The Foreign Earned Income Exclusion (FEIE) is a special provision for U.S. taxpayers living outside the U.S. and its territories. The exclusion is indexed for inflation and consequently changes each year. The Tax Cuts and Jobs Act of 2017 changed the way the index was calculated resulting in amounts, such as the FEIE amount, growing at a slower pace than under the previous method. For 2019 the FEIE amount is $105,900.
The FEIE is applicable to U.S. citizens and certain resident aliens (green card holders) who live and work outside the United States in foreign countries. The exclusion is only for foreign earned income. It is not possible to exclude passive foreign income such as investment income or rental income. The taxpayer must have a Tax Home (see below) in a foreign country and must meet one of two additional criteria: these are known as the Bona Fide Residence Test; and the Physical Presence Test. Finally, the taxpayer must make a valid election (choose to take the exclusion). This is done by filing Form 2555 (for years prior to 2019 Form 2555EZ may be applicable).
Foreign Earned Income is income for services performed in a foreign country. It matters where the services are performed, not when or where the income is received. You may have foreign income while working for a U.S. based employer if you are performing services for that employer outside the United Sates. In this definition, outside the United States means in a foreign country, foreign airspace or foreign territorial water. It does not include U.S territories, possessions, international waters, international airspace, or Antarctica. Importantly, pension or annuity income is not earned income.
Tax Home. A taxpayer can only have one Tax Home at a time. The Tax Home is the taxpayer’s regular or principal place of business. However, if the taxpayer’s own abode is in the U.S., the taxpayer’s Tax Home will most likely also be in the U.S. Being temporarily in the U.S., or if your family is living full-time in the U.S., does not cause your Tax Home to be in the U.S.. A Tax Home is determined in part by understanding the taxpayer’s center of economic interests. Nomadic persons have their Tax Home where they happen to be.
The Bona Fide Residence Test (BFRT). For U.S. citizens to satisfy the requirements of the BFRT, you must be resident of a foreign country (or countries) for the entire tax year (January 1 – December 31 for calendar year taxpayers).
For U.S. resident aliens, you must be a citizen of a treaty country, and you must be resident abroad for an entire tax year.
Importantly, if you are in a foreign country on a temporary (less than one year) visa, even if it is regularly extended, you do not have the right to reside in that country and therefore cannot claim to be resident in that country for this purpose.
To be a bona fide resident, you must have an intention to make your home in a foreign country and not be there merely ‘on assignment’ or seconded temporarily. In these cases, you will not meet the BFRT if your intention is to return to the U.S. when the assignment is completed.
Your own actions must not, on balance, contradict the claim of residency. For example, you cannot continue to claim residency in a U.S. state.
The Physical Presence Test (PPT) requires the taxpayer to be physically in a foreign country (or countries) for 330 days out of any consecutive 12-month period of at least 365 days.
A day is a full 24-hour period beginning at midnight. This is important because someone leaving the U.S. can’t start counting days until they have been in a foreign county for a full day. For example, entering Canada at 1am is the same as entering Canada at 11pm. The day following the day of entry will be the first day counted.
No partial use. Importantly, you cannot choose to use only part of the exclusion. If you are utilizing the exclusion you must exclude your foreign earned income up to the FEIE amount. If your foreign earned income is less than the exclusion amount, all of the income must be excluded if you choose to use the exclusion. Similarly, you cannot create subcategories of foreign earned income and exclude some but not exclude others. For example, you cannot exclude income from one country and not exclude income from a different country or exclude income from one employer and not exclude income from self-employment or a different employer.
Requirement to file a return. You can only exclude your foreign earned income from your gross income by filing a tax return. Even if you know that you will have no income left after you take the exclusion, you must report all of your income on your tax return and attach the Form 2555 to calculate and take the exclusion.
In conclusion, if your Tax Home is outside the U.S. and you meet either the Bona Fide Residence Test or the Physical Presence Test, you can exclude from your gross income up to the FEIE amount (for 2019 this amount is $105,900). This will reduce your taxable income by the excluded amount.