What is the Foreign Earned Income Exclusion (FEIE)?
The U.S. tax system is confusing under the best of circumstances; the system only becomes more complicated for tax preparation for expats living abroad. Though many Americans living abroad may believe that moving away frees them from their obligations to the Internal Revenue Service, this is not the case; in fact, moving overseas often leads to even greater burdens in terms of paperwork, though certain tax provisions – such as the foreign earned income exclusion – may actually reduce your overall financial obligation to the IRS. So, what is the foreign earned income exclusion, and how can you use it to your advantage? Continue reading as the professionals at U.S. Tax Help explain.
Do I Have to File Taxes with the IRS If I Live in a Foreign Country?
The short answer to this question is yes, expats and digital nomads living overseas still have to file a tax return with the IRS, and many will have to send money as well. The United States is one of only two countries that taxes based on citizenship rather than location, meaning that no matter where you are in the world, you retain your U.S. tax responsibilities, even if none of your income is generated in America. Our tax accountant for digital nomads living overseas can help you prepare and file your tax return with the IRS.
If this sounds like something of a pain, it is. That said, there are some definite financial advantages that come with living in another country, even if you have to deal with extra stress around tax season. Many countries have more forgiving tax rates than the U.S., for instance, and expats are often eligible for a number of exemptions, exclusions, credits, and deductions that can save significant sums in the long run. One of the simplest and most useful of these is the foreign earned income exclusion, or FEIE, which you can use when filing a tax return as an expat.
The Foreign Earned Income Exclusion (FEIE)
In order to minimize the likelihood of expats being taxed twice on the same income – both in the U.S. and in their country of residence – the IRS offers the foreign earned income exclusion, which allows a taxpayer living abroad to exclude a significant portion of their total income from what is ultimately taxed by the U.S. government. This exclusion is limited, but substantial, and it is adjusted for inflation every year; in 2019, the cap on what can be excluded is $105,900, up from $103,900 in 2018.
To take advantage of this hugely beneficial tax break, you must meet certain qualifications. Perhaps the most important test to pass relates to where you were over the tax year; for the IRS, this means you must clear either the physical presence test or the bona fide residence test.
- The physical presence test requires that a taxpayer be outside the U.S. for at least 330 days over a 12-month period, though the days do not have to be consecutive.
- The bona fide residence test requires that a taxpayer remain in a foreign country for at least one full tax year, without interruption.
If you pass either of these tests, likely also meet the next requirement: having a tax home in a foreign country. Generally speaking, your tax home is the area in which you permanently or indefinitely work; if your employment is not limited to one location, your tax home may refer to the place where you live. Assuming your tax home is outside of the U.S., you almost certainly qualify for the foreign earned income exclusion.
One important thing to note that the FEIE only applies to earned income – money you obtain in exchange for goods or services, in other words. Unearned income is not affected; in the eyes of the IRS, unearned income is any that you collect passively, such as from rent, stock dividends, or Social Security benefits.
Other Helpful Tax Provisions for Expats
While the foreign earned income exclusion is probably the most popular tax benefit that expats enjoy, it is not the only one. For example, many Americans living abroad can use the foreign housing exclusion or foreign housing deduction to further reduce their tax obligations.
In essence, these two offer the same benefit – a reduction in taxable income based on the amount you pay for housing – with one minor difference: the housing exclusion can only be used for housing expenses paid for with employer-provided income, while the deduction only applies to expat self-employment income. You must also pass the bona fide residence or physical presence test to qualify for these, as with the FEIE.
Another benefit expats can reap is the foreign income tax credit, which allows you to claim a U.S. tax credit for any taxes you pay to the government of another country, namely whichever one you live and work in. If you live abroad and pay an income tax in that country as well as to the IRS, you may be eligible for this credit.
Tax Specialists Helping Expats Navigate FEIE and Income Tax Requirements
If you are an American expat trying to figure out your tax obligations to the IRS, don’t try to tackle the problem alone. The international tax acountants at U.S. Tax Help are skilled at guiding clients through the twists and turns of the American tax code, ensuring compliance while minimizing the final tax bill. Learn more about how the professionals at U.S. Tax Help can make your life easier by visiting us online or calling (541) 362-9127 today.