Living overseas opens up a lot of new lifestyle opportunities and adventures – I would never have considered eating fried tacos for breakfast when I lived in Virginia. But did you know that US citizens who live abroad may also get the benefit of one of the best tax breaks available? Okay, that information might only be a lifestyle opportunity that excites a tax attorney like myself, but it should at least perk up your ears, even if it doesn’t make you do a little jig.
The foreign earned income exclusion (FEIE) allows US citizens who work in a foreign country and who meet certain other requirements to exclude up to $112,000 in 2022 (up from $108,700 in 2021) of earned income from US income tax. Certain foreign housing costs may also be excluded or deducted. To put that in perspective, for a single filer paying income tax at a rate of 24%, the tax on $112,000 is over $26,000. A married filing jointly couple paying income tax at a 22% rate would pay $24,000. That’s a lot of bread to pay in taxes.
To claim the foreign earned income exclusion, you must have:
- Foreign earned income;
- A tax home in a foreign country; and
- Be either:
- A US citizen who is a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year, or a
- A US citizen who is physically present in a foreign country for at least 330 full days during any period of 12 consecutive months.
The FEIE and foreign housing amount are claimed on Form 2555, Foreign Earned Income, which is attached to the Form 1040, US Individual Income Tax Return.
Here is some basic information to help you determine whether to speak with a tax professional about claiming the foreign earned income exclusion or foreign housing amount for 2022.
Do you have foreign earned income?
Earned income is money that is paid to you for your personal services – such as from your work as an employee or from self-employment. For example, if you work remotely for a company as an employee, the wages you receive for your work are considered earned income. Those wages, along with income tax and social security tax that was taken out of your earnings, will be reported to you at the end of the year on Form W-2, Wage and Tax Statement.
If you are self-employed, the money you receive for the work you do is earned income if it is paid for your personal services. As an example, the money I received for this article is income paid for my personal services of writing and is considered earned income. If you are self-employed, (also known as an independent contractor) the person who pays you may give you a Form 1099-NEC, Non-Employee Compensation, at the end of the year. If you are not given a 1099-NEC (or in some cases, a Form 10990-MISC, Miscellaneous Income) it is your responsibility to total what you earned during the year and report that amount as income on your tax return.
What turns earned income into foreign earned income is the location where the services are performed. Thus, if you live in Mexico and work from home as an employee, the wages you earn are foreign earned income. This is true even if you work for a US company and the wages are deposited to your US bank account. As a self-employed person, because I wrote this article while sitting at my desk in Mexico, it is foreign earned income.
If the services are performed in the US, the income is not considered to be from foreign sources even if you are paid while in the foreign country. So, I definitely did not write this article while visiting my father in New Jersey. That would mean the earned income was not foreign earned income, and it would not be excluded under the foreign earned income exclusion.
Money you receive as dividends, interest, social security benefits, or from a retirement account is not earned income. Rental income is not earned income unless significant personal services are performed in connection with the rental. If you operate the property in the manner of a hotel or a traditional bed and breakfast, a percentage of the rental income may be considered to be earned income. However, minor services such as maintenance and collecting rent are not significant personal services. So listing a home you own in a foreign country on AirBnB or VRBO, checking guests in, and recommending restaurants and local activities isn’t considered providing personal services that would turn passive rental income into foreign earned income.
Do you have a tax home in a foreign country?
Your tax home is the place where you regularly work. If you are self-employed and live and work outside the US, you are most likely going to be considered to have a tax home in a foreign country, even if you go back and forth to the US for personal or business visits. Remember, however, any income you earn while you are in the US is not foreign earned income.
Employees who are permanently or indefinitely assigned overseas are considered to have a tax home in a foreign country. Generally, assignments that are expected to last more than one year are considered indefinite. Temporary overseas assignments do not create a foreign tax home. Generally, assignments expected to last one year or less are considered temporary because the expectation is that you will return to live and work in the US.
If you own a house in the US, it does not mean that your tax home is in the US. But if you have a home in the US and you use it as your primary residence, even though you travel overseas frequently for work, it probably means that you do not have a tax home in a foreign country.
Did you meet the bona fide residence test or the physical presence test?
Even if you have a tax home in a foreign country and have foreign earned income, you won’t qualify to exclude income under the FEIE unless you meet either the bona fide residence test or the physical presence test.
Are you a bona fide resident of a foreign country?
To qualify for bona fide residence, you must live in a foreign country for an uninterrupted period that includes an entire tax year. Generally, this means that you must live overseas from January 1 through December 31. For example, if you moved to Mexico in December of 2021, lived there for the entirety of 2022, and moved back to the US in January 2023, you could meet the bona fide residence test for 2022. Short trips to the US during the year for vacation or business do not impact your bona fide residence as long as you have a clear intention to return from those trips to your foreign residence.
But time abroad is only part of the equation to establish a bona fide residence. The Internal Revenue Service (IRS) will also consider factors such as your intention regarding the length and purpose of your trip, whether you have established a home in a foreign country, and your involvement with the activities of the community. These details do not need to be reported on the Form 2555 (the form on which you claim the FEIE), but if the IRS were to audit your return, things like whether you open an account with a local bank, get a drivers’ license or library card, or volunteer with a local charity can be relevant. Voting in US elections does not negatively impact your bid for bona fide resident status.
If you are not a bona fide resident, you can still meet the physical presence test.
If you have a tax home in a foreign country and have foreign earned income, but don’t satisfy the bona fide residence test, you can still meet the physical presence test. The physical presence test requires that you are in a foreign country for at least 330 full days during a 12-month period. The factors regarding intent, residence, and purpose that are important to bona fide residence are not considered. The test is based entirely on how long you stay outside the US, no matter the reason. For this test, a day means a 24-hour day. So days that you arrive or depart from a foreign country don’t count as part of the 330 days.
The 12-month period can be any consecutive period of 366 days. It can begin on any day of the week, and does not have to begin with the first day you were in a foreign country or end on the day you leave. If you arrived in Mexico on December 15, 2021 and returned to the US on December 25, 2022, you could meet the physical presence test for 2022 because you spent more than 330 days in a foreign country during a 12-month period. In this scenario, you could even have traveled to the US during the year for a short visit and still have met the 330-day threshold.
What else is there to know about the FEIE?
You do not have to claim the foreign earned income exclusion.
Even if you meet the requirement to claim the FEIE, you are not required to file Form 2555. Now, you may ask, why wouldn’t you want to exclude money from taxation? The answer is because the IRS doesn’t allow you to double dip. In other words, you can’t use income excluded using the FEIE to calculate other tax credits that are based on total income, such as the foreign tax credit, the additional child tax credit, and the earned income credit. You should speak with a tax professional to determine whether excluding income under the FEIE or including the income and taking credits provides the most tax benefit in your situation.
Revoking an election to claim the foreign earned income exclusion.
If you do file Form 2555, you must file Form 2555 in subsequent years if you are eligible, unless you revoke your election. To revoke, you must attach a statement of intent to revoke to your return. You may want to revoke an election if you have minimal foreign earned income and want to apply that income to increase one of the credits mentioned above. However, once an election has been revoked, you must seek IRS approval to re-elect the foreign earned income exclusion within 5 years of the revocation. Again, it’s a good idea to discuss your options with your tax professional if you are contemplating revoking an election.
Social security tax
Finally, filing Form 2555 does not reduce or eliminate any social security tax due on your foreign earned income. This tax should still be withheld by your employer. If you are self-employed, social security tax is calculated and reported by you on Form 1040 (Schedule SE), Self Employment Tax.
One more thing: The Foreign Housing Amount
If you qualify to exclude income under the FEIE, you may also be able to exclude or deduct your foreign housing amount. The foreign housing amount is the total of your reasonable housing expenses. This could include rent, utilities, insurance, and residential parking. The cost of buying or improving property, mortgages, or domestic labor such as house cleaning or cooking are not eligible expenses.
The limit on expenses used to calculate the foreign housing amount changes each year and can be computed on a worksheet in the Instructions to Form 2555, Foreign Earned Income. The location where you live, whether you receive employer-provided housing or are self-employed, and the number of days you maintain a foreign home all affect the amount that can be excluded or deducted as the foreign housing amount.