The Foreign Earned Income Exclusion: What Americans Working Abroad Should Know

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It’s a common misconception among Americans living abroad — especially those with dual citizenship — that their foreign earned income is exempt from being taxed by the U.S. government. This is simply not the case.

The United States is one of only two countries in the world that tax non-resident citizens on their worldwide income. The other one is the small African nation of Eritrea.

This type of tax system is known as citizenship-based taxation.

So, even if you plan on living in a foreign country for the rest of your life, as long as you retain your U.S. citizenship, Uncle Sam will always want his piece of your pie.

A Real-Life Case in Point

Boris Johnson, the former mayor of London, was born in the United States to English parents in 1964. When he was only five years old, the entire family moved to the United Kingdom.

Over 40 years later, Boris receives a huge tax bill from the IRS — that’s right, the U.S. Internal Revenue Service — on the capital gains from the sale of his home in London.

Although there are laws and treaties to prevent people from being taxed twice on the same money, in this case, the sale of the house was exempt from capital gains tax in the United Kingdom. That meant that there was nothing to stop Uncle Sam from going after the money.

Boris Johnson reportedly paid the tax bill and then renounced his U.S. citizenship.

I got off on a tangent there, so let’s move on to the actual topic of this post, the Foreign Earned Income Exemption.

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:

2016: $101,300 USD

2017: $102,100 USD

2018: $104,100 USD

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 may 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, so you can take advantage of every tax break and credit available.

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About the Author

Q-Roo Paul
Paul Kurtzweil (Q-Roo Paul) was a deputy sheriff in Florida for 25 years before retiring at the rank of lieutenant in 2015. He and his wife moved to Mexico looking to maximize their retirement income. They later started a blog called Two Expats Mexico (qroo.us) to share their experiences, as well as information about the logistical and legal aspects of retiring south of the border.

16 Comments on "The Foreign Earned Income Exclusion: What Americans Working Abroad Should Know"

  1. Great info as always – thank you!

  2. Deanna Blewett | November 15, 2018 at 7:54 am | Reply

    I love your blog. My husband and I are turning 50 this year. All of your information is helping us plan for hopefully an early retirement . Thank you!!!

  3. Winston Churchill was another Brit who was also a U.S. citizen, but, as far as I know, he was never pursued by the IRS for U.S. taxes on his worldwide income.

    • Since FATCA, it has been much easier for the U.S. to track foreign assets of its citizens and cases like the one mentioned in the article are a lot more common nowadays.

  4. Most of my career as US citizen was overseas so filed as you mention. Another point is that it may be optional whether either your employer or yourself pay into Social Security along with your income tax so calculating whether that is good (or not) is a consideration.

  5. Am I to understand, you would have to renounce your US citizenship to avoid this foreign income tax?

    • The income tax is coming from the U.S. government on foreign earned income that U.S. citizens make. The U.S. does give tax credits to avoid being taxed twice on the same money.

      Although some people may be enticed by the financial advantages of renouncing their U.S. citizenship, it’s wise to consider the following before doing it:

      1) Irrevocable and permanent -Except as provided in Section 351 of the Immigration and Nationality Act, this is a permanent decision that cannot simply be undone if you change your mind a couple of years down the road.

      2) You won’t be authorized to live or work in the U.S.- This is something to consider if you’re working for a U.S. company abroad.

      3) Fees and exit taxes- The fee to renounce has been increased to $2,350. You may also have to pay an expatriation tax on your worldwide assets.

      4) Loss of military and government pensions- For those folks living on a government pension, this should be enough to dissuade them from renouncing.

      5) You’ll need another citizenship- It is not recommended to give up your U.S. citizenship if you’re not already a citizen of another country. A citizen is different from a legal resident, so don’t confuse the two.

      People without citizenship to any country are called stateless. Stateless people aren’t entitled to the protection of any country and it’s difficult for them to travel.

      6) You may have difficulty returning, even to visit -Depending where you obtain your new citizenship, you may be required to apply for a visa at a U.S. consulate office before traveling. That application for the visa costs around $160 and there’s no guarantee that it will be granted.

      That was the case with Roger Ver, a wealthy investor who renounced his U.S. citizenship in 2014. Roger became a citizen of St. Kitts and then applied for a non-resident visa to attend a conference in Miami. The visa was denied.

  6. It’s almost as bad for Canadians, if you declare yourself a non resident you have to fork over 15% withholding tax of your earnings (pension etc.) that you receive out of Canada to the CRA ( equivalent to your IRS)
    The non resident Canadian gets absolutely nothing in return from this 15% rip.
    That’s enough whining on my part for today.

  7. I an older post you gave a recommendation for a tax accountant who specializes in ex-pats. Do you have someone that you recommend?

  8. I’d also welcome a recommendation for a tax accountant specializing in expats. Thank you!

  9. I’m glad I have an accountant. I might need to switch to one who specializes in working with Expats though..

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