The Foreign Earned Income Exclusion for US Expats in 2022
In comparison to most other countries, the United States has an unusual tax system in that it taxes all US citizens on their worldwide income, regardless of where they live.
Most other countries either tax only residents or only people who earn money in the country.
The US tax system, on the other hand, requires all American citizens, including expats, who meet minimum global income thresholds of $12,550 (for the 2021 tax year) or $400 of self-employment income, or $5 if married to a non-US taxpayer, to file US taxes. Unfortunately, the tax treaties that the United States has with other countries have no bearing on this requirement.
This means that millions of US expats who are eligible to file foreign income taxes in the country where they live risk paying taxes twice.
To mitigate this risk, the IRS has made a number of provisions available to expats when they file their federal US tax return. The Foreign Earned Income Exclusion is one of the most important and useful of these provisions.
The Foreign Earned Income Exclusion makes no distinction between expats who pay taxes in their home country and those who do not. This means that expats who live in a tax-free country or who do not qualify to pay foreign income tax in any country can still use the FEIE to reduce their US tax bill, often to zero.
In this article, we'll go over the Foreign Earned Income Exclusion in 2022 in detail, including what it is and isn't, who qualifies for it, how to claim it, and when expats benefit from claiming it.
1 - What is the Exclusion for Foreign Earned Income?
The Foreign Earned Income Exclusion is an IRS exemption that American expats can use to reduce (or, in many cases, completely eliminate) their US tax bill when filing their US tax return from abroad.
It allows expats to avoid paying US taxes on the first $100,000 of their earned income. For inflation, the exact threshold rises slightly each year. For example, in 2018, the threshold was $103,900; in 2019, it was $105,900; in 2020, it was $107,600; and in 2022 (for tax year 2021), it was $108,700.
Married US expats who have earned income and meet the IRS tests for living abroad described below can each exclude the FEIE amount.
It is important for expats to understand that it can only be used to exclude certain types of income (see below for details).
"If you are a US citizen or a US resident alien living abroad, you are taxed on your worldwide income." However, you may be able to exclude from income up to a certain amount of your foreign earnings that is adjusted annually for inflation." - IRS
Expats must file IRS Form 2555 with their federal tax return to take advantage of the Foreign Earned Income Exclusion. In order to qualify, they must also meet IRS criteria for living abroad.
Some expats may be able to use Form 2555-EZ, a simplified, shorter version of Form 2555. To qualify for Form 2555-EZ, expats must meet the following criteria:
1 - They are not claiming the Foreign Housing Exclusion or Deduction.
2 - They are claiming for a calendar year.
3 - They have no self-employment income.
4 - They do not earn more than the annual threshold.
5 - They have no business or moving expenses for that year.
2 - Qualifying for the Foreign Earned Income Exclusion in 2022
Expats must meet one of two IRS definitions to claim the Foreign Earned Income Exclusion. It's critical for expats to understand the IRS definitions of a tax home being abroad, as a small error can mean the difference between qualifying and not, and thus whether they face a US tax bill or not.
The IRS has established two broad tests for an expat's tax home, with expats only needing to meet one to claim the Foreign Earned Income Exclusion. The first of these two tests is known as the Physical Presence Test.
The Physical Presence Test requires expats to demonstrate that they were physically present for at least 330 full days outside the US during the tax year. Expats typically claim for the entire calendar year (i.e. the tax year), but expats who moved abroad in the middle of the year, or who returned to the US in the middle of the year, can claim only for the time they lived abroad, as long as they were abroad for at least 330 days after moving abroad (assuming that they moved abroad mid-year, or before, if they moved back to the US mid-year).
The Bona Fide Residence Test is the second of the two IRS tax home tests. The Bona Fide Residence Test requires expats to demonstrate that they are a permanent resident of a foreign country. This could be through a permanent residency visa, paying foreign income taxes in their country of residence, or providing proof of housing rental or ownership, as well as utility bills in the expat's name.
The Physical Presence Test is useful for expats who are moving between countries (such as Digital Nomads) or who cannot demonstrate permanent residence in any one foreign country. However, expats must limit and count the days they spend in the US to ensure they spend at least 330 full 24-hour periods abroad. The Bona Fide Residence Test, on the other hand, is useful for expats who can demonstrate that their tax home is in another country and do not want limits placed on the number of days they spend in the US each year.
3 - Different kinds of income
The Foreign Earned Income Exclusion can only be used to exclude certain types of income from US taxation, not all income.
It can only be used to exclude earned income.
Earned income is defined as income derived from work or services rendered. This includes salary, wages, commissions, bonuses, self-employment income, and professional fees, as well as the value of any other compensation for services, such as food and travel allowances, professional training, relocation expenses, and so on.
It makes no difference where the payment is made or received, including the United States, as long as the income qualifies and the expat can demonstrate that they were living abroad at the time they earned it according to the IRS tests outlined above.
However, unearned income cannot be excluded. Unearned income includes social security benefits, pension income, rents, dividend income, interest, gambling winnings, capital gains, annuities, and alimony payments.
Other types of income that cannot be excluded by expats claiming the Foreign Earned Income Exclusion include:
- Payments received as a military or civilian employee of the United States Government
- Payments received for services performed in international waters
- Payments received after the end of the tax year or other 365-day period being claimed for, even if the service was performed during that time.
- Meals and lodging that are deducted from pay for the employer's convenience.
You're probably starting to realize that, far from being a one-size-fits-all solution for all expats to avoid paying US taxes, the Foreign Earned Income Exclusion is dependent on their circumstances, including their income types and levels, as well as their foreign residency or travel arrangements.
The Foreign Earned Income Exclusion for Expats in the United States
4 - Foreign Earned Income Exclusion Restrictions
The Foreign Earned Income Exclusion is not a magic ticket that keeps expats from having to file US taxes.
It has a number of limitations. For starters, it does not exempt expats from filing a US tax return declaring their worldwide income. (If they earn in a foreign currency, they must convert it to US dollars in order to report it on their US tax return.) As previously stated, expats must still file a federal return and ensure that they qualify in terms of proving that they live abroad, as well as whether their income qualifies as 'earned income' according to the IRS definition.
Second, the $108,700 threshold (for tax year 2021) is a limiting factor for expats earning more than this amount, though other options to avoid double taxation may be available (such as the Foreign Housing Exclusion, and the Foreign Tax Credit, details about which are below).
Third, successfully claiming the Foreign Earned Income Exclusion does not exempt self-employed expats from having to pay Social Security and Medicare taxes, which can amount to 15.4% of an expat's income (although there may be ways to avoid this as well, depending on each expat's circumstances).
Finally, depending on the rules in the state where they previously lived, some expats may be required to continue filing state taxes from abroad.
5 - The Foreign Housing Exclusion/Deduction
Expats who claim the Foreign Earned Income Exclusion but earn more than $108,700 in tax year 2021 and rent a home abroad can exclude additional income by claiming the Foreign Housing Exclusion.
The Foreign Housing Exclusion allows expats who are employed abroad and earn more than the FEIE limit to exclude a portion of their income from US taxation based on a percentage of their housing expenses.
The formula for calculating how much of an expat's income above the Foreign Earned Income Exclusion threshold they can exclude from US taxation is a little complicated: total housing expenses minus 16% of the FEIE amount, up to a maximum total of normally 30% of the FEIE threshold (although this maximum varies depending on which country and city the expat is living in, according to an IRS list which is updated annually, and can be found in Form 2555 instructions).
"In addition to the foreign earned income exclusion, you 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." - the IRS
Rent, utility bills (other than telephone and television), leasehold fees, residential parking costs, occupancy taxes, property insurance, furniture rental, and necessary repairs are all qualifying housing expenses.
Mortgage payments, purchased furniture, and domestic help costs, on the other hand, are not eligible.
Expats can claim the Foreign Housing Exclusion on the same form they use to claim the FEIE, IRS Form 2555.
Self-employed expats who rent their home abroad cannot claim the Foreign Housing Exclusion, but they can claim the Foreign Housing Deduction, which works in a similar way.
The Foreign Housing Exclusion and Deduction, however, cannot be claimed on Form 2555-EZ.
6 - Form 2555 instructions
Form 2555 is not the easiest form to complete, and we recommend that expats with any questions or concerns seek assistance from a reputable and experienced expat tax preparation specialist to avoid making costly mistakes.
The form is divided into 9 sections. Section I is for personal information, employer information (if applicable), and determining where an expat's tax home is.
Section II is used by expats who meet the Bona Fide Residence Test, while Section III is used by expats who meet the Physical Presence Test. Expats only need to complete one of these two sections.
Section IV is for expats' earned income and expenses, which should match the figures on Form 1040.
Sections V and VI deal with the Foreign Housing Exclusion/Deduction, while the final three sections (VII, VIII, and IX) are where expats enter the final figures used to calculate the total amount they will be excluding.
7 - Who should be eligible for the Foreign Earned Income Exclusion in 2022?
The Foreign Earned Income Exclusion is a completely legal way for many expats to reduce their US tax bill, often to zero, though they must still file a US tax return each year, reporting their worldwide income.
Expats who earn less than the annual FEIE threshold, whose only income is earned, who either do not pay foreign income tax or pay foreign income tax at a lower tax rate than the US rate, and who can prove that they live abroad according to IRS criteria, often benefit from claiming the FEIE.
Many Digital Nomads fall into this category because, even if they are not required to pay taxes in any foreign country because they are traveling from country to country while working, they can use the Foreign Earned Income Exclusion to reduce or eliminate their US tax bill if they are outside the US for at least 330 days a year and do not maintain a US abode.
Expats with unearned income, those who earn more than the annual FEIE threshold, those who pay foreign income taxes at a higher rate than the US rate, and those who are unable to meet IRS criteria to prove that they live abroad may need to consider other options to avoid paying US taxes from abroad.
Expats with income in a foreign country who pay foreign income taxes, for example, may be better off claiming the US Foreign Tax Credit, which they can use to offset their US income tax bill based on the value of the foreign tax they've already paid. If they pay foreign tax at a higher rate than the US rate, they will not only eliminate their US federal income tax liability, but they will also receive excess US tax credits that they can carry forward for up to ten years (or back one year, if they file amended returns for those years). Another advantage of claiming the Foreign Tax Credit rather than the Foreign Earned Income Exclusion for expats is that there is no IRS limit on the number of tax credits that can be claimed, and it doesn't matter whether the income is earned or unearned, as long as foreign income tax has been paid on it.
Expats can claim the Foreign Tax Credit by filing Form 1116 with their federal return.
Expats who pay foreign income tax on income earned in the United States, on the other hand, are not eligible for the US Foreign Tax Credit. If they can't claim the Foreign Earned Income Exclusion either (perhaps because their US-sourced income isn't 'earned,' or because they can't prove they live abroad), they may be able to claim tax credits against US federal income taxes paid on their income in the country where they live.
Expats can claim both the Foreign Tax Credit and the Foreign Earned Income Exclusion, but not on the same income. So, for example, a freelancer who receives income both in the US and abroad and pays a higher rate of foreign income tax on their worldwide income in the country where they live could choose to claim US tax credits against the foreign income taxes paid on their foreign-sourced income and the FEIE on their US-sourced income, effectively eliminating their US tax bill.
8 - FBARs and amnesty programs
Expats may also be required to report their foreign bank and investment accounts if they have more than $10,000 in total in qualifying accounts at any time during the tax year by filing a Foreign Bank Account Report, also known as an FBAR.
Expats who are behind on their federal tax or FBAR filing because they were unaware of the requirement to file from abroad can catch up without facing penalties under an IRS amnesty program known as the Streamlined Procedure. Expats must file their most recent three tax returns, as well as their most recent six FBARs, if required. The program allows expats to claim the Foreign Earned Income Exclusion (and/or the Foreign Tax Credit) retroactively.