IRS Publication 54: Tax Rules for Americans Abroad

IRS Publication 54, “Tax Guide for U.S. Citizens and Resident Aliens Abroad,” is a document for Americans living overseas. It explains U.S. tax obligations, which apply to citizens and resident aliens regardless of where they reside. The publication outlines who must file a U.S. tax return, how to report income earned in foreign currencies, and the tax implications of being married to a non-U.S. person. It also introduces the tax benefits available to offset the costs of living and working in another country, explaining the qualifications for these provisions and how they interact with a standard U.S. tax return.

Qualifying for Tax Benefits Abroad

To access the primary tax benefits offered to Americans working overseas, an individual must first meet specific criteria establishing their connection to a foreign country. These qualifications are not about the income earned but about the taxpayer’s location and the duration of their stay outside the United States. The Internal Revenue Service uses two distinct tests to determine eligibility: the Bona Fide Residence Test and the Physical Presence Test. A U.S. citizen can use either test to qualify, while a U.S. resident alien must use the Physical Presence Test.

The Bona Fide Residence Test centers on whether a taxpayer has established a genuine, long-term home in a foreign country. To meet this test, a U.S. citizen must be a resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, from January 1 to December 31. The IRS examines various factors to determine bona fide residence, such as the nature of the stay, the individual’s intentions, and whether they have integrated into the foreign community by establishing a permanent home.

A more straightforward qualification is the Physical Presence Test. This test requires a U.S. citizen or resident alien to be physically present in a foreign country or countries for at least 330 full days during any consecutive 12-month period. A “full day” is a continuous 24-hour period beginning at midnight, and any time spent in the U.S. or traveling over international waters does not count toward the 330-day total. This 12-month period can begin on any day of the month, offering flexibility to individuals whose foreign employment starts mid-year.

Successfully meeting the Physical Presence Test demands careful record-keeping of travel dates. A taxpayer who falls short of the 330-day requirement, even by a single day, will fail the test for that specific 12-month period. The 330 days do not need to be consecutive; they can be broken up by trips back to the United States or travel to other countries.

Defining Foreign Earned Income

Once a taxpayer qualifies through either the residence or presence test, the next step is to identify which income is eligible for tax benefits. Foreign earned income refers to remuneration received for personal services performed in a foreign country. This includes compensation such as wages, salaries, commissions, bonuses, and income from self-employment. The determining factor for whether income is foreign-sourced is the location where the work is physically performed, not the location of the employer or the currency of payment.

Not all income received while living abroad qualifies as foreign earned income. The rules exclude certain types of income, which remain fully subject to U.S. taxation. These non-qualifying sources include:

• Pension payments
• Annuity payments
• Social Security benefits
• Dividend income
• Interest income
• Capital gains
• Combat pay
• Wages paid by the U.S. government or its agencies

For individuals who work both in the U.S. and a foreign country during the tax year, their income must be allocated between U.S. and foreign sources. This allocation is done on a time basis. For example, if a taxpayer worked 240 days in a year, with 200 of those days spent working in a foreign country, then only the portion of their salary attributable to the 200 days qualifies as foreign earned income.

Self-employed individuals must also distinguish between income from their personal services and the return on capital invested in their business. If capital, such as equipment or inventory, is a material income-producing factor in the business, no more than 30% of the net profits can be treated as foreign earned income.

The Foreign Earned Income and Housing Exclusions

The most widely known tax benefit for Americans abroad is the Foreign Earned Income Exclusion (FEIE). This provision allows qualifying individuals to exclude a portion of their foreign earned income from U.S. income tax. The maximum exclusion amount is adjusted annually for inflation; for the 2024 tax year, the limit is $126,500, and it is projected to increase to $130,000 for 2025. A taxpayer cannot exclude more than their total foreign earned income for the year or the annual maximum, whichever is less.

In addition to the FEIE, taxpayers may also be able to exclude or deduct a portion of their housing costs through the Foreign Housing Exclusion or the Foreign Housing Deduction. The exclusion is available to employees who receive a housing allowance from their employer, while the deduction is for self-employed individuals. These benefits are claimed using Form 2555, Foreign Earned Income, which is filed with the taxpayer’s Form 1040.

The calculation for the housing benefit is based on a taxpayer’s actual, reasonable foreign housing expenses. Qualifying expenses include:

• Rent
• Utilities (other than telephone and television)
• Residential parking
• Repairs

The total amount of these expenses is then subject to a limitation based on a percentage of the maximum FEIE. The housing cost limit is 30% of the FEIE, but it can be adjusted by the IRS for specific high-cost locations around the world.

There is also a base amount, or deductible, that taxpayers must subtract from their housing expenses before calculating the exclusion or deduction. This base is 16% of the FEIE maximum. Therefore, the housing benefit is calculated on the amount of qualifying housing expenses that exceed this base amount, up to the overall limit for that location. A married couple who both work abroad and maintain separate households may each be able to claim the housing benefit, provided they both independently meet the qualification tests.

Claiming the Foreign Tax Credit

As an alternative to the exclusions, taxpayers can choose to claim the Foreign Tax Credit (FTC). This credit provides a dollar-for-dollar reduction of U.S. income tax liability for income taxes paid or accrued to a foreign government. The purpose of the FTC is to mitigate double taxation, where the same income is taxed by both the U.S. and a foreign country. The credit is calculated and claimed on Form 1116, Foreign Tax Credit.

Not all taxes paid to a foreign government are eligible for the credit. To be creditable, the foreign tax must be an income tax in the U.S. sense of the term. This means it must be a tax on net income or profits, not on gross receipts, sales, property, or value-added (VAT). The tax must be a compulsory payment and not a payment for a specific economic benefit.

The amount of the Foreign Tax Credit that can be claimed in a given year is subject to a limitation. This limitation prevents taxpayers from using foreign tax credits to reduce U.S. tax on their U.S.-source income. The limit is calculated by multiplying the total U.S. tax liability by a fraction: the taxpayer’s foreign-source taxable income divided by their total taxable income from all sources. Any foreign taxes paid that exceed this limit can be carried back one year or carried forward for up to ten years.

A taxpayer cannot claim the Foreign Tax Credit on income that they have already excluded from U.S. tax using the Foreign Earned Income Exclusion or the Foreign Housing Exclusion. This prevents a double benefit on the same income. The decision to claim the exclusions or the credit depends on various factors, including the taxpayer’s income level and the tax rate in their country of residence. In high-tax countries, the FTC often provides a greater tax benefit than the exclusions.

How and When to File from Abroad

U.S. citizens and resident aliens residing abroad on the regular April 15 tax deadline receive an automatic two-month extension to file their return. For the 2024 tax year, this moves the filing deadline to June 16, 2025. To use this extension, a taxpayer must attach a statement to their return explaining that they were living and working outside the U.S. on the tax due date. An extension to file is not an extension to pay; to avoid interest, any tax owed is still due by the original April 15 deadline.

If more time is needed beyond the automatic June extension, a taxpayer can request a further extension to October 15 by filing Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, by the June 16, 2025, deadline. In certain situations, such as needing more time to meet the requirements of the Bona Fide Residence or Physical Presence tests, an additional extension beyond October 15 may be requested by filing Form 2350, Application for Extension of Time to File U.S. Income Tax Return.

When filing a paper return from abroad, taxpayers must send it to a specific IRS service center. If not enclosing a payment, the return should be mailed to the Department of the Treasury, Internal Revenue Service, Austin, TX 73301-0215, USA. If a payment is included, it should be sent to the Internal Revenue Service, P.O. Box 1303, Charlotte, NC 28201-1303, USA. Many taxpayers living abroad also have the option to use IRS Free File or other commercial e-filing software.