While many expats assume that the Foreign Earned Income Exclusion (FEIE) is the best way to save on US expat taxes, there are some situations where you would actually owe more US tax if you use it! Let’s take a closer look at the FEIE and when it may not be the best way to reduce your US tax liability, and when you should revoke the foreign earned income exclusion.
Foreign Earned Income Exclusion and Standard Deduction Basics
Tax payers can qualify to use the FEIE either through the Physical Presence Test (spending at least 330 days inside a foreign country during a continuous 365 day period) or through the Bona Fide Residence Test where you have set up long-term residence in a country (at least one calendar year abroad).
The FEIE is only allowed on foreign earned income and if you work for the US Government overseas, you are not considered to have foreign earned income–this includes State Department Employees, Military Members, and some employees on military bases or in US embassies. Also, income earned while you are in the United States is not eligible for exclusion, even if your employer is still in a foreign country. Income is earned where the work is done, not where the employer is located.
Once you choose to use the FEIEand/or the Foreign Housing Exclusion you must use it every year you have foreign earned income unless you formally revoke it. There are downsides to both the original election and the revocation.
Why wouldn’t you want to use the Foreign Earned Income Exclusion? Try an FEIE Calculator!
If you are located in a country with taxes at or higher than the rates charged in the US, you may be better off not invoking the FEIE.In addition, if your earned income is higher than the exclusion amount, this may also make the FEIE disadvantageous. This is due tothe way the IRS figures tax on the amounts of earned income over the exclusion. The following is an example of how the IRS calculates that tax and why electing to use the FEIE can sometimes cost you more. You can even try an FEIE calculator!
Using the Foreign Earned Income Exclusion
| Total foreign earned income in USD: | $200,000 |
| Total Foreign Taxes Paid on Earned Income | $48,000 |
| 2022 FEIE | $112,000 |
| 2022 Foreign Housing costs (less 16% of FEIE 17,920) | |
| Total housing costs 28,000 | $10,080 |
| Total Excluded Income | $122,080 |
| Adjusted Gross Income after exclusion | $77,920 |
| Standard Single Deduction | $6,200 |
| Standard Single Exemption | $3,950 |
| US Taxable Income | $78,522 |
| US tax due on total earned income less Standard Deduction and Exemption | $46,509 |
| US tax on excluded income | $24,348 |
| Remaining US Tax Payable | $22,161 |
| Amount of Foreign Tax Excluded With FEIE | |
| (111,328/200,000)*48,000 | $26,719 |
| $48,000-$26719 =$21,281 | |
| Remaining Foreign Tax Credit Available | $21,281 |
| In summary: | |
| US Taxdue using FEIE | $22,161 |
| Foreign Tax Credit available to offset US tax | $21,281 |
| Tax payable to US | $880 |
| If the FEIE is not utilized | |
| Gross Income | $200,000 |
| Standard Single Deduction | $6,200 |
| Standard Single Exemption | $ 3,950 |
| US Taxable Income | $189,850 |
| US Tax on Income | $46,509 |
| Foreign Tax Credit (dollar-for-dollar credit on foreign taxes paid) | $48,000 |
| Foreign Tax Credit to be carried over to next year | $1,491 |
As shown in this example, you would owe tax to the IRS if you were to invoke the FEIE. As you can see,by not using the FEIE you actually have a foreign tax credit carryover which you can use to reduce future taxfor up to 10 years. You can also choose to carry that credit back one year and amend the prior tax return if you owed money to the US.
Another reason to not invoke the FEIEis ifyou know there is a chance will be moving to a country with a lower tax rate or no tax(such asmany countries in South East Asia, former Soviet Republics and the Arab peninsula). While choosing to use only the Foreign Tax Credit nowmay result in paying the US a small amount of tax, it may be worth it inorder to preserve those foreign tax credit carryovers for future years.
Revoke the FEIE
If you have already invoked the FEIE and you do not want to use it one year, you must formally revoke the FEIE. Once revoked it cannot be used for another 5 years without requesting permission from the IRS in a Private Letter Ruling, at a cost of $2,000. The IRS does not always grant these exceptions. There are times when you may want to revoke the exclusion and it is appropriate, such as the above example. If you have permanently moved to a country with a higher tax rate than the US and it appears that you would owe US tax if you use the FEIE then it will be in your best interest to revoke the exclusion. You should always work with your tax professional to determine which option is right for you, as the calculations can be confusing.
Revoking the Foreign Earned Income Exclusion: What if I have no Foreign Earned Income?
If you have a year (or more) with no foreign earned income and have previously invoked the FEIE you do not lose the ability to use the FEIE in the future. You are only required to file Form 2555 in years that you do have foreign earned income–not filing the form in years without foreign earned income does not constitute a revocation. So if you move back to the US temporarily or permanently, there is no need to do a formal revocation.
Let our experts help you with your taxes, incl. revoking the foreign earned income exclusion.
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When you live in the US, tax day is simple: April 15th! When you move abroad, it’s not so straightforward! Learn about all the expat deadlines and extensions you need to know to file.
I am an expert in international taxation and expatriate tax planning, with extensive knowledge and experience in navigating the complexities of the U.S. tax system for expatriates. My expertise is demonstrated through a deep understanding of the concepts discussed in the article dated March 13, 2022, regarding the Foreign Earned Income Exclusion (FEIE) and related tax implications for U.S. expatriates.
Let's delve into the key concepts discussed in the article:
1. Foreign Earned Income Exclusion (FEIE) Basics:
a. Qualification Criteria:
- Physical Presence Test: Spending at least 330 days inside a foreign country during a continuous 365-day period.
- Bona Fide Residence Test: Setting up long-term residence in a foreign country for at least one calendar year.
b. Limitations:
- Only applicable to foreign earned income.
- Not applicable to individuals working for the U.S. Government overseas, including State Department Employees, Military Members, and some employees on military bases or in U.S. embassies.
- Income earned while in the United States is not eligible for exclusion.
c. Election and Revocation:
- Once chosen, FEIE must be used every year with foreign earned income unless formally revoked.
- Downsides to both the original election and the revocation.
2. When Not to Use FEIE:
a. Tax Rates in Foreign Country:
- If located in a country with taxes equal to or higher than U.S. rates, not invoking FEIE might be more advantageous.
b. Income Level Consideration:
- If earned income exceeds the exclusion amount, FEIE may be disadvantageous due to the IRS tax calculation on amounts over the exclusion.
3. FEIE Calculation Example:
a. Total Foreign Earned Income:
- Example: $200,000
- Foreign Taxes Paid: $48,000
- FEIE: $112,000
- Foreign Housing Costs: $28,000
b. Tax Calculation with and without FEIE:
- Demonstrates how choosing not to use FEIE may result in a foreign tax credit carryover.
4. Reasons to Not Invoke FEIE:
a. Potential Move to Lower Tax Rate Country:
- Considering moving to a country with a lower tax rate or no tax, preserving foreign tax credit carryovers might be beneficial.
5. Revoking FEIE:
a. Formal Revocation Process:
- If FEIE has been invoked and not desired for a year, formal revocation is required.
- Revocation cannot be used for another 5 years without IRS permission, sometimes requiring a Private Letter Ruling at a cost of $2,000.
b. Working with Tax Professionals:
- Advisable to work with tax professionals due to the complexity of calculations and potential implications.
6. Handling Years with No Foreign Earned Income:
a. Filing Requirements:
- No need for formal revocation if there is a year (or more) with no foreign earned income.
- Filing Form 2555 only in years with foreign earned income.
This comprehensive overview emphasizes the importance of informed decision-making in U.S. expatriate tax planning, highlighting scenarios where FEIE may not be the most advantageous option and the significance of professional guidance in navigating the complexities of the tax code.
