{"id":8797,"date":"2020-04-22T18:31:56","date_gmt":"2020-04-22T18:31:56","guid":{"rendered":"https:\/\/accountingtoronto.ca\/staging\/?p=8797"},"modified":"2024-07-01T11:04:12","modified_gmt":"2024-07-01T11:04:12","slug":"everything-you-need-to-know-about-the-foreign-earned-income-exclusion","status":"publish","type":"post","link":"https:\/\/accountingtoronto.ca\/staging\/everything-you-need-to-know-about-the-foreign-earned-income-exclusion\/","title":{"rendered":"Everything You Need to Know About the Foreign Earned Income Exclusion"},"content":{"rendered":"\n

If you are a U.S. national who is residing outside of the country, you may find yourself facing a tricky situation surrounding the taxes on your earnings. As per the 16th Amendment<\/a>, the government is within its rights to impose a nationwide tax on residents of any of the 50 states. Since the literal translation of the word “resident” would not technically apply to you, however, it seems unfair to be held liable for the said payments. The government agrees. In order to avoid double-taxation, which is one of the most dangerous pitfalls of the system, the Internal Revenue Service has established a Foreign Earned Income Exclusion (FEIE).<\/p>\n\n\n\n

What Is Foreign Earned Income Exclusion?<\/h3>\n\n\n\n

Foreign Earned Income Exclusion (FEIE) is explained in section 911 of the 26th title<\/a> of the official United States Code. Although some legalese and specialized accounting terms may be tough to get through, this is the law allowing you to sidestep paying both domestic and foreign income tax. In order to do so, it offers a full exclusion to a portion of annual earnings generated overseas. As with most other exclusions given by the IRS, it is not limitless and carries a ceiling that will be explained shortly. The FEIE is also only applicable to U.S. citizens and permanent residents who meet the predetermined eligibility requirements that involve the bona fide residence or the physical residence test.<\/p>\n\n\n\n

How Do You Qualify for the Exclusion?<\/h3>\n\n\n\n

As per the IRS, you can qualify for the exclusion by satisfying one of the aforementioned two tests. The first one, which is the bona fide test<\/a>, is based on your current status in a foreign country. It states that you may be eligible to circumvent the physical count of days spent in some other country if you have been given the status of a legal citizen or resident of that country. For instance, if you spend five years living in France, per se, you will automatically qualify for permanent residency under their immigration laws. Once you become a resident of France, earnings under the threshold will automatically be exempt from taxation in the U.S. since you meet the bona fide presence test.<\/p>\n\n\n\n

Since most countries do not hand out residency or citizenship status, however, the IRS also uses the physical presence test<\/a> to determine eligibility. If you spend 330 full days in a foreign country during a period of 12 consecutive months, you will be entitled to claim Foreign Earned Income Exclusion (FEIE). Many taxpayers have issues with this test because of the fact that the 12-month period does not imply a calendar year. You could actually use this test even if your foreign earnings come from a period starting in June of the first year and ending in May of the subsequent. Thus, the typical time frame that the IRS relies on, which is from January 1 to December 31, would not be relevant here. To figure out the 12-month period when there are vacations or other travels involved, the best course of action is to rely on a cross border tax accountant.<\/p>\n\n\n\n

Form 2555 EZ<\/h3>\n\n\n\n
\"Form<\/figure>\n\n\n\n

After determining that you indeed qualify for the FEIE, it is time to get into the paperwork that will let you claim the exclusion. As with every other type of tax in the U.S., there is a specialized form, Form 2555, solely created to cater to people who qualify for this exclusion. It consists of three pages and nine different parts. Taxpayers can also resort to a shorter version called Form 2555 EZ. In order to qualify for the shorter one, however, they must have no self-employment income, no business or moving expenses, and no intention of claiming the foreign housing exclusion or deduction. All of those conditions are listed alongside the basic 2555 conditions on top of the form itself<\/a>. Taxpayers who are not sure if they should do Form 2555 EZ or the long version should consult a cross border tax accountant. Doing so will help avoid reporting income on the wrong form and falling victim to a prolonged procedure and additional expenses.<\/p>\n\n\n\n

Non-Qualifying Types of Income<\/h3>\n\n\n\n

Not all income earned in a foreign country will be eligible for the FEIE. The reason why is that certain types of income are already eligible for other exclusions, deductions, or credits in either the foreign country or the U.S. Thus, allowing them to remain untaxed via the FEIE would mean that practically no tax was assessed at all. The current list of non-qualifying earnings<\/a> includes:<\/p>\n\n\n\n