Working Abroad: Foreign Earned Income Exclusion

Source: istockphoto

This article is directed toward Americans who are earning income outside of the United States and would like to reduce their tax responsibility to Uncle Sam.

That opening sentence will likely prompt more than a few readers to ask themselves, “Why would I pay taxes to the American government if I live and work in another country?”

That’s an excellent question and the answer is simple: the United States is one of only two countries on the planet that taxes its non-resident citizens on their global income. The other country is the small African nation of Eritrea.

I took the liberty of providing a map for those readers who are unfamiliar with Eritrea (indicated in green):

User:Rei-artur derivative work: Sémhur (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

Now that we have the geography out of the way, let’s move on to the actual topic of the article.

Foreign Earned Income Exclusion (FEIE)

This is how it works: if you meet the requirements below, you can exclude foreign earned income from your gross income on your U.S. tax return. The maximum amount of the exclusion depends on the tax year and increases each year based on inflation.

Here are the maximum exemptions for the indicated tax years:

2015: $100,800

2016: $101,300

2017: $102,100

As you can see, that’s a substantial amount of money.

Basic Requirements:

According to the IRS, in order to qualify for the income exclusion you must 1) have foreign earned income, 2) your tax home must be in a foreign country and 3) you must be one of the following:

  • A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,
  • A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

The first option, being a bona fide resident of a foreign country, is not as easy to prove as you might think. It’s not a standard “yes” or “no” type of question and it can be a little subjective.

For more information about proving that you’re a bona fide foreign resident, click HERE.

The second option, the physical presence test, is much easier to prove and that’s the recommended route for most people.

You’ll need to track the exact dates that you were in the United States during the 12 month period. If you even go one day over, you’ll lose the exemption. Click HERE to learn more.

If you are employed by the U.S. Government or one of its agencies, you cannot claim the exemption.

Income Limitations

The FEIE only applies to the income that you earn by actually providing services in the foreign country: salaries, wages, commissions and tips.

It does not apply to passive income, which is referred to as unearned income by the IRS. The following are examples of unearned income: pension and annuity payments; social security payments; capital gains; interest; gambling winnings; and alimony.

Rental Income

Generally speaking, rental income is unearned income. If you perform personal services in connection with the production of rent, up to 30% of your net rental income can be considered earned income.

Here is an example taken directly from IRS Publication 54 (2016):

Larry Smith, a U.S. citizen living in Australia, owns and operates a rooming house in Sydney. If he is operating the rooming house as a business that requires capital and personal services, he can consider up to 30% of net rental income as earned income. On the other hand, if he just owns the rooming house and performs no personal services connected with its operation, except perhaps making minor repairs and collecting rents, none of his net income from the house is considered earned income. It is all unearned income.

Bad News for the Self-Employed

If you’re self-employed, you can still claim the exemption on income; however, you’ll still be responsible to pay self-employment tax on the income. In other words, Uncle Sam will be asking for 15.3% of your reported foreign income. Yep, that one stings a little.

Let’s Wrap This Up

Taxes can be a little more complicated once you live and work in a foreign country. It’s always advisable to speak with a professional who specializes in preparing taxes for expats.

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About the Author

Q-Roo Paul
Paul Kurtzweil (Q-Roo Paul) was a deputy sheriff in Florida for 25 years and retired at the rank of lieutenant in 2015. He moved to Mexico with his wife six days later to enjoy a laid-back, Caribbean lifestyle on a tight budget. In 2016, Paul started a blog to share information with other people who may be thinking of making the move to Mexico. The blog, Two Expats Living in Mexico (qroo.us), has been viewed over a million times and Paul's articles appear in periodicals across Mexico.

21 Comments on "Working Abroad: Foreign Earned Income Exclusion"

  1. Informative article, as usual, however, just to be clear, FEIE does NOT include Passive income and capital gains such as stock & ETF gains, dividends, interest, foreign real estate sales, rental profits, etc.

  2. Am I correct that you will have to pay Mexican income taxes as well?

  3. Gotta send you kudos Q-Roo: your blog is always pertinent, interesting, and best of all for my English major degree, flawlessly edited!!
    On another note: wondering if you’ve heard of any increase in kidnappings over there?

    • Thanks, Mary. I haven’t heard of any increased activity here in Quintana Roo. I also just checked the crime statistics for the area via a site we use here and all is well.

  4. Very timely article. Great info. Thanks for posting!

  5. Buenos Dias, good morning dear Paul. I am a continuous reader of your most interesting and informative articles. I believe there is a small mistake in your last statement, quote: the United States is one of only two countries on the planet that taxes its non-resident citizens on their global income.
    I live in Canada and in the Winter, usually till the end of April in Centro Merida, Yucatan, in my lovely historic renovated home. CANADA is for your information and addition THE THIRD COUNTRY ” that taxes its non-resident citizens on their GLOBAL income !!! In most cases of your detailed information, it is very important to understand that there is a VAST difference between the Laws ANY of the USA and CANADA, applicable to almost everything government controlled or regulated. Sincerely Werner.

    • Hi, Werner. Thanks for following the blog.

      I just checked the Canadian government’s main website, http://www.canada.ca and confirmed that Canada does not tax non-resident citizens for global income, only on income originating from Canadian sources.

      People that go back and forth, often referred to as snow birds, don’t generally meet the definition of a non-resident.

      Copied and pasted directly from their site concerning Canadian citizens living abroad:

      Generally, when you leave Canada to live in another country (emigrate), you become a non‑resident of Canada for income tax purposes.

      You are a non-resident of Canada for income tax purposes if you:

      * normally or routinely live in another country and are not considered a resident of Canada

      * do not have significant residential ties to Canada, and live outside Canada throughout the tax year, or stay in Canada for less than 183 days in the tax year

      Non-residents of Canada are required to pay taxes only on certain income from Canadian sources.

  6. Paul – thanks as always. I know you like to keep your articles short, but perhaps a follow-up on this one would be in order, addressing passive income, retirement income (traditional IRAs, Social Security) and some mention of Mexican income taxes?

    • I tweaked this one to include more about passive and rental income. I’ll address Mexican taxes in a future article.

  7. Thanks, another clear, concise explanation that could help us. Appreciated!

  8. Eritea = Eritrea 😉 Good article though!

  9. Thanks for this article! Not to nitpick, but the name of the country in Africa you referred to is Eritrea, which achieved independence from Ethiopia in 1993. As Joe B. mentioned earlier today, more clarification on how capital gains from real estate sates and/or rental income would impact US and Canadian taxpayers would be useful.

    • Thanks, Bob. I fixed the spelling and addressed rental income. This article only addresses Americans and the FEIE. I need to collaborate with a tax expert from Canada so I can do some articles that address their tax implications.

  10. Thanks for making me laugh while reading about taxes!!

  11. Greg Archibald | March 27, 2017 at 1:53 pm | Reply

    Huge thanks Paul,
    I thought I was pretty familiar with FEIE, but this informative article was thorough and fun, like the rest of your work.
    -Arch

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