Foreign Earned Income Exclusion: Explanations and Plans?
Updated: Jul 23
American taxpayers must report their worldwide income on their US tax returns, should they have a filing obligation. The foreign earned income exclusion may assist lower their US tax liability though should they qualify for it and elect to use it. I will discuss the FEIE three prong tests and how you should plan for it to be eligible to exclude some or all of your foreign earned income.
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 physically 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 the entity paying you is located in Japan, UK, or United States.
Dividends, interest, annuities, pensions, unemployment income, and social security and welfare type benefits are not earned income for foreign earned income exclusion 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 affects 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.