Foreign Earned Income Exclusion

Excluding foreign wages from US taxes using Form 2555

United States passport against a backdrop of foreign currency
© Michael Grabois / Moment Open / Getty Images

People who live and work outside the United States may be able to exclude all or part of their foreign-source wages and self-employment income from the federal income tax through a provision called the foreign earned income exclusion. To qualify for the foreign earned income exclusion, a person needs to:

    Persons who qualify are eligible to exclude up to $100,800 in foreign earned income annually, depending on the year. The amount of the foreign earned income exclusion changes each year. Here's the maximum allowable exclusions for tax years 1998 through 2015.

    Persons may also be eligible to to exclude an additional amount for housing using the foreign housing exclusion or deduction.

    Types of Income to Which the Foreign Earned Income Exclusion Applies

    The foreign earned income exclusion applies only to income arising from performing services either as an employee or as an independent contractor. "The term 'earned income' means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered (Internal Revenue Code section 911(d)(2)(A)). Thus, wages and self-employment income may qualify for the foreign earned income exclusion. Other types of income cannot be excluded using this provision.

    From Which Tax is Income Excluded?

    The foreign earned income exclusion functions to exclude earned income from the federal income tax. The foreign earned income exclusion does not exclude income from Social Security or Medicare taxes. Thus, the foreign earned income exclusion does not reduce the self-employment tax, which is the mechanism by which self-employed persons pay in the Social Security and Medicare taxes.

    Further, self-employed persons are eligible to take the foreign housing deduction instead of the foreign housing exclusion. There's more details at Self-Employment & Foreign Exclusions.

    How does the Foreign Earned Income Exclusion Impact the Tax Calculation?

    Taxpayers claiming the foreign earned income exclusion will pay tax at the tax rates that would have applied had they not claimed the exclusion. In other words, the federal income tax is calculated by first calculating the amount of income tax on income without taking the foreign earned income exclusion into account, and then subtracting the tax as calculated on the amount of foreign earned income that is excluded. The result is the amount of the federal income tax liability. To facilitate this calculation, taxpayers use the Foreign Earned Income Tax Worksheet found in the Instructions for Form 1040. This special method of figuring the tax has been in effect since 2006.

    Persons must meet one of two qualification tests to claim the Foreign Earned Income Exclusion. A person must meet either the bona fide residence test or the physical presence test.

     

    Bona Fide Residence Test

    One Full Year of Residence
    A person is considered a "bona fide resident" of the foreign country if that person resides in that country for "an uninterrupted period that includes an entire tax year." A tax year is January 1 through December 31. The qualifying period for the bona fide residence test must include one full calendar year.

    Trips outside the Foreign Country
    Brief trips or vacations outside the foreign country will not jeopardize a person's status as a bona fide resident, as long as the trips are brief and the person clearly intended to return to the foreign country. A person can even make brief trips to the United States.

    Statement to Foreign Authorities
    A person is not be considered a bona fide resident of a foreign country if a person has submitted a statement to the foreign country that he or she are not a resident of that country, and the foreign government has determined that the person is not subject to their tax laws as a resident.

    Tax Treaty
    Special treatment of income under an income tax treaty does not prevent a person from meeting the bona fide residence test.

     

    Physical Presence Test

    A person is considered physically present in a foreign country (or countries) if the person resides in that country (or countries) for at least 330 full days in any consecutive 12-month period. A person can live and work in any number of foreign countries but must be physically present in those countries for at least 330 full days.

    Full Day
    A "full day" is 24 hours. So, the day of arrival in and the day of departure from a foreign country are generally not counted towards the physical presence test.

    12-Month Period
    The qualifying period can be any consecutive 12-month period of time. A person does not have to begin his or her qualifying period with the first day in a foreign country. A person can choose which 12-month period to use for the physical presence test. This gives the taxpayer freedom to choose a 12-month period that provides the greatest income exclusion. Both vacation and business days spent in the foreign country count towards meeting the 330 day threshold.

    Travel Outside the Foreign Country
    Travel outside of the foreign country where a person resides generally will not jeopardize the 330 full days requirement for the physical presence test. The IRS explains it this way, "You can move about from one place to another in a foreign country or to another foreign country without losing full days. If any part of your travel is not within any foreign country and takes less than 24 hours, you are considered to be in a foreign country during that part of travel." (Source: Publication 54, section on the physical presence test.)

    Waiver to the Time Requirements due to Adverse Conditions
    The minimum time requirements for both the bona fide and physical presence tests can be waived.

    The only valid reason for a waiver is that the taxpayer is forced to leave the foreign country because of "war, civil unrest, or similar adverse conditions." The taxpayer should be able to prove that he or she would have met the time requirements if adverse conditions had not interrupted their residence.

    Prohibition on Travel to Cuba
    Time spent residing or working in Cuba will not qualify for the bona fide residence or physical presence tests.

    Maximum Exclusion

    The amount of foreign wages and salary a taxpayer can exclude per year is limited to actual foreign earned income or the annual maximum dollar limit, whichever is less. Starting with tax year 2006, the foreign earned income exclusion is adjusted each year for inflation by the Internal Revenue Service.

     

    Maximum Foreign Earned Income Exclusion
    Tax YearAmountSource
    2016$101,300Revenue Procedure 2015-53 (PDF)
    2015$100,800Revenue Procedure 2014-61 (PDF)
    2014$99,200Revenue Procedure 2013-35 (PDF)
    2013$97,600Revenue Procedure 2012-41 (PDF)
    2012$95,100Revenue Procedure 2011-52 (PDF)
    2011$92,900Revenue Procedure 2010-40 (PDF)
    2010$91,500Revenue Procedure 2009-50 (PDF)
    2009$91,400Revenue Procedure 2008-66 (PDF)
    2008$87,600Revenue Procedure 2007-66 (PDF)
    2007$85,700Revenue Procedure 2006-53 (PDF)
    2006$82,400Revenue Procedure 2006-51 (PDF)
    2002 through 2005$80,000Internal Revenue Code section 911
    2001$78,000Internal Revenue Code section 911
    2000$76,000Internal Revenue Code section 911
    1999$74,000Internal Revenue Code section 911
    1998$72,000Internal Revenue Code section 911

     

    Prorated Exclusion

    Under the physical presence test, a taxpayer can choose any consecutive 12-month period to qualify for the foreign earned income exclusion. This creates the possibility that the amount of the exclusion may need to be spread over two year and that the amount of the maximum exclusion in a year may need to be prorated. To prorate the maximum exclusion, use the number of days you were physically present during the tax year. The exclusion is calculated by the ratio of the number of days physically present in the foreign county (numerator) to the number of days in the year (denominator). (See Publication 54, section on part-year exclusion.)

    The pro-rated exclusion amount may not exceed the maximum allowable exclusion.

    Taxpayers may also qualify for a prorated exclusion if you intended to meet all the time requirements but you left the country due to civil unrest. According to IRS Instructions for Form 2555:

    Waiver of Time Requirements

    If your tax home was in a foreign country and you were a bona fide resident of, or physically present in, a foreign country and had to leave because of war, civil unrest, or similar adverse conditions, the minimum time requirements specified under the bona fide residence and physical presence tests may be waived. You must be able to show that you reasonably could have expected to meet the minimum time requirements if you had not been required to leave. Each year the IRS will publish in the Internal Revenue Bulletin a list of countries and the dates they qualify for the waiver. If you left one of the countries during the period indicated, you can claim the tax benefits on Form 2555, but only for the number of days you were a bona fide resident of, or physically present in, the foreign country.

    If a person can claim either of the exclusions or the housing deduction because of the waiver of time requirements, attach a statement to the return explaining that the taxpayer expected to meet the applicable time requirement, but the conditions in the foreign country prevented you from the normal conduct of business. Also, enter "Claiming Waiver" in the top margin on page 1 of Form 2555.

    Persons who live and work outside the United States can exclude from federal income tax amounts paid by their employer for housing. This includes any amounts paid directly to the taxpayer or on the taxpayer's behalf for housing, rent, education for the taxpayer's children, or tax equalization ("gross up") payments.

     

    Time Requirements

    For the housing exclusion, you must meet the same time requirements under the bona fide or physical presence tests.

     

    Qualifying Expenses

    The following expenses qualify for the foreign housing exclusion:
    • Rent,
    • Fair rental value of housing provided by the employer,
    • Repairs,
    • Utilities other than telephone,
    • Real property and personal property insurance (homeowners & renters insurance),
    • Occupancy taxes,
    • Nonrefundable security deposits or lease payments,
    • Furniture rental,
    • Residential parking fees.
    Additionally, taxpayers may be eligible to exclude housing amounts paid by their employer. Employer-provided amounts include:
    • Tax equalization payments paid by your employer,
    • Education expenses for your dependent children.
    For more information on excluding employer-provided housing expenses, see the Foreign Housing Exclusion and Deduction section of Publication 54.

     

    Non-Qualifying Expenses

    The following expenses do not qualify for the foreign housing exclusion:
    • Lavish or extravagant expenses (as determined by a person's circumstances),
    • Deductible interest and taxes (for example mortgage interest),
    • Cost of buying property (for example, principal payments on a mortgage),
    • Domestic labor (for example, maids and gardeners),
    • Pay television,
    • Home improvements,
    • Purchased furniture,
    • Depreciation of property or improvements.

     

    Coordination with the Foreign Earned Income Exclusion

    Persons can claim the foreign earned income exclusion, the foreign housing exclusion, or both. However, the same income cannot be excluded twice. Generally, it is advantageous to consider the foreign housing exclusion if a person's foreign earned income exceeds the maximum amount of the foreign earned income exclusion amount.

     

    Maximum Foreign Housing Exclusion

    The amount of the housing exclusion is 16% of the foreign earned income exclusion amount ($15,616 for 2013). There are higher maximum amounts for selected foreign locations. The IRS lists the housing exclusion amounts in an appendix to the Instructions for Form 2555.

    Self-employed persons cannot claim the foreign housing exclusion. Instead, they must claim the foreign housing deduction instead. (See Publication 54, the section on the foreign housing deduction.)

    Self-employed persons working abroad may claim the foreign earned income exclusion and the foreign housing deduction. Both the income exclusion and the housing deduction will be calculated based on your net income as figured on Schedule C or Schedule F. So, calculating the right amount of the exclusion depends on figuring your business income accurately.

     

    Foreign Earned Income Exclusion

    Self-employed persons may claim the foreign income exclusion on self-employment income.
    This will reduce the federal income tax, but it will not reduce the self-employment tax.

     

    Foreign Housing Deduction for Self-Employed Persons

    Self-employed persons working abroad do not qualify for the foreign housing exclusion. Instead they can deduct allowable housing expenses under the foreign housing deduction. The foreign housing deduction is calculated on Form 2555 Part VI and IX. The foreign housing deduction reduces the federal income tax, but does not reduce the self-employment tax.