Do I Need to File Form 673 to Claim Tax Withholding Exemptions?

U.S. citizens working abroad may be eligible for tax benefits that reduce or eliminate withholding on their income. By submitting Form 673 to their employer, they can claim an exemption from U.S. federal income tax withholding on certain foreign-earned income and housing costs.

Eligible Types of Compensation

Income that qualifies for exemption under Form 673 includes foreign-earned wages and certain housing-related benefits. Wages must be earned for services performed in a foreign country. Compensation for remote work done from the U.S. does not qualify. Eligible income includes salaries, bonuses, and commissions paid by either a U.S. or foreign employer, as long as the work is conducted outside the U.S.

Employer-provided housing benefits may also be exempt if they meet the criteria for the foreign housing exclusion or deduction under Section 911 of the Internal Revenue Code. This includes reimbursements for rent, utilities, and other reasonable living expenses incurred while residing abroad. Limits on the amount that can be excluded vary by location, with high-cost cities such as Hong Kong or London having higher allowable exclusions.

Conditions for Claiming Withholding Exemption

To qualify for an exemption from U.S. federal income tax withholding, individuals must meet residency and income requirements under the foreign earned income exclusion (FEIE) and foreign housing exclusion provisions. Eligibility is determined by either the bona fide residence test or the physical presence test.

The bona fide residence test requires an individual to be a tax resident of a foreign country for an entire tax year, demonstrating an intention to establish a long-term presence. This is assessed based on factors such as the nature of employment, duration of stay, and ties to the foreign country, including property ownership or local tax obligations.

The physical presence test requires the taxpayer to be in a foreign country for at least 330 full days within any 12-month period. These days do not need to be consecutive, but time spent in the U.S. for vacations or business trips reduces the total count. This test benefits individuals on temporary overseas assignments who may not establish permanent residency but still qualify based on extended stays abroad.

How to Complete the Form

Form 673 requires detailed information to ensure the withholding exemption is applied correctly. It begins with the taxpayer’s name, Social Security number, and foreign address. Employers use this section to verify the individual’s overseas work status, so accuracy is important. Errors could lead to delays or unnecessary withholding.

The form also requires an estimate of foreign-earned income that qualifies for exemption. The IRS adjusts the foreign earned income exclusion limit annually for inflation. For 2024, the limit is $126,500. This figure should reflect only income expected to be earned while meeting the residency or presence requirements. Overestimating could result in underpayment penalties, while underreporting may lead to excessive withholding.

If claiming the foreign housing exclusion, the form requires an estimate of qualifying housing expenses. These amounts vary based on location-specific limits published annually by the IRS. Taxpayers in designated high-cost areas should ensure their estimates align with the latest permissible thresholds. Keeping records of lease agreements and utility bills can help substantiate claims if the IRS requests verification.

Handling Changes in Your Tax Status

Changes in employment, residency, or tax laws can affect the validity of a withholding exemption claimed through Form 673. A taxpayer who initially qualifies based on foreign residency or physical presence might lose eligibility due to an early return to the U.S. or a change in work location.

Employers are not responsible for monitoring individual tax circumstances, so any changes must be reported promptly. If a taxpayer realizes mid-year that they will not meet the minimum time requirements abroad, they should notify payroll departments to resume withholding. Failure to do so could lead to tax underpayment issues, with potential penalties and interest. Taxpayers can mitigate this by making estimated tax payments using Form 1040-ES to cover any shortfall before filing their annual return.

Potential Consequences of Skipping Form 673

Failing to submit Form 673 when eligible can lead to unnecessary tax withholding, reducing take-home pay. Without this form, employers must withhold U.S. federal income tax as if the employee were working domestically, even if the income qualifies for exclusion under the Foreign Earned Income Exclusion (FEIE) or the Foreign Housing Exclusion.

While excess withholding can be reclaimed when filing an annual tax return, this delays access to funds that could be used for living expenses or investments. Additionally, if an individual does not file Form 673 and later fails to properly claim the FEIE on their tax return, they may lose the ability to exclude that income for the given tax year. The IRS generally does not allow retroactive claims of the exclusion without a valid reason, meaning a missed opportunity to submit Form 673 could result in a higher overall tax liability.