For expatriates living abroad, the reach of the U.S.’ worldwide tax system can turn an inherently complex tax situation into a nightmare.
Some may think that because they are living and working abroad and pay tax in their country of residence, they would be exempt from having to pay income taxes to the U.S. government.
Unfortunately, that is not the case.
Expatriates from the U.S. are expected to report and pay taxes on their worldwide income in the same manner as US-based taxpayers.
While this complicates matters for those living and working abroad, there is a somewhat clear-cut solution for those who qualify: the Foreign Earned Income Exclusion.
The FEIE allows certain expats to receive an exclusion of up to $101,300 per year for a single taxpayer ($202,600 for married couples where both spouses work) for the year 2016.
According to the IRS:
“If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income. However, you may qualify to exclude from income up to an amount of your foreign earnings that is adjusted annually for inflation ($92,900 for 2011, $95,100 for 2012, $97,600 for 2013, $99,200 for 2014, $100,800 for 2015 and $101,300 for 2016.)”
In order to qualify for the FEIE one must:
- Reside and work outside of the U.S.
- Meet either the Physical Presence Test or the Bona Fide Residence Test
It is important to understand that not all types of income may be excluded.
6 Forms of Income that Cannot Be Excluded
The IRS has laid out six forms of income that are not considered “foreign”:
- Pay received by military or civilian employees of the U.S. Government (or any of its agencies)
- Pay for services conducted in international waters (not a foreign country)
- Pay in specific combat zones
- Payments received after the end of the tax year following the year in which the services that earned the income were performed
- The value of meals and lodging that are excluded from income furnished for the employer’s convenience
- Pension or annuity payments, including social security benefits
NOTE: Self-employed individuals can claim the FEIE for self-employment income. Although the excluded amount will reduce the individual’s regular income tax, it will not reduce the individual’s self-employment tax.
Directions for Claiming the FEIE
In order to claim the FEIE, Form 2555 (if you are also claiming the foreign housing cost amount exclusion) or Form 2555-EZ (if you are only claiming the foreign income tax exclusion) will need to be filed. Either Form 2555 or Form 2555-EZ should be filed along with your timely filed Form 1040.