For U.S. citizens and resident aliens living abroad, worldwide income remains subject to U.S. taxes. However, the Foreign Earned Income Exclusion (FEIE) allows qualifying expats to exclude a portion of their foreign earnings from U.S. taxation. This exclusion helps reduce tax liability and avoid double taxation on income earned outside the United States.
For 2024, the FEIE limit is $126,500 per qualifying individual, meaning an expat couple could potentially exclude up to $253,000 if both spouses qualify. However, strict eligibility rules and potential pitfalls make it essential for expats to understand how the exclusion works before filing their taxes.
This guide explains the Foreign Earned Income Exclusion, who qualifies, what income can be excluded, how to claim it, and common mistakes to avoid.
Qualifying for the Foreign Earned Income Exclusion
Not every U.S. citizen living abroad qualifies for the FEIE. To claim the exclusion, an individual must meet two key requirements:
- Have foreign earned income – Only income earned from working abroad qualifies. Passive income, such as rental income, dividends, or pensions, does not qualify.
- Pass either the Physical Presence Test or the Bona Fide Residence Test – These tests determine whether an individual has a legitimate tax home in a foreign country.
Physical Presence Test
To qualify under this test, an individual must be physically present in a foreign country for at least 330 full days within a 12-month period. These days do not need to be consecutive but must occur within a rolling 12-month timeframe.
Bona Fide Residence Test
This test applies to individuals who establish permanent residency in a foreign country and intend to stay for an indefinite period. Unlike the Physical Presence Test, this method requires proving closer ties to the foreign country, such as:
- Holding a residency visa
- Renting or owning a home abroad
- Establishing foreign bank accounts
- Paying taxes to the foreign government
While the Physical Presence Test is purely based on time spent abroad, the Bona Fide Residence Test requires proof of long-term commitment to living in another country.
What Income Can Be Excluded?
Only foreign earned income qualifies for the FEIE.
This includes:
- Wages and salaries from employment abroad
- Self-employment income (though self-employed individuals must still pay self-employment tax)
- Bonuses, commissions, and freelance income from work performed outside the U.S.
However, the FEIE does not apply to:
- Unearned income such as rental income, capital gains, dividends, and pensions
- Employer-provided housing and allowances (though a separate Foreign Housing Exclusion may apply)
- Government employment income paid by the U.S. government
The exclusion only applies to earned income, meaning individuals relying on investment income, Social Security, or U.S. government pensions must still report and pay U.S. taxes on that income.
How to Claim the Foreign Earned Income Exclusion
To claim the FEIE, taxpayers must file IRS Form 2555 (Foreign Earned Income) along with their U.S. tax return. The process involves:
- Determining Eligibility – Confirm that the income qualifies and that the individual meets either the Physical Presence or Bona Fide Residence Test.
- Completing IRS Form 2555 – This form requires details on foreign income, residency status, and travel dates.
- Filing by the Deadline – The standard tax deadline for U.S. citizens is April 15, but expats receive an automatic extension to June 15. A further extension until October 15 can be requested if needed.
- Claiming the Foreign Housing Exclusion (If Applicable) – If an employer provides housing benefits, additional tax savings may be available through the Foreign Housing Exclusion, also reported on Form 2555.
Even though the FEIE reduces taxable income, expats are still required to file a U.S. tax return annually if their income exceeds the filing threshold.
Common Pitfalls When Using the Foreign Earned Income Exclusion
While the FEIE offers substantial tax benefits, mistakes in filing or eligibility can lead to denied claims or unexpected tax bills. Common errors include:
- Miscounting Travel Days – Failing to meet the 330-day rule for the Physical Presence Test can result in losing the exclusion for the entire tax year. Expats should track travel dates carefully.
- Not Establishing a Foreign Tax Home – If an individual maintains strong ties to the U.S., such as a permanent residence or frequent visits, the IRS may deny the FEIE claim under the Bona Fide Residence Test.
- Forgetting State Taxes – Some U.S. states, such as California, New York, and Virginia, do not recognize the FEIE and may still require state tax filings for expats.
- Failing to File on Time – The IRS requires Form 2555 to be filed with a tax return. Late filing can result in penalties or losing the exclusion.
- Ignoring Foreign Tax Credit Options – The Foreign Tax Credit (FTC) may be a better option for some expats who pay high foreign taxes. In some cases, using the FTC instead of the FEIE provides greater tax savings.
Avoiding these pitfalls ensures that expats fully benefit from the tax exclusion while staying compliant with IRS rules.
Tips for Maximizing the Foreign Earned Income Exclusion
To take full advantage of the Foreign Earned Income Exclusion, planning ahead is essential. The following strategies can help expats stay eligible and minimize their U.S. tax liability:
- Plan your travel days carefully – If you’re relying on the Physical Presence Test, make sure you do not exceed 35 days in the U.S. during any 12-month period. Even short visits back home can jeopardize your eligibility, so track travel days closely.
- Align work location with tax home – To qualify, your tax home must be in a foreign country. Avoid working remotely for a U.S. company while physically residing in the U.S. for part of the year.
- Consider the Foreign Housing Exclusion – If you pay for housing expenses while living abroad, you may be able to exclude additional income beyond the FEIE limit. Keep records of rent, utilities, and related costs.
- Use the best 12-month period – For the Physical Presence Test, you can choose any 12-month period. Selecting a window that maximizes your time abroad can improve your chances of qualifying.
- Combine with the Foreign Tax Credit when appropriate – In some cases, you may benefit by excluding part of your income with the FEIE and using the Foreign Tax Credit for the rest. This is useful if your income exceeds the FEIE cap or you face high foreign taxes.
Careful coordination of these strategies can make a significant difference in how much tax you owe—or avoid—each year.
Foreign Earned Income Exclusion and Self-Employment Taxes
One important limitation of the Foreign Earned Income Exclusion is that it does not exempt self-employed individuals from U.S. self-employment taxes. While the FEIE can reduce or eliminate income tax on foreign earnings, self-employed expats are still required to pay Social Security and Medicare taxes on their net earnings.
Here’s what self-employed expats need to know:
- Self-employment tax is separate from income tax – Even if you exclude your income under the FEIE, the IRS still requires a 15.3% self-employment tax on earnings over $400.
- Form 2555 does not reduce self-employment tax – Unlike employees, self-employed individuals can’t eliminate self-employment taxes using the FEIE alone.
- Consider a totalization agreement – The U.S. has treaties with several countries to prevent double taxation of Social Security. If you pay into the foreign country’s system, a totalization agreement may exempt you from U.S. self-employment tax.
- Entity structure can matter – In some cases, forming a foreign corporation and electing to be taxed as a corporation (rather than a sole proprietor) may help reduce or eliminate self-employment tax liability.
Because these rules are nuanced and vary by country, self-employed expats should consult a tax professional to avoid unexpected tax obligations and to structure their business income in the most tax-efficient way.
How Dimov Tax Can Help Expats Claim FEIE
The Foreign Earned Income Exclusion is a powerful tool for U.S. expats looking to reduce their U.S. tax burden. By meeting the residency or physical presence requirements and correctly filing IRS Form 2555, eligible taxpayers can exclude up to $126,500 in 2024 from their taxable income.
However, navigating tax laws for expats can be complex. Dimov Tax specializes in tax planning for Americans living abroad, helping expats maximize deductions, avoid costly mistakes, and ensure full compliance with U.S. tax laws.
Contact Dimov Tax today to get expert guidance on claiming the FEIE and optimizing your expat tax strategy.