EXPAT TAX TIPS ON THE FOREIGN EARNED INCOME EXCLUSION IN 2021
First published: June 2016
Last updated: May 2021
One of the most common tax relief measures available to U.S. expats is the foreign earned income exclusion (“FEIE”). This expat tax basic is an important method for avoiding the double taxation of your income. If you qualify, you may be able to exclude all or part of your foreign salary or wages from your income when filing your U.S. federal tax return.
Here are five key tips to keep in mind regarding the exclusion:
Tip 1 - THE FEIE REQUIREMENTS
Provided an individual is able to establish that his or her “tax home” is outside the U.S. and can satisfy either the “bona fide residence” test or the “physical presence” test, such individual can exclude from income a portion of their income earned overseas.
Your “tax home” is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. You are not, however, considered to have a tax home in a foreign country for any period in which your “abode” is in the United States. “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling. The location of your abode often will depend on where you maintain your economic, family, and personal ties.
A U.S. citizen will satisfy the “bona fide residence” test if he or she resides in a foreign country for an uninterrupted period that includes the entire tax year. It is important to keep in mind that merely being in a foreign country for one full year does not automatically qualify an individual. The test is based on facts and circumstances. The length of your stay overseas and its nature are examples of key facts that the IRS will examine. Other factors include whether you purchased a home overseas, any declaration you may have made to the foreign authority indicating that you are not a resident of the country, and whether your family lives with you abroad.
An individual will qualify under the “physical presence” test if they are present in a foreign country for 330 full days during any period of 12 consecutive months. The 330 days do not need to be consecutive nor do they have to be in the same tax year.
Tip 2 - THE FEIE LIMITATION AMOUNT
The FEIE limitation amount is adjusted annually for inflation. For the 2020 tax year, the amount is up to $107,600 per qualifying person (which will increase to $108,700 for the 2021 tax year). If filing individuals are married and both work abroad and meet either the bona fide residence test or physical presence test, the limitation amount can be doubled.
In addition to the FEIE, the foreign housing exclusion may be available with respect to certain housing costs incurred abroad.
Tip 3 - FEIE COORDINATION WITH OTHER CREDITS OR DEDUCTIONS
Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered revoked.
Assuming sufficient credits are available (i.e., your creditable foreign tax exceeds your U.S. tax on your foreign income), U.S. expat parents should consider the foreign tax credit because legislation was enacted providing that taxpayers who utilize the FEIE cannot claim the child tax credit (which may be refundable up to an amount of $1,400 per child). This limitation does not apply, however, when the FTC is utilized.
Additionally, excluding earned income under the FEIE can adversely affect one’s ability to qualify (or fully qualify) under retirement plans like an IRA, because this requires having reportable earned income. If you choose the FTC, however, you can report taxable earned income, which alleviates this adverse consequence.
Tip 4 - THE FEIE FORM
In order to choose the FEIE, an individual must file a U.S. federal income tax return (Form 1040) and attach Form 2555 to the return. Once you choose to exclude your foreign earned income or housing amount, that choice remains in effect for that year and all later years unless you revoke it.
What many expats don’t realize is that while the FEIE may eliminate the requirement to pay tax, it does not eliminate the obligation to file a tax return – in fact, in order to claim the FEIE, you actually need to file your return, and not filing on time may prevent you from being able to later make the claim on your return.
Tip 5 - REVOKING THE FEIE
You can revoke your FEIE choice for any tax year. You do this by attaching a statement that you are revoking one or more previously made choices to the return or amended return for the first year that you do not wish to claim the exclusion(s). You must specify which choice(s) you are revoking. You must revoke separately a choice to exclude foreign earned income and a choice to exclude foreign housing amounts.
If you revoked a choice and within 5 tax years again wish to choose the same exclusion, you must apply for IRS approval. Because requesting a ruling can be complex, you may need professional help. Also, the IRS charges a fee for issuing these rulings.
At Expat Tax Professionals, our experts have extensive experience in utilizing all of the tax benefits available to U.S. expats, including the FEIE, FTC, foreign housing exclusion, treaty benefits, and more. We have helped many expats significantly reduce or eliminate their U.S. tax obligations using one or more of these benefits. We are ready to help you with your U.S. tax filings. Contact us today!