If certain requirements are met, the foreign earned income exclusion allows a U.S. citizen or resident alien of the United States living aboard to exclude foreign earnings from US taxation up to an amount that is adjusted annually for inflation. The 2021 foreign earnings limit is $108,700. This exclusion helps those eligible to avoid being taxed in both the foreign country where the income is earned and the United States.
Who Qualifies for the Earned Income Exclusion?
According to the IRS, you must have foreign earned income (i.e. wages, salaries, professional fees, and other compensation received for personal services performed), your tax home must be in a foreign country, and you must be one of the following:
- A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year
- A U.S. resident alien who is a citizen of a country with which the U.S. has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an interrupted period that includes the entire tax year, OR
- A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
The tax home, bona fide resident, and the physical presence tests mentioned above have several nuances that should be discussed with your tax advisor to help determine proper eligibility.
How Do You Claim the Foreign Earned Income Exclusion?
If it has been determined that you are eligible for the exclusion, you would complete IRS Form 2555 Foreign Earned Income and include it with your timely filed personal income tax return including extensions. The choice to claim the exclusion will remain in effect for all future years unless it is revoked by including a statement on the return for the first year you don’t wish to claim the exclusion. Revoking the foreign earned income exclusion will limit the ability to claim it again in the proceeding 5 years and additional approvals by the IRS will be necessary.
Determining eligibility for the foreign earned income exclusion is made on a case by case basis, and requires careful consideration of all the facts and circumstances. Please don’t hesitate to reach out to AZ’s International Tax Team for assistance!
This article was written by Robert Holden, CPA in our Bozeman office.