This article was written by ProTax Consulting for our US resident nomadic folks!
Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult tax, legal and accounting advisors before engaging in any transaction and/or filling your taxes. Further, this article has been tailored to, and written for, US citizens, taxpayers, and companies.
What You Should Know About the Foreign Earned Income Exclusion
Most of us have enjoyed the occasional romantic daydream of expatriation to another country where we live a comfortable, unhurried existence on a tropical island or some other exotic location. As the fantasy progresses, we may see ourselves making a living tending bars or beach combing. But if you're a tax resident of the US, you can be sure that the realities of federal taxes are never far away.
We know...what a drag.
As grumpy as it may make us, two things are certain in life and one of them is taxes. But one thing NOBODY wants to be doing, is paying taxes twice. Most countries expect people residing there to pay taxes. That means that American expats need to find ways to avoid being taxed twice on the same income. This is where the Foreign Earned Income Exclusion comes into play.
What Is the Foreign Earned Income Exclusion?
The FEIE is a way for U.S citizens living and working abroad to exclude a certain amount of their foreign earned income for taxation by the U.S government and by doing so avoiding double taxation. The ceiling for foreign earned income exclusion for the 2020 tax year is currently set at $107,600. The reason the FEIE is needed is because the U.S is one of the few countries that taxes their citizens on income earned anywhere in the world.
What Types of Income Are Considered Taxable by The U.S.?
What constitutes earned income is a very well-defined classification. Earned income is defined as pay received for services performed, meaning wages, salaries, and professional fees. Other forms of earned income include commissions, bonuses and tips. Expats should also consider certain types of non-cash income as well. This would include provided room and board, or the use of an automobile. Types of income not considered income are annuities, including Social Security and expense reimbursement from employers.
So, for most people who are working abroad, their foreign earned income will most likely be taxable by the U.S. government. It should be noted that even if their income was to actually be eligible for FEIE exclusion to the point of zero liability, they would still be expected to file a U.S federal income tax return.
How Can I Claim The FEIE?
There are a lot of myths and misconceptions surrounding the tax obligations of U.S expats to the federal government and their host country. In order to claim the foreign earned income exclusion, you must:
- Be a U.S. citizen or a resident alien. A resident alien is someone who is a permanent resident but does not yet have citizenship. In the U.S a resident alien must have a green card, or have had one in the last year.
- You must be what is considered a qualifying presence in a foreign country. This means that you have satisfied the Bonafide Resident Test, and/or the Physical Presence Test.
- Both of these qualifiers refer to the amount of time an expat has spent in their host country. The duration of time necessary to qualify for these residency tests is between 330 days and a full calendar year.
- You must have paid foreign taxes on foreign earned income.
- This is also applicable to income earned through self-employment with the minimum taxable amount being $400.
Once you have satisfied these requirements, you can then use the FEIE to reduce to U.S tax liability to as low as zero on foreign earned income up to $107, 600. You can claim this exclusion by filing Form 2555 along with your annual federal income tax return. For foreign earned incomes that exceed this financial ceiling, expats should consider filing Form 1116 to claim foreign tax credits where applicable.
For further reading check out our article debunking US tax myths by the brilliant Alexander Stylianoudis, who loves tax conversations more than anything. Massive thanks to Pro Tax Consulting for bringing us this information.