A lot of expats look into the Foreign Earned Income Exclusion as a line of support to help them keep more of their earnings. This comes in handy especially as they negotiate the challenges of living abroad.
Complying with US tax rules and optimizing the advantages of this deduction depend on your understanding of the qualifying requirements, which include passing certain residence tests.
We will go into detail about Foreign Earned Income Exclusion meaning in this post, including how it operates, who is eligible and what are the requirements, plus other relevant details.
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What is Foreign Earned Income Exclusion?
A percentage of foreign-earned income can be exempt from US taxes for both US citizens and resident aliens residing overseas thanks to the Foreign Earned Income Exclusion or FEIE.
Because income earned abroad may be subject to taxation by both foreign and US governments, this clause helps avoid double taxes.
Individuals can use the FEIE to exclude eligible overseas earnings, but it does not remove the requirement to submit US tax returns, even though it lowers taxable income.
The maximum exclusion amount was set at $120,000 in 2023. It rose again in 2024 to reflect inflation.
For individuals who meet the requirements, this amount may be excluded from taxable income. This greatly lowers their tax burden.
Nevertheless, the exclusion does not apply to passive income such as dividends, pensions, interest, or rental revenue; rather, it only covers wages, salaries, and income from self-employment.
The exclusion amount will be adjusted if the person does not meet the requirements for full-year residency or presence overseas.
FEIE Eligibility
Taxpayers must fulfill certain Foreign Earned Income Exclusion requirements in order to be eligible. They are as follows:
Tax Home
For the duration of their genuine residency or physical presence, the taxpayer’s tax home must be in a foreign nation. So, they need to have a permanent address or a regular place of business overseas.
Bona Fide Residence Test
For the duration of the entire tax year, individuals must continue to have a legitimate residence in a foreign nation. This suggests that they have made that nation their home and have more ties there than with the US.
Exceptions
- If you have to flee a foreign nation because of a war, civil disturbance, or other comparable unfavorable circumstances, the IRS may relax the time limits for the bona fide residence test.
- Should you terminate your overseas residence, the bona fide residence period ends on the final day of the tax year when such was executed.
Physical Presence Test
As an alternative, the person may be eligible if they spend a minimum of 330 days of their calendar year physically present in a foreign nation.
Exceptions
- If you are forced to flee a foreign nation due to a war, civil turmoil, or other similar unfavorable circumstances, the IRS can dismiss the physical presence requirement.
- Occurrences like illness, vacation, or business trips will not be taken into account for the 330-day physical presence test.
Anyone employed by the US government are not permitted to claim any Foreign Earned Income Exclusion benefit.
How to claim Foreign Earned Income Exclusion
In addition to their yearly tax return, taxpayers need to file IRS Form 2555. The foreign earned income and the exclusion’s rationale are shown on this form.
Foreign Earned Income Exclusion vs Foreign Tax Credit
- A portion of your foreign-earned income may be excluded from your US taxes under FEIE. By using the Foreign Tax Credit or FTC, you can deduct the sum of foreign income taxes you have paid from your US tax obligations.
- Income from investments or passive sources that is not covered by the FEIE may be eligible for FTC reimbursement.
- The same revenue cannot be used for the FTC if you use the FEIE. For any foreign income that is not covered by the FEIE or for income that exceeds the FEIE limit, you may still use the FTC.
- To prevent receiving two benefits, deduct the FEIE amount from your foreign income when calculating the FTC.
- Should the FEIE prevent you from utilizing all of your foreign tax credits for the year, you might be able to roll them over to subsequent tax years.
- To use the FEIE, file IRS Form 2555 and report it on Schedule 1 of Form 1040. To use the FTC, file Form 1116 and report it on Schedule 3 of Form 1040.
The Foreign Earned Income Exclusion supersedes the Foreign Tax Credit if you claim both in the same tax year. Apply the exclusion first if you are eligible for the FEIE due to your foreign income.
You may be eligible to roll over any foreign tax credits that you were not able to use this year due to the FEIE to future tax years.
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