The foreign earned income exclusion is designed to prevent double taxation by excluding income taxed in another country from U.S. taxation. While the U.S. Internal Revenue Service (IRS) taxes your worldwide income, if you are an American expat, this leads to being taxed twice on the same income. The earnings you receive overseas are taxed in the foreign country and can also be taxed again by the IRS. Discover how to utilize the Foreign Earned Income Exclusion to your benefit.
Key Takeaways
- The foreign earned income exclusion was created to avoid double taxation for Americans living abroad.
- Only U.S. citizens who meet specified criteria may claim the foreign earned income exclusion, including U.S. citizens or resident aliens.
- Resident aliens from countries with which the U.S. has an income tax treaty may also qualify.
- If you live and work abroad, investigate the foreign earned income exclusion while preparing your taxes.
- A foreign housing amount represents the housing costs you incur abroad with foreign earned income.
Mastering the Foreign Earned Income Exclusion
To elect the foreign earned income exclusion on IRS tax Form 2555:
- You must be a U.S. citizen or resident alien. A resident alien is a foreign person residing in the country with no citizenship, requiring a current or previous year’s green card in the U.S.
- You need a qualifying presence in a foreign country. Qualifying presence can be achieved by meeting the bona fide resident test (residing in the country for a full tax year) or the physical presence test (being physically in the country for at least 330 days in a 12-month consecutive period).
- You must have foreign earned income. This includes wages from employment or self-employment services performed in a foreign country but excludes income from foreign-source pensions, investments, alimony, or gambling.
Comprehending the Foreign Housing Amount
The foreign housing amount encompasses the housing costs paid abroad using foreign earned income, beyond 16% of the maximum exclusion amount, but it also has a cap of 30%. For the 2022 tax year, the maximum exclusion is $112,000, increasing to $120,000 in 2023.
Example: MP, an American working in Vietnam, lived in Hanoi for 345 days and earned a salary of $225,000—paying $30,596 for housing. By applying the foreign earned income exclusion and housing amount, MP avoids U.S. taxation on much of this income, although some residual amount might still be taxed, requiring using the foreign tax credit.
Qualifying for the Foreign Earned Income Exclusion
To qualify, you must be a U.S. citizen or resident alien physically present in another country for at least 330 days during 12 consecutive months, or a U.S. citizen who is a legal resident of a foreign country for an uninterrupted full tax year. Resident aliens from countries with an applicable tax treaty must also fulfill residency conditions.
Foreign Earned Income Exclusion for 2022
For 2022, the exclusion limit is $112,000, and for 2023, it increases to $120,000. Income within these thresholds will not be taxed.
U.S. Taxes on Foreign Income
Yes, as a U.S. citizen or resident alien, you are obligated to pay taxes on all foreign earned income, regardless of your residency status; however, you may be eligible for the foreign earned income exclusions or foreign income tax credits.
Related Terms: Double Taxation, Resident Alien, Foreign Tax Credit, Taxable Income, Nonrefundable Tax Credit.
References
- Internal Revenue Service. “Foreign Earned Income Exclusion”.
- Internal Revenue Service. “Foreign Housing Exclusion or Deduction”.
- Internal Revenue Service. “Form 2555, Foreign Earned Income”.
- Internal Revenue Service. “Instructions for Form 2555”, Pages 2–3.
- Internal Revenue Service. “Topic No. 851 Resident and Nonresident Aliens”.
- Internal Revenue Service. “Foreign Earned Income Exclusion - Bona Fide Residence Test”.
- Internal Revenue Service. “Foreign Earned Income Exclusion - Physical Presence Test”.
- Internal Revenue Service. “Foreign Earned Income Exclusion - What Is Foreign Earned Income”.
- Internal Revenue Service. “Figuring the Foreign Earned Income Exclusion”.
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2023”.
- Internal Revenue Service. “Figuring the Foreign Earned Income Exclusion”.
- Internal Revenue Service. “Form 1116, Foreign Tax Credit (Individual, Estate, or Trust)”.
- Internal Revenue Service. “Frequently Asked Questions (FAQs) About International Individual Tax Matters”.
