Section 911: Foreign Earned Income Exclusion Explained

The Foreign Earned Income Exclusion (FEIE), under Section 911 of the U.S. Internal Revenue Code, offers a tax benefit to U.S. citizens and resident aliens living and working abroad. Since U.S. citizens are taxed on their worldwide income, the FEIE helps mitigate double taxation, which occurs when income is taxed by both the U.S. and a foreign country. The exclusion allows qualifying individuals to exempt a portion of their foreign-earned income from U.S. federal income tax.

Qualification Requirements for the Exclusion

To benefit from the Foreign Earned Income Exclusion, a taxpayer must first satisfy the Tax Home Test. This test requires that your tax home be in a foreign country. Your tax home is your main place of business or employment. It is the location where you are permanently or indefinitely engaged to work. If you do not have a regular place of business due to the nature of your work, your tax home may be the place where you regularly live.

After establishing a foreign tax home, you must meet one of two additional tests.

Bona Fide Residence Test

To meet this test, you must be a U.S. citizen who is a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. This requires demonstrating your intent to remain in the foreign country for an extended or indefinite period. Factors that help prove this intent include leasing long-term housing, opening local bank accounts, and integrating into the local community.

Physical Presence Test

To qualify under this test, a U.S. citizen or resident 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 starting at midnight. Any time spent in the U.S., even for a brief period, does not count toward the 330-day requirement. This test is often used by individuals on specific, long-term assignments abroad.

Calculating Your Excludable Amounts

The first step in calculating the exclusion is to identify your foreign earned income. This includes payments for personal services rendered, such as salaries, wages, commissions, and self-employment income. Unearned income like dividends, interest, capital gains, rental income, and pension distributions does not qualify for the exclusion. Pay received as an employee of the U.S. government also cannot be excluded.

Once you determine your total foreign earned income, you can apply the annual exclusion limit, which the IRS adjusts yearly for inflation. For the 2024 tax year, the maximum exclusion is $126,500, and for 2025, it is projected to be $130,000. If you meet the qualification tests for only part of the tax year, you must prorate the maximum exclusion amount based on the number of days in your qualifying period.

You may also be able to claim a Foreign Housing Exclusion or Deduction for reasonable housing expenses. This benefit is calculated based on your actual foreign housing costs, like rent and utilities, minus a base housing amount. The excludable housing amount is also subject to a government-set limit that can be higher in designated high-cost localities. The housing exclusion is calculated first, and the general income exclusion then applies to your remaining foreign income, up to the annual limit.

Information and Forms Needed to Claim the Exclusion

Claiming the Foreign Earned Income Exclusion requires filing Form 2555, Foreign Earned Income, with your U.S. tax return. To accurately complete Form 2555, you must gather specific documentation ahead of time, including:

• General information such as your name, Social Security number, foreign address, and employer details.
• For the Physical Presence Test, a detailed log of your travel, including the dates of your arrivals in and departures from the United States and foreign countries.
• For the Bona Fide Residence Test, evidence of your residency, such as the type of visa you hold, the date your residency began, and whether you have submitted a statement of nonresidency to foreign authorities.
• Detailed financial records, including documentation of your foreign earned income and a complete record of your housing expenses, supported by rent receipts and utility bills.

The Filing Process and Tax Calculation

Once completed, Form 2555 must be attached to your annual U.S. income tax return, Form 1040. Taxpayers residing abroad have an automatic two-month filing extension to June 15. If more time is needed to meet the qualification tests, you can file Form 4868 to request a further extension to October 15, though this does not extend the deadline to pay any tax owed.

The tax calculation uses a “stacking rule” that affects the tax on any non-excluded income. The tax is calculated using the rates that would have applied if your excluded income were still included. This means your non-excluded income is “stacked” on top of your excluded income, potentially pushing it into higher tax brackets. The IRS provides a specific worksheet for this calculation.

Choosing to claim the FEIE is an election that remains in effect for all subsequent tax years unless you formally revoke it. If you revoke the exclusion, you are generally prohibited from claiming it again for the next five tax years without obtaining special consent from the IRS.

Choosing Between the Exclusion and the Foreign Tax Credit

A primary decision for taxpayers abroad is whether to use the Foreign Earned Income Exclusion or the Foreign Tax Credit. The Foreign Tax Credit, claimed on Form 1116, offers a dollar-for-dollar reduction of your U.S. tax liability for income taxes you have already paid to a foreign government. A foundational rule is that you cannot claim both the FEIE and the Foreign Tax Credit on the same portion of income.

The best option depends on the tax rate in your country of residence. The FEIE is frequently more advantageous for individuals in countries with low or no income taxes, as there are minimal foreign taxes to claim as a credit. Conversely, the Foreign Tax Credit is often the better choice for those in high-tax countries. If your foreign tax liability is higher than what you would owe in U.S. taxes, the credit can eliminate your U.S. tax bill, and any excess credit can often be carried forward.