What Is the Exclusion for Foreign Earned Income?
The overseas-earned income exclusion aims to avoid double taxes by removing income taxed abroad from U.S. taxation. The IRS taxes your international income twice if you’re an American expat. The foreign government taxes your income, and the IRS can tax it again.
Understanding Foreign Earned Income Exclusion
IRS Form 2555 elects foreign earned income exclusion. Taxpayers who use this exclusion also make domestic retirement plan contributions or claim the international tax credit or deduction for foreign taxes paid on this income.
It would be best if you qualified for the overseas-earned income exclusion.
- You are a U.S. citizen or resident alien. Residents aliens are foreigners who live in their host nation without citizenship. This categorization in the U.S. requires a green card or one from the last year.
- I have a qualified foreign presence. Living in the nation for a complete tax year meets the bona fide resident standard for qualifying presence status. At least 330 days of physical presence in 12 months will also satisfy the requirement.
- Your income is foreign. You have foreign-earned income if you receive payment for work or services abroad. Foreign-earned income does not include foreign pensions, investments, alimony, and gambling.
Foreign housing amount
A statutory maximum and a foreign housing amount limit the exclusion. We prorate any qualifying days in a foreign nation that are fewer than a complete tax year.
Foreign housing expenses are those paid with foreign-generated income beyond 16% of the basic amount. This is limited to 30% of the maximum exclusion. Employees exclude foreign housing, and self-employed people subtract it.
The maximum 2022 tax exclusion is $112,000, rising to $120,000 in 2023.
Example of Foreign Earned Income Exclusion
How does the foreign-earned income exclusion work? American M.P.s work in Vietnam. Living in Hanoi for 345 days of the tax year, they spent ten days home for Thanksgiving. They paid $30,596 of their $225,000 salaries to lease an apartment for a year. M.P. paid $75,000 in Vietnamese and $81,000 in U.S. income taxes on this income. Thus, their overseas income is taxed twice.
As a U.S. citizen who paid foreign taxes on money earned abroad during 335 eligible days, M.P. might choose to exclude it from their U.S. taxable income.
The 2022 M.P. exclusion is $112,000, and the foreign housing amount is $15,040 ($33,600 in housing costs minus the $16,944 base amount). Since $13,652 is under $31,770, no additional reduction is needed.
M.P.s can deduct $111,000 from taxable income under overseas earned income. However, $114,000 remains, resulting in double taxation due to $37,000 paid in foreign taxes and $36,000 owed in U.S. taxes.
M.P.s should apply a $37,000 nonrefundable foreign tax credit against their $36,000 U.S. taxes. By filing Form 2555 for the overseas earned income exclusion and Form 1116 for the foreign tax credit, individuals can avoid paying U.S. taxes on their international income.
Who is exempt from foreign-earned income?
A U.S. citizen or resident alien who is physically present in another country for 330 days or more during 12 consecutive months, a U.S. citizen who is a legal resident of a foreign country for an uninterrupted period that includes an entire tax year, or a U.S. resident alien who is a citizen or national of a nation with which the U.S. has an income tax treaty
What is the 2022 foreign-earned income exclusion?
Foreign-earned income exclusion is $112,000 in 2022. The 2023 sum is $120,000. Individual income below these levels is tax-free.
Do I pay U.S. taxes on foreign income?
Yes, as a U.S. citizen or resident alien, you must pay taxes on any overseas earned income, although you may qualify for exemptions or credits.
- The foreign-earned income exclusion was intended for overseas Americans to prevent double taxes.
- Qualified U.S. citizens or resident aliens can claim overseas earned income inclusion.
- Resident aliens from countries with whom the U.S. has an income tax treaty may qualify.
- Before filing your taxes, check the foreign-earned income exclusion if you live and work overseas.
- Foreign housing expenditures are covered by foreign income.