If You Make Money Overseas, Is It Taxable?

If you are a U.S. citizen or a resident alien, the money you make overseas is taxable by the United States. The U.S. tax system is based on citizenship, not residency, meaning your worldwide income is subject to U.S. income tax regardless of where you live. This applies to wages, self-employment income, and certain investment income from foreign sources.

Even if you live abroad, you are still required to file a U.S. tax return annually if your income meets the filing thresholds. The tax code includes provisions designed to prevent double taxation, which is paying tax to both a foreign country and the U.S. on the same earnings. These mechanisms require you to actively claim them on your tax return.

Qualifying for Tax Benefits Abroad

To use the tax benefits for Americans working overseas, you must meet three IRS requirements. First, you must pass the tax home test. Then, you must meet either the bona fide residence test or the physical presence test to prove your connection to a foreign country.

The Tax Home Test

Your tax home is the general area of your main place of business or employment, not necessarily where your family home is. To qualify for these tax benefits, your tax home must be in a foreign country. The IRS requires this to ensure the benefits are for those who have relocated their economic life abroad, not just traveling for a temporary assignment.

A consideration is your “abode,” which is the location of your personal and economic ties. If you maintain an abode in the United States, you will not have a foreign tax home and will be disqualified from certain benefits. For those without a regular place of business, like digital nomads, the IRS may consider their tax home to be where they regularly live.

The Bona Fide Residence Test

The bona fide residence test assesses your residency status in a foreign country. To meet this test, you must be a resident of a foreign country for an uninterrupted period that includes an entire tax year, from January 1 to December 31.

This test focuses on your intentions and actions related to establishing a foreign life. The IRS considers factors like establishing a permanent home, your visa type, and whether your family has relocated with you.

Stating to foreign authorities that you are not a resident can jeopardize your status. If your employment is for a definite period, you likely will not qualify. This test allows for trips back to the U.S. without breaking your residency, provided you intend to return to your foreign home.

The Physical Presence Test

The physical presence test is a mathematical calculation. To pass, you must be physically present in a foreign country or countries for at least 330 full days during any 12-month period. A full day is a continuous 24-hour period, so travel days to or from the U.S. do not count toward the total.

The 330 days do not need to be consecutive, and the 12-month period can start on any day. This test is useful for those on specific assignments or who travel often, as it only counts time outside the U.S. Failing to meet the 330-day requirement for any reason leads to disqualification, with a rare exception for leaving a country due to war or civil unrest.

Excluding Foreign Earned Income

Once you qualify, you can use the Foreign Earned Income Exclusion (FEIE) to exclude a portion of your foreign earnings from U.S. income tax. You claim this exclusion by filing Form 2555, Foreign Earned Income. Once you choose the exclusion, it remains in effect for all future years unless you formally revoke it. If revoked, you cannot claim it again for five years without IRS permission.

What is Foreign Earned Income

Foreign earned income is compensation for services performed in a foreign country, including salaries, wages, commissions, and professional fees. For the self-employed, it is the income from business activities conducted abroad.

The exclusion does not apply to unearned income like interest, dividends, capital gains, rental income, or pensions. Pay received from the U.S. government or its agencies also does not qualify as foreign earned income.

The Exclusion Limit

The exclusion amount is capped and adjusted annually for inflation. For 2024, the maximum exclusion is $126,500 per person, projected to be $130,000 for 2025. If you and your spouse both qualify, you can each claim the full exclusion.

If you qualify for only part of the tax year, you must prorate the maximum limit based on your number of qualifying days. For instance, if you have 122 qualifying days, your maximum exclusion would be calculated as (122/365) multiplied by the annual limit.

The Foreign Housing Exclusion and Deduction

In addition to the FEIE, you may be able to exclude or deduct a portion of your housing costs. The calculation is based on qualifying expenses like rent, utilities, and furniture rental. Phone and television services are not included.

From your total expenses, you must subtract a base housing amount, which is 16% of the maximum FEIE limit. Housing expenses that exceed this base may be eligible for the benefit, up to a cap of 30% of the FEIE limit. This benefit is an exclusion for employees and a deduction for self-employed individuals.

Claiming the Foreign Tax Credit

As an alternative to the FEIE, you can claim the Foreign Tax Credit (FTC) for income taxes paid to a foreign government. This provides a dollar-for-dollar reduction of your U.S. tax liability, which is more beneficial than a deduction. For those in high-tax countries, the FTC is often a better option than the FEIE.

How the Credit Works

For example, if you owe $5,000 in U.S. taxes on foreign income but paid $4,000 in income taxes to your country of residence, the FTC could reduce your U.S. tax liability by $4,000.

You can use the FTC even if you claim the FEIE, but not on the same income. If your foreign income exceeds the FEIE limit, you can claim the FTC on the remaining income subject to U.S. tax. This strategy allows you to combine benefits.

Qualifying Foreign Taxes

Not all foreign taxes are eligible for the credit. The FTC can only be claimed for foreign taxes on income, war profits, and excess profits. Taxes not based on income, such as value-added (VAT), sales, or property taxes, are not creditable.

A creditable tax must be a compulsory payment levied on income as defined by U.S. tax principles. It cannot be a payment for a specific economic benefit. Some foreign levies called an “income tax” may not qualify if they do not meet the IRS definition.

Limitation on the Credit

The Foreign Tax Credit cannot be used to reduce U.S. taxes on U.S. source income. Your total credit is subject to a limitation to ensure it only offsets the U.S. tax liability on your foreign source income.

This limitation is calculated on Form 1116, Foreign Tax Credit. The formula determines the proportion of your total income that is from foreign sources and applies that ratio to your U.S. tax liability. Any foreign taxes paid that exceed this limit can be carried back one year or forward for up to ten years.

Filing Your U.S. Tax Return from Abroad

Living abroad does not remove the obligation to file a U.S. tax return, which involves different deadlines than for domestic filers. All income and expenses must be reported in U.S. dollars, requiring you to translate any amounts from a foreign currency. Compliance is necessary to avoid penalties.

Filing Deadlines

Taxpayers with a foreign tax home on the regular due date receive an automatic two-month filing extension, moving the deadline from April 15 to June 15. This extension is for filing only. Any tax owed is still due on April 15 to avoid interest.

For more time, you can file Form 4868 for an extension to October 15. You can file electronically using IRS-approved software or mail a paper return to the designated IRS service center.

Other Reporting Obligations

You may have other reporting duties for foreign financial assets. If the total value of your foreign financial accounts exceeds $10,000 at any time during the year, you must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). This is filed electronically and is separate from your tax return.

You may also need to file Form 8938, Statement of Specified Foreign Financial Assets, with your tax return. This applies if your foreign assets exceed certain thresholds, which are higher for those living abroad. For a single person abroad, the threshold is over $200,000 on the last day of the tax year or over $300,000 at any time during the year. Penalties for failing to file these returns can be severe.