The Foreign Earned Income Exclusion: A Complete Guide for Expats 

If you’re an American living abroad, the Foreign Earned Income Exclusion (FEIE) could save you thousands of dollars on your US taxes. In this guide, we’re going to look at some important questions about the FEIE, such as: 

• What is the Foreign Earned Income Exclusion? 
• How can I qualify for the FEIE? 
• How much can I save using the FEIE? 

Armed with the answers to these questions, you’ll be well on your way to reducing your US tax bill.  Here’s a quick rundown of what the foreign-earned income exclusion is for 2023 and how it works.

What Is the Foreign Earned Income Exclusion? 

The Foreign Earned Income Exclusion is a tax benefit that allows you to exclude a certain amount of foreign-earned income (over $100,000 USD) from US taxation. 

The FEIE is one of the ways that the IRS helps expats avoid double taxation on their foreign-sourced income. Because the IRS assumes that you will be taxed in your country of residence on your foreign-earned income, it allows you to exclude this income from US taxation using the FEIE. 

How Much Can I Exclude with the Foreign Earned Income Exclusion? 

Every year, the amount of the FEIE is adjusted for inflation. Sometimes, this can cause confusion since early projections of the new FEIE limit may underestimate or overestimate the allowed excludable amount. 

The FEIE limit for the 2022 tax year is $112,000. Thanks to inflation, in the 2023 tax year (Filed in 2024) FEIE limit will increase to $120,000. This is the largest increase we have seen in recent years.

How to Qualify for the Foreign Earned Income Exclusion 

There are two tests that can determine whether you qualify for the FEIE, the Physical Presence Test and the Bona Fide Residence Test. Let’s take a closer look at both. 

1. Using the Physical Presence Test to Qualify for the FEIE 

The  Physical Presence Test is one way Americans working overseas can qualify for the FEIE and save money on their US tax return. 

To pass this test, all of the following must be true: 

• You 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. 
• You have a tax home in a 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.
• You have been physically present in a foreign country for at least 330 days out of any 12-month 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 does not count. It’s critical that you track travel days carefully if planning to use the Physical Presence Test, as you’ll need to be able to show details to the IRS if requested. 

2. Using the Bona Fide Residence Test to Qualify for the FEIE 

The alternative to qualifying with the Physical Presence Test is by using the Bona Fide Residence Test. 

To use this test, ALL of the following must be true: 

• You have foreign-earned income– This is the same requirement as for the Physical Presence Test. You must have income earned in a foreign country to pass the test and use the FEIE to save on your US taxes while abroad. 
• You have a tax home in a foreign country– Again, this is the same requirement for using the Physical Presence Test to qualify. You must establish a tax home and live full-time with no intentions of returning to the US. For contractors, the IRS will assume that when your contract ends, you will return to the US, so contractors can not use the Bona Fide Residence Test.
• You have been a bona fide resident for a full tax year. The definition of a “bona fide resident” can be murky. The biggest factor here for passing the test is that you must demonstrate that you are permanently living abroad with no immediate plans to return to the US. This would include having a long-term lease or owning a home, having local bank accounts and utility bills, etc. To learn more about bona fide residency, visit the IRS website. 

Having a Home in the US Affects Bona Fide Residency 

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, the government classifies your tax home where you primarily live and work, regardless of real estate or foreign rental income. 

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 property back in the States, you could rent it out, let your 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. 

Which Test Should I Use to Qualify for the Foreign Earned Income Exclusion? 

Before deciding which test you’ll use to qualify for the FEIE, it’s important to fully understand the difference between the Bona Fide Residence Test and the Physical Presence Test. 

Often, your specific situation will determine which test is the best option for qualifying for the FEIE. For instance, if you are on a foreign assignment with a specified end date (but for at least 330 full days), you’ll likely need to use the physical presence test. 

Whereas, if you have moved to a foreign country with no intentions of returning, you’ll likely need to use the Bona Fide Residence test. (Other factors also need to be considered while determining which test is best for you)

Which Form Do I Use for the Foreign Earned Income Exclusion? 

Once you’re confident you qualify for FEIE, you’ll need to complete and attach  Form 2555 as part of your federal tax return. 

To complete foreign earned income exclusion Form 2555, you will need to know the following: 

• Which test are you using to qualify (bona fide residence or physical presence) 
• Dates you traveled internationally to/from the US during the tax year 
• Your prior year Form 2555 (if available) 
• Documentation of your foreign-earned income 

Each expat is required to complete their own Form 2555—even spouses. If you file as married filing jointly, each spouse will need to complete their own Form 2555. You’ll then attach both forms to your joint tax return. 

What Is Foreign Earned Income? 

The FEIE only allows you to exclude  foreign-earned income from your US expat taxes. For US expats, the term refers to your wages from working outside of the US. It does not include investment income or passive income. This means that if you are a real estate investor in Costa Rica and rent out properties for a living, any rental income will not qualify as “foreign earned income” for the FEIE. But what exactly is foreign-earned income? To understand this concept, we must look at what the IRS considers “earned income” and “foreign income.” 

What Is Earned Income? 

Earned income is the opposite of passive income. Passive income means income that is not directly related to traditional work, such as income from interest, capital gains, or a retirement plan. Earned income, on the other hand, means any income you’ve earned by working, such as: 

• Wages 
• Salaries 
• Bonuses 
• Tips 
• Commissions 
• Vacation pay 
• Sick leave 
• Severance pay 
• Union strike benefits 
• Disability benefits 
• Self-employment income 

Only earned income can be excluded using the FEIE. Passive income does not qualify. 

What Is Foreign Income? 

Generally, the IRS classifies income as foreign or domestic based on where it is earned. If you are living and working abroad, your income is considered to be foreign-earned income, even if a US company is paying you.

The opposite is true as well.  If you work in the US, your earnings are considered US-earned income.

This is true no matter who pays your salary, whether a US company or a foreign company.

In most cases, if the IRS considers your income to be both earned and foreign, it can be excluded using the FEIE.

Foreign Earned Income Exclusion Extensions 

Are you an expat who hasn’t been out of the country long enough to claim the Foreign Earned Income Exclusion (FEIE)? Don’t worry – you may be able to request an extension to file your expat taxes until you meet the time requirements. 

Typically, you must claim the FEIE within one year of your return’s due date or by amending a timely filed return. However, there are exceptions. If the IRS hasn’t discovered your failure to file your return claiming the exclusion, or you owe no tax after taking the exclusion into account, you may still be able to claim the exclusion. 

Even if you haven’t filed returns in prior years, you might still be able to exclude your foreign-earned income from US tax. Doing so could eliminate your tax liability and avoid any penalties and interest that would be assessed. 

Don’t let the fear of missing the FEIE deadline keep you from filing your expat taxes on time – request an extension and speak with tax professionals like Greenback to ensure you’re taking advantage of all available tax benefits. 

Common Foreign Earned Income Exclusion Mistakes 

1. Thinking You Don’t Need to File a US Tax Return If You Qualify for the FEIE 

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 to exclude this income, you must qualify and fill out the required Form 2555. 

2. Failing to Prorate the FEIE When Needed 

Under the Physical Presence Test, you can qualify for the FEIE by being outside the US for 330 days out of any 12-month period. This 12-month period does not need to be the same as the tax year. For instance, you could qualify for the FEIE by living outside the US from April to April (rather than the tax year, which is January to December). 

However, if you move abroad midyear, you will not be able to claim the full FEIE amount, which is intended for the full tax year. You will only be able to claim the portion of the FEIE that corresponds with the amount of time you spent abroad. 

To figure out your maximum exclusion amount, simply multiply the maximum excludable amount for the year by the number of your qualifying days in the year. Then, divide that number by the number of days in the year. 

For example, if you moved abroad in April 2022, you would calculate your FEIE amount for the 2022 tax year as follows:  

$112,000 (FEIE limit in 2022) x (274 days (number of qualifying days) ÷ 365 (total number of days in the year)) = $84,076  

What Other Tax Benefits Can Expats Use to Reduce Their US Tax Liability? 

1. The Foreign Tax Credit 

Another provision to help avoid double taxation is the Foreign Tax Credit. The Foreign Tax Credit lets Americans offset their US tax bill based on taxes they’ve paid (or owe) to a foreign government. 

It’s worth noting that the Foreign Tax Credit is a true credit, not a deduction. What’s the difference? 

• Tax deductions reduce how much of your income is subject to taxation. Specifically, a deduction lowers your taxable income by the percentage of your federal income tax bracket. For example, if you fall into the 32% tax bracket, a $1,000 deduction would reduce your final tax bill by $320. 
• By contrast, tax credits reduce your tax bill by a dollar-for-dollar amount. This means that a $1,000 tax credit would reduce your final tax bill by the exact same amount—$1,000. 

As mentioned above, the Foreign Tax Credit is a credit. This means that you can use it to reduce your final tax bill by whatever amount you can claim, dollar for dollar. If you owe $4,000 in US taxes but can claim a $1,500 Foreign Tax Credit, you’ll only have to pay $2,500 ($4,000 – $1,500 = $2,500). 

The amount you can claim as a Foreign Tax Credit will depend on what you pay (or owe) to a foreign government. This often means that Americans living in countries with a higher income tax rate than the US—such as Japan—can erase their US tax debt entirely. 

However, the Foreign Tax Credit only applies to certain types of income, and there are unique considerations related to each foreign country. There is also a cap on how much you can claim each year. 

Most importantly, you can claim both the Foreign Tax Credit and the FEIE in the same year, just not on the same income.

2. Foreign Housing Exclusion 

If you qualify for the FEIE, you are also eligible for the Foreign Housing Exclusion. 

The Foreign Housing Exclusion allows you to reduce your US taxable income by a portion of your qualifying housing expenses. Qualifying housing expenses typically include rent, utilities (except TV and internet), insurance, property taxes, and furniture rentals. 

Like the FEIE, to qualify for the Foreign Housing Exclusion, you must pass either the Physical Presence Test or the Bona Fide Residence Test. 

The specific amount of housing costs that you can exclude depends on the country and city in which you reside. Generally, if you live in a city with a higher cost of living, you can exclude a higher amount from your US expat taxes. 

Use this  Foreign Housing Exclusion calculator  to determine the amount you’ll be able to exclude. 

Electing and Revoking the Foreign Earned Income Exclusion: When It May Cost You More 

Once you choose the FEIE (and/or the Foreign Housing Exclusion), you must use it every year you have foreign earned income—unless you formally revoke it. 

Once revoked, you cannot use the FEIE for another five years without requesting permission from the IRS in a Private Letter Ruling at the cost of $2,000. The IRS does not always grant permission, either. 

There are times when expats benefit from revoking the FEIE. Expats often do this to use the Foreign Tax Credit to offset their US taxes instead of the FEIE. In these cases, the individual has typically moved permanently to a country with a higher tax rate than the US and earns more than the amount they can exclude with the FEIE.

You should work with your tax professional to determine if electing or revoking the FEIE is right for you, as the calculations can be confusing. 

Who Should Claim the Foreign Earned Income Exclusion in 2023?

When it comes to claiming the Foreign Earned Income Exclusion (FEIE), it’s crucial to understand not only who can claim it, but also who should claim it. The FEIE can be particularly advantageous for expats who meet specific criteria, including earning less than the annual FEIE threshold, having only earned income, not paying foreign income tax or paying at a lower rate than the U.S., and meeting IRS criteria for living abroad, such as the “physical presence test” or “bona fide residence test.”

This makes the FEIE an excellent option for digital nomads who frequently travel from country to country in short stints, as they may be able to entirely avoid paying foreign income taxes by meeting the IRS criteria and spending at least 330 days a year abroad without maintaining a U.S. household.

However, the FEIE may not be suitable for expats with significant unearned income, earning over the annual FEIE threshold, paying foreign income taxes at a higher rate than the U.S., or unable to fulfill the IRS criteria to prove their residency abroad. In such cases, alternative tax strategies may be more appropriate.

While the FEIE can provide valuable tax benefits for eligible expats, it’s crucial to carefully assess your individual circumstances and seek guidance from a qualified tax professional service like Greenback to determine if claiming the FEIE is the right choice for you.

Let Greenback Help You Save Money with Foreign Earned Income Exclusion  

The Foreign Earned Income Exclusion is a great tool for US expats to reduce their tax liability. Contact us, and one of our customer champions will be happy to help. If you need very specific advice on your specific tax situation, you can also click below to get a consultation with one of our expat tax experts.