Tips and Updates on the Foreign Earned Income Exclusion

Tips for Foreign Earned Income Exclusion 2019

The Foreign Earned Income Exclusion (FEIE) is a handy money-saving provision that you’re definitely going to want to become familiar with if you happen to be an expat. How can you qualify for the exclusion? How is the maximum amount of the Foreign Earned Income Exclusion for the 2020 tax year determined? Get the answers you need below.

How You Can Use the Foreign Earned Income Exclusion Example

The foreign earned income exclusion example is one of the ways that the IRS helps expats avoid double taxation on their foreign sourced income. To use this handy exclusion, you’ll need to qualify by using either the bona fide residence test or the physical presence test.

Using the Physical Presence Test to Qualify for the FEIE

The Physical Presence Test (PPT) is one way Americans working overseas can qualify for the FEIE and save money on their US Tax Return. In order to pass this test, you must have:

  • Foreign Earned Income. This would include a salary, wages, bonus or self-employment income. Note that this does not include dividends, interest, pension distributions or capital gains.
  • A “Tax Home” in the Foreign Country. This is often misunderstood when attempting to qualify for tax benefits, but a “tax home” is where an individual is permanently or indefinitely engaged in work – regardless of where their personal residence is. To establish a “tax home,”, you must have a work engagement expected to last at least one year. If you’ve retained a personal residence (abode) in the US, you can’t be considered to have a tax home in a foreign country. Learn more about this requirement on the IRS website.
  • Been Physically Present in a Foreign Country for the Necessary Time frame. This time frame is 330 days out of a 365-day period. This does not have to be on a calendar-year basis, and can be adjusted over a two-year span as needed to qualify. An important thing to note is that you must spend 330 full days in the foreign country, as partial days and time spent traveling do not count. It’s critical that you track travel days carefully if planning to use the PPT, as you’ll need to be able to show details to the IRS if requested. Visit this link to download an app that will help you keep track of your days and travel.

Using the Bona Fide Residence Test to Qualify for the FEIE

The alternative to qualifying with the PPT is by using the Bona Fide Residence Test (BFT). In order to use this test, you must have:

  • Foreign Earned Income. This is the same requirement as for the PPT; you must have income earned in a foreign country in order to pass the test and use the FEIE to save on your working overseas tax.
  • A “Tax Home” in a Foreign Country. This is the same requirement for using the PPT to qualify. You must establish 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.
  • Been a Bona Fide Resident for the Specified Amount of Time. This means you must have been a bona fide resident of a foreign country for an entire tax year. The biggest factor here for passing the test is that you must demonstrate intent to stay in the foreign country indefinitely with no immediate plans to return to the US. You can read more about the specifics of a bona fide resident here.

Having a Home in The US

If you’re like many expats, you may still have a home in the US. What you do with this home and how you classify it can make a difference in the types of tax benefits you will get as an expat. Generally speaking, the government classifies your ‘tax home’ where you primarily live and work. 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 physical home back in the States, you could rent it out, let 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.

Foreign Housing Exclusion

While we’re on the subject of housing, it’s a good idea to discuss the Foreign Housing Exclusion. You can use this exclusion in addition to the FEIE, increasing the FEIE by the amount of your qualified housing expenses. There are two different ways this is calculated:

  • If you’re a salaried wage earner, you may qualify for the Foreign Housing Exclusion.
  • If you are self-employed, you may qualify for a deduction.

The exclusion or deduction amount depends on the country in which you reside – there is a calculation you can follow to figure this out. It will look like this:

Housing Expense Limitation – Base Housing Cost = Maximum Housing Exclusion

Note that if you live in a city with a higher cost of living, you may be able to exclude an even higher amount from your US expat taxes. In terms of expenses allowed, you can use rent, utilities (except TV and internet), insurance, property taxes and furniture rental.

As a US expat, the Foreign Earned Income Exclusion and other tax exclusions/deductions are great tools for reducing your tax liability. It’s always a good idea to understand these benefits and discuss any questions with an expat tax professional in order to save big on your US expat taxes!

How Will You Qualify for the Foreign Earned Income Exclusion?

Your specific situation as a US expat will determine which test is the best option for qualifying for the FEIE. If you are a contractor or are on an assignment that has a specified end date (but for at least 330 full days), you’ll likely need to use the PPT to save on your working overseas tax (read about expat tax implications for contractors here). In any event, it’s a good idea to consult with an expat tax professional to better understand requirements for your US expat taxes.

Once you’re confident you qualify, you’ll need to attach Form 2555 or Form 2555-EZ alongside your Federal Tax Return. As you may have guessed, Form 2555-EZ is indeed easier to fill out and requires less paperwork. However, you should only use Form 2555-EZ if you are not planning on utilizing the Foreign Housing Exclusion, because that would preclude you from doing so. If you plan to deduct qualified housing expenses, you’ll need to use Form 2555, but that one form allows you to elect to use both the FEIE and the Foreign Housing Deduction.

The Foreign Earned Income Exclusion 2020 Limits

Every year, the amount of the FEIE is adjusted for inflation. And sometimes, this can cause confusion. For instance, early projections of the new FEIE limit may underestimate or overestimate the allowed excludable amount. The Foreign Earned Income Exclusion limit for 2020 will be $107,600.

Avoid Common Foreign Earned Income Exclusion 2020 Mistakes

According to the IRS, a frequent error made by those who want to use the FEIE is assuming that, since the income is excludable from tax, the taxpayer is not required to report income under the limit. In other words, some taxpayers believe the exclusion recuses them from filing requirements if their income is under the limit. Don’t make that mistake! You must still file annual Federal Tax Returns, and in order to exclude this income, you must qualify and fill out the required Form 2555.

Lastly, if you qualified for the exclusion but were in your resident country for less than a full year, you’ll have to adjust the amount of the FEIE used. To figure out what your maximum exclusion amount is, simply multiply the maximum excludable amount for the year by the number of your qualifying days in the year. Then, you’ll want to divide that number by the number of days in the year.

Let Greenback Help You Save on You Expat Taxes

There are plenty of tax-saving opportunities for expats. Our expert accountants can help you uncover the tax credits and foreign earned income exclusions that apply to you. Get started with Greenback, and we’ll make becoming tax compliant a cinch.