What is the Foreign Earned Income Exclusion?
If you are a U.S. citizen or green card holder, your worldwide income is subject to U.S. taxation, regardless of your country of residence. However, if certain requirements are met (described below), you qualify to exclude up to $120,000 of foreign earned income for 2023. Foreign earned income is pay for personal services performed such as wages, salaries, or professional fees while working in a foreign country. If both you and your spouse work abroad and each of you meets the requirements, you can each utilize the foreign earned income exclusion. In addition, you can exclude or deduct certain foreign housing amounts.
A common misconception about the foreign earned income exclusion is that it is exempt income and thus not reportable on a U.S. tax return. In fact, the exclusion applies only if the qualifying individual files a tax return and reports the income.
You qualify for the foreign earned exclusion if BOTH of the following apply:
Your tax home is in a foreign country
One of the following applies to you:
bona fide resident of a foreign country test
physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months
Your tax home is your principal place of employment (or business) in which you have been assigned for more than 1 year and where you maintain your "abode". “Abode” has been variously defined as one's home, habitation, residence, domicile, or place of dwelling. If you maintain a dwelling in the United States (whether or not that dwelling is used by your spouse and dependents), it doesn't necessarily mean that your abode is in the United States during that time. However, you aren't considered to have a tax home in a foreign country when your abode is in the United States.
You are employed on an offshore oil rig in the territorial waters of a foreign country and work a 28-day on/28-day off schedule. You return to your family residence in the United States during your off periods. You are considered to have an abode in the United States and don’t satisfy the tax home test in the foreign country. You can’t claim either of the exclusions or the housing deduction.
For several years, you were a marketing executive with a producer of machine tools in Toledo, Ohio. In November of last year, your employer transferred you to London, England, for a minimum of 18 months to set up a sales operation for Europe. Before you left, you distributed business cards showing your business and home addresses in London. You kept ownership of your home in Toledo but rented it to another family. In November of last year, you moved your spouse, children and furniture to a home your employer rented for you in London. You and your spouse opened bank accounts with a London bank and secured consumer credit. You joined a local business league and both you and your spouse became active in the neighborhood civic association and worked with a local charity. Your abode is in London for the time you live there. You satisfy the tax home test in the foreign country.
Bona Fide Residence Test
To be a bona fide resident of a foreign country, you must have entered the foreign country intending to remain there for a prolonged period and make your home in that country. Bona fide residence is determined by the length and nature of your stay abroad. Consideration is given to the type of quarters occupied, whether your family went with you, the type of visa, the employment agreement, and any other factors. You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for 1 year. To meet the bona fide residence test, you must be a resident for an uninterrupted period that includes an entire tax year (January 1 through December 31).
During the period of bona fide residence in a foreign country, you can leave the country for brief or temporary trips back to the United States or elsewhere for vacation or business. However, you must have a clear intention of returning from such trips, without unreasonable delay, to your foreign residence or to a new bona fide residence in another foreign country.
You could have your domicile in Cleveland, Ohio, and a bona fide residence in Edinburgh, Scotland, if you intend to return eventually to Cleveland. The fact that you go to Scotland does not automatically make Scotland your bona fide residence. If you go there as a tourist, or on a short business trip, and return to the United States, you haven’t established bona fide residence in Scotland. But if you go to Scotland to work for an indefinite or extended period and you set up permanent quarters there for yourself and your family, you probably have established a bona fide residence in a foreign country, even though you intend to return eventually to the United States. You are a resident of Scotland because your stay in Scotland appears to be permanent.
Once you have established bona fide residence in a foreign country the entire tax year, you will qualify as a bona fide resident starting with the date you actually began the residence and ending with the date you abandon the foreign residence. You could qualify as a bona fide resident for an entire tax year plus parts of 1 or 2 other tax years.
You were a bona fide resident of England from March 1, 2016, through September 14, 2018. On September 15, 2018, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2017, you also qualify as a bona fide resident from March 1, 2016, through the end of 2017 and from January 1, 2018, through September 14, 2018.
Physical Presence Test
You meet the physical presence test if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 qualifying days do not have to be consecutive. The physical presence test is based only on how long you stay in a foreign country or countries. This test does not depend on the kind of residence you establish, your intentions about returning to the United States, or the nature and purpose of your stay abroad.
There are four rules you should know when figuring the 12-month period:
Your 12-month period can begin with any day of the month. It ends the day before the same calendar day, 12 months later
Your 12-month period must be made up of consecutive months. Any 12-month period can be used if the 330 days in a foreign country fall within that period
You do not have to begin your 12-month period with your first full day in a foreign country or to end it with the day you leave. You can choose the 12-month period that gives you the greatest exclusion
In determining whether the 12-month period falls within a longer stay in the foreign country, 12-month periods can overlap one another
You are a construction worker who works from time to time in a foreign country over a 20-month period. You might pick up the 330 full days in a 12-month period only during the middle months of the time you work in the foreign country because the first few and last few months of the 20-month period are broken up by long visits to the United States.
You work in New Zealand for a 20-month period from January 1, 2017, through August 31, 2018, except that you spend 29 days in February 2017 and 28 days in February 2018 on vacation in the United States. You are present in New Zealand 330 full days during each of the following two 12-month periods: January 1, 2017 - December 31, 2017, and September 1, 2017 - August 31, 2018. By overlapping the 12-month periods in this way, you meet the physical presence test for the whole 20-month period.
Foreign Housing Exclusion and Deduction
In addition to the foreign earned income exclusion, you also can claim an exclusion or a deduction from gross income for your housing amount if your tax home is in a foreign country and you qualify for the exclusions and deduction under either the bona fide residence test or the physical presence test.
Who/What Does Not Qualify?
Pay received as a military or civilian employee of the U.S. Government or any of its agencies
Pay for services conducted in international waters (not a foreign country)
Pay in specific combat zones, as designated by an Executive Order from the President, that is excludable from income
Pension or annuity payments, including social security benefits
A qualifying individual may claim the foreign earned income exclusion on foreign earned self-employment income. The excluded amount will reduce the individual’s regular income tax, but will not reduce the individual’s self-employment tax. Also, the foreign housing deduction – instead of a foreign housing exclusion – may be claimed.
A qualifying individual claiming the foreign earned income exclusion must figure the tax on the remaining non-excluded income using the tax rates that would have applied had the individual not claimed the exclusions.
Part Year Exclusion
If you qualify under either the bona fide residence test or the physical presence test for only part of the year, you must adjust the maximum limit based on the number of qualifying days in the year.
You report your income on the calendar-year basis and you qualified for the foreign earned income exclusion under the bona fide residence test for 75 days in 2017. You can exclude a maximum of 75/365 of $102,100, or $20,979, of your foreign earned income for 2017. If you qualify under the bona fide residence test for all of 2018, you can exclude your foreign earned income up to the 2018 limit.
Article by Lewis Grunfeld, CPA
Lewis Grunfeld, CPA, is a renowned expert in international and U.S. expat taxation, with expertise spanning over ten years. He has successfully helped thousands of expats around the world navigate complex international U.S. tax regulations, and achieve significant tax savings. His work is driven by a strongly rooted passion for assisting the expat community through a wide range of tax situations, ensuring tailored solutions for each unique situation.
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