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U.S. Taxation of Citizens and Residents Abroad – Foreign Earned Income Exclusion

April 26, 2022

There may be times when a U.S. Citizen, permanent resident, or resident alien needs to earn income or visit outside the U.S. for business or personal reasons. U.S. citizens are subject to reporting and taxation of their worldwide income regardless of where the income is earned or received. U.S. citizens who are resident abroad are often also subject to taxation from the foreign host country which can lead to double taxation unless a tax treaty applies. Qualifying taxpayers may reduce this tax burden by utilizing the foreign earned income exclusion and the foreign tax credit.


A U.S. citizen living abroad is eligible for the foreign earned income exclusion and deduction if his or her tax home is in a foreign country and the individual is either:


  • a U.S. citizen who meets the requirements of the bona fide residence test by having been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year; or

  • a U.S. citizen who meets the requirements of the physical presence test by being present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.


For purposes of the foreign earned income exclusion, earned income includes wages, salaries, professional fees, and other amounts received as compensation for personal services rendered, including the Fair Market Value of any non-cash remuneration.


Foreign Earned Income Exclusion Defined

If the tax home of a U.S. citizen or resident alien living abroad is in a foreign country and he or she satisfies either bona fide residence test or physical presence test, the individual may elect to exclude from gross income a designated amount of foreign earned income each tax year. Expenses directly connected with earning excluded income are not deductible, nor are foreign income taxes imposed on excluded income creditable against U.S. tax.


The inflation-adjusted maximum amount of foreign earned income that a U.S. citizen or resident alien can elect to exclude from gross income is

  • $112,000 for tax years beginning in 2022

  • $108,700 for tax years beginning in 2021


A stacking rule applies to the foreign earned income to determine tax rates applicable to non-excluded income. The purpose of the stacking rule is to ensure that U.S. citizens living abroad are subject to the same U.S. tax rates as individuals living and working in the United States. Thus, income that has been excluded from gross income as either foreign earned income or as a foreign housing allowance is included for purposes of determining both the regular and alternative minimum tax rates applicable to the non-excluded income. Accordingly, under the stacking rule:


  • Regular income tax is equal to the excess, if any, of the tax which would be imposed if the taxpayer’s taxable income were increased by the excluded amount, over the tax which would be imposed if the taxpayer’s taxable income were equal to the amount excluded.

  • Tentative minimum tax is equal to the excess, if any, of the amount which would be the tentative minimum tax if the taxpayer’s taxable income were increased by the amount excluded, over the amount which would be the tentative minimum tax if the taxpayer’s taxable income were equal to the excluded amount. However, the computation of the tentative minimum tax on the non-excluded income is made without regard to the alternative minimum foreign tax credit.


Foreign Earned Income Exclusion and Proration for Partial Years

U.S. citizens and resident aliens living abroad who qualify for only part of a tax year must prorate the exclusion limit based on the number of qualifying days in the tax year. The maximum amount excludable is multiplied by the number of qualifying days and then divided by the number of days in the tax year (365 days except in a leap year when it is 366 days).


Foreign Earned Income Exclusion Election

The foreign earned income exclusion is elected on Form 2555, Foreign Earned Income. This form is attached to a timely filed Form 1040 or Form 1040-SR tax return, an amended return, or a late return filed within one year from the original due date.


The IRS may also grant a reasonable extension beyond the time provided for worthy causes shown. The automatic 12-month extension for making certain elections does not apply to the foreign earned income exclusion election.


Alternatively, the individual may request a special extension of time for filing a return until after the completion of a qualifying period. This request for extension is made on Form 2350, Application for Extension of Time to File U.S. Income Tax Return. Tax extension requests are commonly made for an extension until January 31 following the calendar year in which the individual determines he or she qualifies under the bona fide foreign residence test. However, Form 2350 does not extend the time to pay federal income taxes.


Revocation of Foreign Earned Income Exclusion

A taxpayer may revoke the election to exclude foreign earned income for any tax year after the tax year for which the election was made without the permission of the IRS. Revocation is done by filing a statement with an original, amended, or late-filed return for the year in which the revocation becomes effective. Once it is revoked, the taxpayer may not claim the earned income exclusion for five tax years after the tax year for which the revocation was first effective unless he or she first receives the consent of the IRS.


Finally, there are various rules for deducting Foreign Earned Income Exclusion and Foreign Tax Credits. If you do not deduct correctly when filing your return, you may be subject to additional taxes or penalties from the IRS. We recommend that you seek professional advice to ensure that you file your tax return correctly.

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