Foreign Earned Income Exclusion Explained
Why wouldn't any American taxpayer want to lower their US tax liability while traveling and living abroad?
United States resident aliens such as those with a permanent resident permit (green cards) and those who meet the physical presence test are generally subject to tax on their worldwide income and gains similar to U.S. citizens with some exceptions.
A U.S. citizen or resident alien who earns income in a foreign country may also be taxed on that income by the foreign host country, which can lead to double taxation. Several IRC provisions are intended to help mitigate this situation, including the foreign earned income exclusion and the housing exclusion or deduction, under section IRC section 911.
Do I qualify for foreign earned income exclusion?
To qualify for the foreign income and housing exclusion tax benefits, a taxpayer must:
have a tax home in a foreign country,
have foreign earned income, and
be a U.S. citizen or a resident alien who meets the bona fide residence test or the physical presence test in a foreign country.
A tax home is generally the taxpayer’s regular place of business or employment. If the individual has more than one regular place of business, then the tax home is located at his or her principal place of business or employment. If the individual has no principal place of business because of the nature of the business, or because the individual is not engaged in a trade or business, his or her tax home is at the individual’s regular place of abode. The location of the abode is based on where the taxpayer maintains their family, economic and personal ties.
A foreign country includes any territory under the sovereignty of a government other than that of the United States. This excludes international waters and airspace above them, Antarctica or U.S. territories such as Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa. The days spent in the excluded area listed above do not count as days in a foreign country.
Foreign earned income
Generally, foreign earned income is income you receive for services you perform in a foreign country. Earned income is pay for personal services performed, such as wages, salaries, bonuses, commissions, freelance, or professional fees.
The source of your earned income is the place where you perform the services for which you received the income. Foreign earned income is income you receive for performing personal services in a foreign country. Where or how you are paid has no effect on the source of the income. For example, the income you receive for work done in Mexico is income from a foreign source even if the income is paid directly to your bank account in the United States and your employers/payors are in Japan, UK, and United States.
Dividends, interest, annuities, pensions, and social security benefits are not earned income for FEIE purposes.
Bona Fide Residence Test
To meet the bona fide residence test under the FEIE, an individual must generally be:
(1) 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 (for example, January 1 through December 31, for calendar-year taxpayers), or
(2) A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, (example from January 1 through December 31, for calendar-year taxpayers)
How a temporary absence from a foreign country affect a Foreign Earned Income Exclusion qualification?
During the period of bona fide residence in a foreign country, the taxpayers can leave the country for brief or temporary trips back to the United States or elsewhere for vacation or business. However, to keep their status as a bona fide resident of a foreign country, they must have a clear intention of returning from such trips, without unreasonable delay, to their foreign residence or to a new bona fide residence in another foreign country.
The determination of a bona fide resident is based on all the facts and circumstances. The Courts have considered the length of stay plus additional factors such as:
a taxpayer’s intention,
establishment of a home in a foreign country,
participation in social and cultural activities in a foreign community,
nature and duration of employment, and
reasons for temporary absences from the foreign home.
Once you have a clear intention to and in fact return to a foreign country after a temporary presence in the US, let's say 60 days, you could argue that you are still a bonafide resident of a foreign country for FEIE purpose. However, personal services income earned in the United States is U.S. source and therefore not eligible for FEIE.
Physical Presence Test
To meet this test, the individual taxpayer must be physically present in a foreign country for at least 330 full days during 12 consecutive months. It can begin with any day of the month. A full day is a period of 24 consecutive hours, beginning at midnight. Additionally, an individual's physical presence in a foreign country may be for any reason such as for business purposes or vacation time, or any combination of purposes.
Certain days are excluded and do not count as days spent in a foreign country if they are:
spent on traveling to and from the United States over international waters (in transit),
to recover from an illness,
war or civil unrest, or
under orders from superiors.
Waiver of Time Requirement in foreign countries
There are sometimes adverse conditions and emergencies that may require an individual to leave a country. Without the time requirement, the FEIE may not be met. Therefore, the IRS may waive the time requirements under certain circumstances.
Both the bona fide residence test and the physical presence test contain minimum time requirements. The minimum time requirements can be waived, however, if you must leave a
foreign country because of war, civil unrest, or similar adverse conditions in that country. You
must be able to show that you reasonably could have expected to meet the minimum time requirements if not for the adverse conditions. To qualify for the waiver, you must actually have
your tax home in the foreign country and be a bona fide resident of or be physically present
in the foreign country on or before the beginning date of the waiver. The Internal Revenue Service generally publish in the Internal Revenue Bulletin a list of countries that qualify for the waiver and the effective date.
For example, you were on 2 years assignment in the Democratic Republic of Congo starting June 1, 2018, and you repatriated to the US on December 30, 2018. Assuming you or your employer didn't have any intention to end your contract, then you qualify for the FEIE based on the IRS Revenue Procedure 2019-15. However, the exclusion of foreign income applies to the time you were actually working in the DRC. All personal services income earned while in the US is US source and doesn't qualify for the Foreign Earned Income Exclusion.
United States COVID-19: Waiver of Sec. 911 FEIE Time Requirements
IRS expands Foreign Earned Income Exclusion eligibility due to Covid-19 under the Revenue Procedure 2020-27 for qualified individuals. COVID-19 emergency is now an adverse condition for the time limit requirement.
The qualifying period for FEIE purpose now includes the time spent in the US from the dates below to July 15, 2020:
December 1, 2019, for expats who left China (excluding Hong Kong and Macau)
February 1, 2020, for expats who left any other foreign countries
Under this Rev. Proc. 2020-27, an American expat who was present in the United Kingdom on January 1 through March 1, 2020, establishes that he or she reasonably expected to work in the United Kingdom for the entire calendar year, but departed the United Kingdom on March 2, 2020, due to the COVID-19 Emergency, and returns to the United Kingdom on August 25, 2020, for the remainder of the calendar year, would be a qualified individual for 2020 with respect to the period between January 1 through March 1, 2020, and August 25 through December 31, 2020, assuming the individual has met the other requirements for qualification under section 911. In this case, as discussed, if you are considered a tax resident of the UK for the entire year, you may treaty resource the income earned in the US during the emergency stay.
Either you are new in expat life or you have been living in foreign countries as an expat for years, you should be aware of the qualification rules for the foreign earned income exclusion and also how to stay qualified for the FEIE if you must travel back to the U.S. and outside of a foreign country we defined above.
How can Whin Global help?
Because the foreign earned income exclusion and the housing exclusion or deduction is calculated on a daily basis, maximizing the number of days in a foreign country within the 12-month period and within the tax year increases your tax benefits.
Please call our office or contact us to discuss your situation and to review your eligibility to qualify to take the foreign earned income exclusion (FEIE) and the housing exclusion or deduction, and to plan for the maximum tax benefit. We are here to assist you. There are alternatives to FEIE if you do not qualify to take the FEIE.
Whin Global provides U.S. domestic and expat tax compliance and consulting services to American expats, resident aliens, and nonresident individuals and small businesses with US tax and/or foreign financial reporting needs. Get in touch for a tax consultation.
(originally published January 8, 2020)