Do I still need to file a U.S. tax return? Yes, if you are a U.S. citizen or a resident alien living outside the United States, your worldwide income is subject to U.S. income tax, regardless of where you live. However, you may qualify for certain foreign earned income exclusions and/or foreign income tax credits.
Should I take foreign earned income exclusion or foreign tax credit? ›
The FEIE is generally best for taxpayers whose income is earned in a low- or no-income tax country. It will allow them to shield up to $112,000 (2022 figure) from U.S. taxation, while the Foreign Tax Credit would have little or no benefit since they are in a low- or no-income tax country.
Do you get taxed twice on foreign income? ›
But for expats, double taxation typically refers to having their income taxed by the US as well as the country they've made their home in. The US is one of only two countries in the world with citizenship-based taxation. (The other is Eritrea.)
What happens if you don't report foreign income? ›
As a U.S. taxpayer, you can face penalties for failing to report your foreign-earned income even if you don't owe any federal income tax. The IRS penalizes both failures to report and failures to pay and the penalties for reporting violations can be substantial.
Do US citizens have to pay taxes on foreign unearned income? ›
Is Foreign Unearned Income Taxable? Yes. When expats file their US Federal Tax Returns each year, they must report all of their worldwide income, including both earned and unearned income. Like earned income, you'll include your unearned income in your Adjusted Gross Income (AGI) on your tax return.
Do I have to take foreign earned income exclusion? ›
The foreign earned income exclusion is voluntary. You can choose the foreign earned income exclusion and/or the foreign housing exclusion by completing the appropriate parts of Form 2555.
This is true regardless of whether you retire in the US or abroad. And because your Social Security payments are derived from a US source, they cannot be excluded from taxation using the Foreign Earned Income Exclusion, which only applies to foreign-source income.
Why do US citizens pay taxes abroad? ›
You may wonder why U.S. citizens pay taxes on income earned abroad. U.S. taxes are based on citizenship, not country of residence. That means it doesn't matter where you call home, if you're considered a U.S. citizen, you have a tax obligation.
Is FEIE an itemized deduction? ›
What Is the Foreign Tax Deduction? If you choose to deduct all foreign income taxes on your U.S. income tax return, you must itemize the deduction on Schedule A (Form 1040).
Who can claim foreign tax credit? ›
Qualifying Foreign Taxes
You can claim a credit only for foreign taxes that are imposed on you by a foreign country or U.S. possession. Generally, only income, war profits and excess profits taxes qualify for the credit. See Foreign Taxes that Qualify For The Foreign Tax Credit for more information.
How do I maintain US residency while living abroad? ›
Maintaining A US Address While Living Abroad
- Keep and use U.S. savings and checking accounts. ...
- Maintain a U.S. mailing address. ...
- Ensure all mail, including documents from USCIS (United States Citizenship and Immigration Services), is delivered to this address.
- Have a valid driver's license in the United States.
To sum it up, the Bona Fide Residency test has to do with your economic and social ties, whereas the Physical Presence Test has to do with the number of days you spend outside the U.S. If you're unsure of how your days shake out, use the IRS Physical Presence Test calculator to help you figure it out.
Do I pass the physical presence test? ›
To pass the test, you must spend more than 330 full days overseas within a rolling 12-month period. Pay attention to that “full day” requirement of the 330-day rule — it can trip up unsuspecting expats who haven't tracked their time properly.
What is bona fide residence test? ›
The Bona Fide Residence Test is used by US Taxpayers who are subject to income tax in the US and want to claim foreign-earned income exclusion. To qualify for FEIE, a taxpayer must have been a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.
What is not allowed foreign tax credit? ›
The IRS states the following types of foreign taxes are not eligible for the FTC: Taxes on excluded income (for example, if you've already used the foreign earned income exclusion) Taxes refundable to you. Taxes paid to a foreign country deemed to support international terrorism.
Can I switch between FEIE and FTC? ›
It's possible to claim both the FEIE and FTC, however they can't be applied to the same income.
Per the Bank Secrecy Act, every year you must report certain foreign financial accounts, such as bank accounts, brokerage accounts and mutual funds, to the Treasury Department and keep certain records of those accounts.
Why does the IRS want to know if I have a foreign bank account? ›
Since foreign accounts are taxable, the IRS and U.S. Treasury have a very rigid process for declaring overseas assets. Any American citizen with foreign bank accounts totaling more than $10,000 in aggregate, or at any time during the calendar year, is required to report such accounts to the Treasury Department.
Does IRS audit foreign income? ›
Not Reporting All Taxable Income
When filing your US tax return, you must report your worldwide income. That includes all income from both US and foreign sources. Leaving any income off of your return could result in an audit.
How do I report foreign earned income on my U.S. tax return? ›
You must attach Form 2555, Foreign Earned Income, to your Form 1040 or 1040X to claim the foreign earned income exclusion, the foreign housing exclusion or the foreign housing deduction. Do not submit Form 2555 by itself.
How can I avoid double taxation? ›
If businesses want to avoid dual taxation, they can retain their earnings and not distribute them further. Lastly, they can split their income and pay wages and salaries to the employees to cut their tax burden.
Do US citizens have to pay taxes on foreign income? ›
Yes, if you are a U.S. citizen or a resident alien living outside the United States, your worldwide income is subject to U.S. income tax, regardless of where you live. However, you may qualify for certain foreign earned income exclusions and/or foreign income tax credits.
What is the foreign income exclusion limit for 2023? ›
For this purpose, the base housing amount for the taxable year is limited to an amount that is tied to the maximum foreign earned income exclusion amount of the qualified individual, which is $120,000 for 2023.
What happens if you don't report foreign income to IRS? ›
As a U.S. taxpayer, you can face penalties for failing to report your foreign-earned income even if you don't owe any federal income tax. The IRS penalizes both failures to report and failures to pay and the penalties for reporting violations can be substantial.
Do I have to report foreign earned income? ›
In general, yes — Americans must pay U.S. taxes on foreign income. The U.S. is one of only two countries in the world where taxes are based on citizenship, not place of residency. If you're considered a U.S. citizen or U.S. permanent resident, you pay income tax regardless where the income was earned.
How do I report foreign-earned income on my U.S. tax return? ›
You must attach Form 2555, Foreign Earned Income, to your Form 1040 or 1040X to claim the foreign earned income exclusion, the foreign housing exclusion or the foreign housing deduction. Do not submit Form 2555 by itself.
If you are an American living abroad, you must file a US federal tax return and pay US taxes on your worldwide income no matter where you live at that time. In other words, you are subject to the same rules regarding income taxation as people living stateside.
Does feie apply to state taxes? ›
Can expats who pay foreign taxes avoid California's taxes? Unfortunately, expats can't apply the federal Foreign Tax Credit or Foreign Earned Income Exclusion to their California state tax bill.
Can I take both the foreign earned income exclusion and the foreign tax credit? ›
You cannot claim both the Foreign Tax Credit (Form 1116) and the Foreign Earned Income Exclusion (Form 2555) on the same dollar of income. If you exclude the income form your tax return, you cannot also claim a credit on that same income.
What is the 330 days foreign exclusion rule? ›
Generally, to meet the physical presence test, you must be physically present in a foreign country or countries for at least 330 full days during a 12-month period including some part of the year at issue. You can count days you spent abroad for any reason, so long as your tax home is in a foreign country.
What is the IRS lifetime exemption for 2023? ›
Lifetime IRS Gift Tax Exemption
If a gift exceeds the 2023 annual $17,000 limit, that does not automatically trigger the gift tax. Also for 2023, the IRS allows a person to give away up to $12.92 million in assets or property over the course of their lifetime and/or as part of their estate.
What is the foreign earned income exclusion for 401k? ›
The Foreign Earned Income Exclusion (FEIE) is the maximum income a US expat can earn abroad without paying tax to the IRS. This amount can be excluded from US taxation—whether or not you've paid tax in your country of residence. For 2023, the maximum FEIE amount is $120,000.
