How the Foreign Earned Income Exclusion Works
- mainandbarbour
- Jan 6
- 5 min read
Updated: Feb 11
As national borders become less of a barrier for people to work and reside in foreign countries, doing business right way and ensuring that taxes obligations are properly managed is now a necessity. The rise of international travel, and the opportunity to become a digital nomad, international employee, or to retire abroad are now a huge desire for many people. The ever-changing political environment has fast-tracked people’s decisions to live and work abroad. So how does the average expat figure out how to stay on Uncle Sam’s good side, while at the same time creating the most beneficial tax planning strategies? The goal of this article is to help you understand the basics of one of the post powerful tax tools, the Foreign earned income exclusion (FEIE). It is important to note that in some cases the FEIE and the Foreign Tax Credit can be used together on the same tax return to effectively reduce a taxpayer’s tax burden. Although use of the FEIE over the FTC generally makes the most sense in countries where there is either no tax or a lower tax rate than the U.S.
Foreign Earned Income Exclusion
The IRS spells out the following four requirements that must be met to claim the Foreign Earned Income Exclusion:
You need to have a tax home in a foreign country.
You must live in a foreign country.
You need to have foreign earned income (such as wages, salaries or self- employment income).
You must pass the physical presence test or be able to establish that you are bona resident of a foreign country.
A critical element to understand is what constitutes foreign earned income. Equally important to understand is how to establish your abode and tax home in a foreign country.
Foreign Earned Income
There is a much longer explanation, but for the purposes of this article, it is important to understand that the United States is one of the few countries in the world that taxes by citizenship rather than by residency. For example, if you are a citizen of the United Kingdom (U.K.) but resided in Fiji, any income that you earned while not in the U.K. would not be taxable to you by the U.K. government. Nearly every country in the world works this way. On the flip side, Uncle Sam generally stakes claim to any income earned by its citizens no matter where they reside in the world. Whether you lived and earned income for 6 months in Jamaica or Los Angeles, as a citizen you must ensure that the U.S. Government gets their cut. Although this may be a bit of a damper for aspiring expats, there are several measures that an informed taxpayer can take to ensure that this does not become overly burdensome.
One of the most important aspects that you must understand that often trips people up, is that foreign earned income is the income that you earn in a foreign country, not necessarily for a foreign company or country. Therefore, where you are physically present while earning income is the critical factor. The country of origin of the company that you work for, or where people are that receive your services is not relevant. For example, if you are a digital nomad that lives in Country Y but provides accounting services to clients primarily located in the U.S., you would be positioned to claim the income that you earned for those services. If, however, you live and work in the U.S. for a foreign company based in the U.S. and perform those same services for global clients, you would not be able to claim the exclusion.
Foreign earned income is income that an individual actually earns (think what you engaged in labor for) for services performed in a foreign country during the period that the foreign country is your tax home. Foreign earned income does not include passive income such as rental payments, capital gains, dividends, interest, etc.
Your Tax Home
The IRS wants to ensure that people are not attempting to lower or even eliminate their tax bill simply by loosely claiming that they have foreign earned income by going on a few temporary international trips. The key here is that it must be established that your time abroad is not determined by a definite return date to live back in the United States. In other words, you should be able to show under scrutiny that your time abroad is indefinite and/or that you are putting down roots in your new home. In order to evaluate whether citizens or resident aliens have established abode in a foreign country, the IRS provides two standards.
Physical Presence Test
You must be physically present in a foreign country for 330 full days in a period of twelve consecutive months.
A full day is 24 consecutive hours, which begins at midnight and ends at midnight. It’s important to note that the time you spend traveling on or over international waters to arrive at your destination does not count toward a full day.
You are allowed, with some conditions, to move and/or travel to other foreign countries and still maintain your full days.
Many digital nomads, self-employed entrepreneurs and remote employees successfully use this test.
Bona Fide Residence Test
You must be a bona fide resident of the country for a full tax year.
Establishing bona fide residency leans less on your time in a foreign country, and more on proving via a variety of factors and circumstances that you are in fact a resident of the foreign country.
Determining whether an individual is in fact a bona fide resident is based on the respective facts of each case. Examples could include setting up permanent living quarters for you and your family, placing the majority of your remaining belongings in the U.S. in a storage facility, and other lifestyles choices that effectively establish ties with the new country.
This test is often suitable for expats seeking to establish long term or permanent ties to a new country. Because establishing a tax home and abode can be a complicated topic, we will cover it in more depth in a subsequent post.
Self-Employment Income
The FEIE not only applies to salaries and wages that you may receive from an employer but also to self-employment income. So, if you are an entrepreneur earning foreign earned income (Remember, you physically reside while earning your income is the key.), you are also eligible to exclude income that would otherwise be taxed. However, the FEIE does not get you out of your self-employment tax obligations. Those taxes still must be filed and paid as if the exclusion were not available to you.
In Summary
These are just the basics on the FEIE. But if you can qualify in 2025, you may be able to exclude $130,000 of your income if you are single, and $260,000 if you are married filing jointly. You don’t struggle through this on your own during tax season. It’s always a good idea to seek assistance from a qualified tax professional such as an Enrolled Agent (EA), CPA or tax attorney.
Should you need assistance, please don’t hesitate to contact us here.
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