What is the Foreign Earned Income Exclusion?
Foreign Earned Income Exclusion (FEIE) allows US citizens or holders of the US green card to exclude the income they earn outside the US from being taxed. This tax includes wages and income that may have come from self-employed income.
To qualify for the FEIE, one has to work and live outside the US. This condition is verified by passing the physical presence test, or the Bona Fide resident test.
To pass the physical presence test, you must be physically out of US mainland and territory for a minimum of 330 days in a given continuous year (12 months). A whole day is calculated as 24 hours. Days spent traveling do not count.
There is flexibility in calculating the continuous 12 months. You can shift the start of the year to favor your tax filing time. This is more helpful when applying for an extension, where shifting the days can afford you extra time to do the filing.
You qualify for the Bona Fide residence test, you must prove that you pay taxes in another country, and have an official permanent residence in that country. As of 2015, people who qualified for the FEIE could exclude up to $100,800 of their income earned outside the US. This figure changes.
The FEIE only allows the exclusion of income for purposes of federal income taxation. It does not apply for state taxes. You also have to pay for Medicare and social security taxes.
What type of income is eligible for FEIE?
This is any income that comes from services offered as an employee or an independent contractor. “Earned income” stands for any salaries, wages, professional fees and any other monetary compensation offered in exchange for services. Self-employment income would fall under income as an independent contractor.
What effect does FEIE have on tax rates?
The tax rates (tax brackets that apply) do not change regardless of FEIE. The tax payable is calculated by applying federal income tax rates without FEIE, and then with FEIE. The difference in the amount of the two tax payable figures forms the tax applicable.
How is Foreign Earned Income Exclusion claimed?
FEIE is voluntary but paying tax is mandatory. You have to file taxes regardless of the FEIE. You initiate your claim by filling Form 2555 which you attach to your annual federal income tax return. The amount that you state as the FEIE will be applied in the following tax years until you apply for a revocation. You can only apply for FEIE again after 5 years.