How do you know if you can claim the Foreign Earned Income Exclusion this year? Answer these questions:
- Are you aS. expat (an American citizen living abroad)?
- Do you like saving money?
- Do you want to reduce your tax burden?
If your response to all these questions is “yes,” then keep reading to discover how the Foreign Earned Income Exclusion can work in your favor.
The Basics
If you’re living overseas, then chances are good that you are already acutely aware that as an American citizen and taxpayer, you continue to have filing obligations to the U.S.
That’s right, we’re talking about taxes.
The United States is one of the few countries that continue to tax their citizens even if they no longer live within their borders. What this means to you is that you will have to file U.S. tax documents as required by American law.
While you’ll be taxed on your worldwide income, the Foreign Earned Income Exclusion prevents double taxation by the country you are currently living in and the U.S. by allowing you to exclude your foreign earnings from income up to an amount that is adjusted annually for inflation. For 2020, that figure comes in at $107,600 per person. Excluding this portion of your income will reduce your tax liability to the U.S., provided you qualify.
The Tests
In order to be able to claim the Foreign Earned Income Exclusion, you will need to live outside the U.S. for the majority of the year, so the Internal Revenue Service (IRS) has developed two (alternative) tests to establish residency:
- Bona fide residency, establishing that you did indeed live in a country outside of the United States for the full calendar year
- Physical presence. You must prove that you were physically outside the U.S. for at least 330 full days during a consecutive 12-month period that coincides with the calendar year
With the bona fide residency test, you must establish that your permanent home is in the foreign country. The Foreign Earned Income Exclusion will not come into play, for example, if you took a three-month sabbatical to attend cooking school in France but always intended to return to your permanent residence in the United States. You may leave the country for short trips back to America to visit family or travel elsewhere for vacation, but your intention must be to return from these trips to your foreign residence.
The physical presence test is more flexible. It does not rely on your intentions or where you live abroad. It simply looks at the number of days you were abroad. It doesn’t matter if you have established a home in the foreign country, or if you plan to return to U.S. or are on vacation or travelling and working as a Digital Nomad, as long as the 330-day threshold is met.
If you plan to claim the Foreign Earned Income Exclusion, use Form 2555. For additional tax requirements living abroad, consult a specialist expat tax professional.
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