#Foreign #Earned #Income #Exclusion #Overview #FAQs
What is the Foreign Earned Income Exclusion?
The foreign earned income exclusion is an Internal Revenue Service (IRS) policy that subtracts income earned and taxable in a foreign country from income taxable in the United States. Expats must still file tax returns in the United States
In general, American taxpayers are required to pay income taxes on their earnings worldwide, not just within the United States. However, the exclusion of income earned abroad prevents double taxation on Americans who live and work abroad.
Key takeaways
- The foreign earned income exclusion was created to avoid double taxation for Americans living and working abroad.
- If you live and work abroad, use IRS Form 2555 to exclude your foreign income from U.S. taxes.
- There is also a deduction for foreign housing paid for by income earned abroad.
Maximum exceptions for ’24 and ’25
For tax year 2024, the maximum exclusion for foreign-earned income is $126,500. For tax year 2025, the maximum is $130,000.
Understanding the Foreign Earned Income Exclusion
The foreign earned income exclusion is reported on IRS Tax Form 2555. The same form is used to claim the housing exclusion, or deduction, which is deducted from tax amounts paid by an employer for housing in a foreign country.
You must meet certain qualifications to claim the foreign-earned income exclusion:
- You are a US citizen or resident alien. A resident alien is a permanent resident without citizenship. To fall under this classification in the United States, a taxpayer must have a current green card or have had one within the past calendar year.
- You have a qualified presence in a foreign country. Qualifying attendance status is met by residing in the foreign country for a full tax year. You can also take the physical presence test by being physically there for at least 330 days during a consecutive 12-month period.
- You have foreign earned income. You have foreign earned income if you receive wages or receive self-employment income from work performed in a foreign country. Income you receive from pensions, investments, alimony or gambling from foreign sources is not foreign-earned income.
Foreign housing amount
There is a maximum exclusion amount plus the foreign residence amount that limits the exclusion. It is prorated if the number of qualifying days in a foreign country is less than a full tax year.
The foreign housing amount is the housing costs you paid with foreign earned income in excess of the base housing amount. The basic housing amount is 16% of the maximum foreign earned income exclusion calculated on a daily basis.
This means that in 2024, when the maximum annual exclusion is $126,500, an individual’s base housing amount is the number of qualifying days for housing expenses multiplied by $52.60 (16% of $126,500 is $20,240, $20,240 divided over 365 days equals $55.45 per day). .
The maximum annual exclusion rises to $130,000 for tax year 2025.
For most people, excluded housing expenses are capped at 30% of the maximum exclusion amount, although there are exceptions for taxpayers who live in high-cost areas.
The foreign housing amount is taken as an exception by employees and as a deduction by self-employed individuals.
Example of foreign earned income exclusion
Let’s see how the foreign earned income exclusion works.
Michael is an American working in Vietnam. He lived in Hanoi for 355 days of the tax year and was absent for 10 days on a trip home for Thanksgiving. He received a salary of $225,000, of which he paid $33,600 to rent an apartment for the year. The MP paid the equivalent of $75,000 in Vietnamese income tax.
Michael also owed $81,000 in U.S. income tax excluding foreign earned income, the foreign residence amount, and the non-refundable foreign tax credit available to U.S. taxpayers who pay taxes abroad.
Because Michael is a U.S. citizen who paid foreign taxes on income earned over 355 qualifying days, he can exclude $126,500 of income earned abroad from his U.S. taxable income for tax year 2024. Additionally, he can deduct a foreign residence amount of $15,040 ($33,600 housing costs – $16,944 base amount).
Because his income exceeds the cap for the year, Michael must receive an additional non-refundable foreign tax credit for the U.S. taxes owed.
As long as he files Form 2555 to elect the foreign earned income exclusion and Form 1116 to claim the foreign earned income tax credit, he will not owe U.S. taxes on the foreign income.
Who qualifies for the foreign earned income exclusion?
Generally, anyone who lives, works, and pays taxes in a foreign country but is required to file U.S. taxes qualifies for the foreign-earned income exclusion. This includes:
- A U.S. citizen or U.S. resident alien who is physically present in another country for 330 days or more in 12 consecutive months;
- A U.S. citizen who is a legal resident of a foreign country for a continuous period that includes a full tax year;
- A resident alien of the United States who is a citizen or national of a country with which the United States has entered into an income tax treaty and who is lawfully residing in the foreign country for a continuous period that includes a full tax year,
What is the foreign earned income exclusion for 2024?
For tax year 2024, the foreign earned income exclusion is $126,500. In 2025, the cap will increase to $130,000. Any income earned below these amounts will not be taxed on the individual.
Do I have to file US taxes if I live and work abroad?
Yes, as a US citizen or resident alien, you must file a tax return that includes all of your income anywhere in the world. However, you may qualify for foreign earned income exceptions or foreign income tax credits to reduce or eliminate your U.S. taxes.
Bottom line
If you are a U.S. citizen or resident alien, you must file income tax forms with the IRS. However, there is an exception applied to foreign income of Americans living and working abroad that avoids the risk of double taxation.
#Foreign #Earned #Income #Exclusion #Overview #FAQs
