The Foreign Earned Income Exclusion (FEIE) allows certain U.S. taxpayers who live and work abroad to exclude part of their foreign-earned income from U.S. federal income tax. It helps prevent double taxation by reducing the amount of income subject to U.S. tax while the taxpayer also pays taxes in another country.
Even though the U.S. taxes its citizens on worldwide income, the FEIE provides relief to those whose main source of income is earned outside the United States.
To claim the exclusion, taxpayers must meet three requirements: they must have a tax home in a foreign country, earn foreign income from work, and meet one of the two residency tests:
These tests prove that your main ties, either residential or physical, are to a foreign country.
The exclusion amount changes each year based on inflation.
To claim the exclusion, you must file Form 2555 with your annual U.S. tax return. The form requires details about your income, foreign residence, and qualifying days abroad. Even if your entire income is excluded, filing a return remains mandatory.
In addition to the main exclusion, taxpayers may also qualify for the Foreign Housing Exclusion*, which allows the deduction of certain housing costs incurred while living abroad.
The FEIE only applies to earned income, that is, income you receive for work performed in a foreign country. Common examples include salaries, wages, commissions, or self-employment income from work done abroad.
However, not all income types qualify. The following categories are excluded from the exclusion:
In short, the FEIE applies only to active income you earn through services, not to investment or government income.
Taxpayers should be aware of these limitations before relying on the exclusion.
Also, the exclusion does not apply to self-employment tax The FEIE excludes income for income tax, not for self-employment tax. Those working abroad independently may still owe Social Security and Medicare taxes.
For Americans living and working in Israel, the FEIE can be a valuable way to reduce double taxation on income earned in Israel. However, coordination between the U.S. and Israeli tax systems is essential.
The U.S.–Israel Tax Treaty and the foreign tax credit rules often work in tandem with the FEIE. Strategic planning ensures that you don’t lose benefits by claiming one method over another.
Philip Stein and Associates can help you understand how the foreign earned income exclusion works for you or your employees. We also help you select between the foreign tax credit or the FEIE based on which is more advantageous for your unique situation. Contact us to discuss your case today.
*Foreign housing exclusion or deduction | Internal Revenue Service. (n.d.). https://www.irs.gov/individuals/international-taxpayers/foreign-housing-exclusion-or-deduction