By Alex McGowin

CPA Tax Consulting Expert 

U.S. citizens are generally taxed on their worldwide income regardless of where their income is earned or received. 

For expat residents abroad, this often means they are also subject to taxation from the foreign host country which can lead to double taxation. One way that qualifying taxpayers may reduce this burden is by utilizing the FEIE.

 

This exclusion is particularly beneficial when a U.S. citizen is resident in a low or no-tax foreign country as there is no specific requirement that you pay tax locally.

 

The maximum amount of the FEIE is indexed for inflation each year. For the 2022 tax year, the maximum amount was $112,000 and for 2023 the maximum exclusion will be $120,000.

 

The FEIE amount is limited to the lesser of the foreign earned income of the U.S. citizen or resident alien living abroad for the tax year or the exclusion amount, prorated to the number of qualifying days in the tax year (e.g., if you qualified for half of the year then you would be eligible for half the exclusion).

 

For example. It is a rare individual that can read the standard rules of the FEIE and really understand how it applies. To make this more practical, below is a fairly common example of an individual that has moved abroad. I'll provide the basic requirements below and apply them to this fact pattern so you can see it in action.

 

Nicky Saban is a U.S. citizen that moved to Costa Rica in July of 2022. He spent no days in the U.S. after he moved. He is single and owned a home in Texas which he decided to rent out. He signed a year's long lease in Costa Rica where he will be working remotely as a self-employed graphic designer. He earned $100,000 through his self-employed business in 2022.

Who qualifies? To summarize the qualification rules, a U.S. citizen living abroad is eligible for the foreign earned income and housing exclusion if his or her tax home is in a foreign country and the individual is either:

 

• A U.S. citizen who meets the requirements of the Bonafide Residence Test ("BFR") by having been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year; or

 

• A U.S. citizen who meets the requirements of the Physical Presence Test ("PPT") by being present in a foreign country or countries during at least 330 full days during any period of 12 consecutive months.

 

The PPT has a strict day threshold where you can only spend 35 days in the U.S. over 365 days. So this one can straddle 2 years as it is not specific to a calendar year.

 

The BFR test requires a full calendar year of "bonafide residency". Although it does not have a specific day threshold, the more days you are in the U.S. more less likely you would be considered a bonafide resident. This test has a higher bar for proving residency in the foreign country. For example, you stay in the foreign country has to be more than merely transient.

Both of these tests require that you have foreign-earned income and that your tax home is outside the U.S. during the qualifying period.

 

Foreign earned income. This is the more intuitive of the terms but it essentially means the income has to be earned through the performance of services while physically present outside the U.S. This generally includes wage and self-employment income. If does not include passive income such as interest, dividends, and retirement distributions.

 

Tax home. Your tax home has to be in a foreign country through the qualifying period. Simply put… your tax home is where you work. This may be the same place as where you live or it may not be. There is an additional, but related, requirement that you must have your "abode" outside the U.S. as well.

 

To determine where your abode is the IRS would compare your domestic ties in the foreign country to that of the IRS. This is generally where the controversy sets in but a simple rule of thumb is to lose the home in the U.S. (or rent it out) and bring your family with you abroad.

 

So, how do these rules apply to our friend Nicky?

 

Nicky has a foreign-earned income. His income is from the provision of services and, for part of the year, those services were performed physically outside the U.S.

Nicky's tax home is outside the U.S. for the 2nd half of the year as that is where he works. In his case, it is reasonable to say his abode is also outside the U.S. as he rented out his house in the U.S. and appears to have his domestic ties more closely aligned to Costa Rica.

Nicky would not meet the BFR test for 2022 as he was not there for the entire calendar year.

Nicky would qualify for the PPT however since he had his tax home/abode outside the U.S. for 330 of 365 days. This would be from July 2022 to July 2023. Since his qualifying period is only for half of 2022 he would only be eligible for half of the exclusion, or $56,000.

 

Nicky would claim the FEIE by filing Form 2555 with his timely U.S. tax return for 2022.

 

Note that this is not the whole story as there are other things to consider (e.g., housing exclusions, self-employment tax, foreign tax credit, state taxes, etc…). This article is meant to give the basic rules and practical application of the FEIE. Nicky would be quite pleased with this result if he is used to paying full U.S. tax on a similar income amount.

 

The foreign earned income exclusion is one of the best tools a U.S. expat has available to reduce their U.S. tax burden. Hire a professional to make sure it is done correctly.

As always, this is not to be considered tax advice. My firm, McGowin Tax LLC specializing in U.S. international tax planning and consulting for individuals and small businesses. Visit us at McGowinTax.com or email Alex McGowin directly at alex.mcgowin@mcgowintax.com.