Tax Saving Tips for American Expats Living Abroad
If you’re an American living overseas, the foreign earned income exclusion (FEIE) may allow you to avoid paying U.S. federal income taxes on your foreign earnings. As with most U.S. tax provisions, there are some specific criteria you need to meet in order to qualify. Here, we answer common questions about the FEIE and provide tips to help you take advantage of this tax benefit as a U.S. expat. Importantly, if you pay income taxes in a foreign country, you may obtain a better result by utilizing foreign tax credits instead of, or as well as, the FEIE.
How do I qualify for the FEIE?
In order to qualify for the FEIE, you must meet the following criteria.
Earn income from employment in a foreign country.
The FEIE is an exclusion of foreign earned income from taxable earned income for U.S. tax purposes. It is available to U.S. citizens and green card holders who live and work in foreign countries. The exclusion applies only to foreign earned income, not passive income from investments, rental sources, annuities or pensions.
To qualify, you must have income that you earned while living in a foreign country, regardless of where the income came from. For example, you may qualify for the FEIE if you work for a U.S.-based employer but are performing services for that employer while living outside of the United States.
Your tax home must be in a foreign country
“Tax home” is a term used to determine when you can deduct expenses for traveling away from home on business. In general, your tax home is your home base or primary place of business. For example, if you are a pilot based at the John F. Kennedy International Airport but you fly all over the world, your tax home is in New York. An individual shall not be treated as having a tax home in a foreign country for any period for which his abode is within the United States.
If your tax home is in a foreign country, then you must meet the requirements of one of the following two tests:
1. The bona fide residence test – To pass the requirements of the bona fide residence test (BFRT), you must be a resident of a foreign country for an uninterrupted period of time that includes an entire tax year (January 1 through December 31 for calendar-year taxpayers). You may briefly visit the United States or other countries during the period of establishing bona fide residence, as long as you clearly intend to return to your foreign residence.
Once you have established residency in a foreign country for an uninterrupted period that includes an entire tax year, the date of your bona fide residency begins with the first date of your residency and ends with the date you abandon your foreign residence.
2. The physical presence test – The physical presence test requires that a taxpayer reside in a foreign country for a 12-month period, which can be any period of 12 consecutive months that includes 330 full days of presence in a foreign country. Taxpayers who qualify under the physical presence test for a partial year should carefully choose the 12-month period that allows them the maximum exclusion for the year.
It’s important to note that a “day” is considered a full 24-hour period, beginning at midnight. If you are leaving the United States, you cannot start counting days until you have been in the foreign country for a full day. For example, entering Canada at 1 a.m. is the same as entering Canada at 11 p.m. The day following the day of entry will be the first day counted for the physical presence test.
Use the full exclusion.
In order to use the foreign earned income exclusion, you must exclude foreign earned income up to the FEIE amount. You cannot choose to use only part of the FEIE. If your foreign earned income is less than the exclusion amount and you choose to use the exclusion, all of your earned income must be excluded.
Similarly, you cannot create subcategories of foreign earned income and exclude some, but not exclude others. For example, you cannot exclude income from one country and not exclude income from a different country, or exclude income from one employer and not exclude income from self-employment or a different employer.
File a tax return.
The only way to exclude your foreign earned income from your gross income is by filing a tax return. Even if you know that you will have no income left after you take the exclusion, you must report all of your income on your tax return and attach Form 2555 to calculate and claim the exclusion.
How much can I exclude?
The FEIE limit is adjusted for inflation every year. The 2023 FEIE limit is $120,000, up from $112,000 in 2022, which is the largest increase in recent years.
The table below shows FEIE limits since 2020. For 2023, the 7.1% increase is a significant benefit for expats living abroad or considering a move overseas.
|Tax Year||Foreign Earned Income Exclusion Amount|
|2023 (filed in 2024)||$120,000|
|2022 (filed in 2023)||$112,000|
|2021 (filed in 2022)||$108,700|
|2020 (filed in 2021)||$107,600|
When can I qualify for the FEIE?
The timing of your qualification depends on when you pass the requirements of the BFRT or the PPT. As noted above, the BFRT requires you to be a resident of a foreign country for an uninterrupted period of time that includes an entire tax year, while the PPT requires you reside in a foreign country for a period of 12 consecutive months that include 330 full days of presence in that country.
It’s important to note that under the BFRT, you must be a foreign resident for a full calendar year before you can qualify for a partial-year residency. At the end of your second year of residency you may qualify as a bona fide resident from the date you originally took up residence, and apply your bona fide residence status to your partial first year living overseas. In this case, you must file Form 2350 and obtain a filing extension until the end of January of the third year in which you live overseas.
February 15 – You move to Australia and do not return to the United States
January 11 – Because you have spent 330 out of the prior 365 days as a foreign resident, you have now met the requirements of the PPT. However, you cannot yet claim on your 2021 tax return that you meet the PPT because your date of qualification falls outside the 2021 tax year.
February 28 – You now meet the time component of the BFRT, but you will not meet your calendar year requirement until December 31, 2022.
January 1 – You can now claim the FEIE for the tax year ending December 31, 2022, and can also extend your qualification back to January 15 of the tax year ending December 31, 2021.
January 31 – If you filed Form 2350 and were granted a 2021 tax year extension, this extension expires on January 31, 2023. This gives you all of January 2023 to file your 2021 tax return.
Important Notes About Form 2350
If you are planning to file Form 2555 to exclude foreign-earned income using FEIE, you must file Form 2350 by the due date of your initial foreign return. If you are granted an extension, you will have 30 days from satisfying either the BFRT or the PPT to file.
It’s important to note that Form 2350 does not provide an extension for your payment. You will still need to calculate your tax liability and pay any owed amount by the tax filing deadline. If you’re not certain that you will be living in a foreign country until the end of the second tax year, you may want to consider filing and paying without the FEIE. Once you qualify for the FEIE, you can always file an amended return to claim any previous overpayments. This strategy can help you avoid late payment penalties and interest.
As you can tell, FEIE requirements are complex. Don’t be overwhelmed; Creative Planning International is here for you. We work with U.S. expats and cross-border families to help maximize their wealth and avoid costly mistakes, especially when it comes to U.S. expat taxes and investments. We understand the complex interaction of multi-jurisdiction tax and regulatory regimes and take into account currency, diversification and other portfolio considerations as we help you plan and invest for the future.
If you’re an American living abroad and could use some help navigating your U.S. expat tax strategy, request a meeting with a member of our team.