Foreign Earned Income Exclusion Definition

What Is the Overseas Earned Revenue Exclusion?

The overseas earned earnings exclusion is meant to forestall double taxation by excluding earnings taxed abroad from U.S. taxation. The U.S. Inner Income System (IRS) will tax your earnings earned worldwide. Nonetheless, in case you are an American expat, this implies you might be taxed twice on this earnings. The earnings you obtain abroad sees the overseas nation tax and will be taxed once more by the IRS.

Understanding Overseas Earned Revenue Exclusion

The overseas earned earnings exclusion is elected on IRS tax Type 2555. Moreover, taxpayers who declare this exclusion make home retirement plan contributions of any sort which are based mostly on this earnings or declare the overseas tax credit score or deduction for any taxes paid to a overseas authorities on this earnings.

You could meet particular {qualifications} to assert the overseas earned earnings exclusion.

1. You’re a U.S citizen or resident alien. A resident alien is a overseas particular person and is a everlasting resident with out citizenship of the nation wherein they reside. To fall below this classification in america, an individual must both have a present inexperienced card or have had one over the past calendar yr.
2. You may have a qualifying presence in another country. Qualifying presence standing is met by satisfying the bona fide resident take a look at by being a resident within the nation for a full tax yr. You may additionally fulfill the bodily presence take a look at by being bodily current there for at the very least 330 days inside a 12-month consecutive interval.
3. You may have overseas earned earnings. You may have overseas earned earnings should you obtain wages by way of employment or compensation by way of self-employment for providers you carry out in another country. The earnings you obtain from foreign-source pensions, investments, alimony, or playing just isn’t overseas earned earnings.

Overseas Housing Quantity

There’s a statutory most exclusion quantity plus a overseas housing quantity which limits the exclusion. It’s prorated if the variety of qualifying days in another country is lower than a full tax yr.

The overseas housing quantity is the housing prices you paid with overseas earned earnings that exceeds 16% of the utmost exclusion, or base, quantity. This quantity has a cap quantity at 30% of the utmost exclusion quantity. The overseas housing quantity is taken as exclusion by workers and as a deduction by the self-employed people.

For the 2021 tax yr, the utmost exclusion quantity was $108,700, and it goes as much as $112,000 in 2022.

Instance of Overseas Earned Revenue Exclusion

Let’s see how the overseas earned earnings exclusion works. MP is an American working in Vietnam. They lived in Hanoi for 345 days of the tax yr and had been absent for 10 days on a visit house for Thanksgiving. They earned a wage of $225,000 and paid $30,596 of it to lease a flat for the yr. MP paid $75,000 in Vietnamese earnings tax and owed $81,000 in US earnings tax on this earnings. The upshot is that their overseas earned earnings is being taxed twice.

Since MP is a U.S. citizen who paid overseas taxes on earnings they earned throughout 335 qualifying days in another country, they might elect to exclude the overseas earned earnings from their U.S. taxable earnings.

MP’s 2022 exclusion is $112,000, and MP’s 2022 overseas housing quantity is $15,040. ($33,600 in housing prices – $16,944 base quantity). Since $13,652 is lower than the $31,770 cap quantity, no additional discount is important. The overseas earned earnings exclusion permits MP to exclude $111,000 from their taxable earnings. However $114,000 stays included, and since they’ve paid overseas taxes of $37,000 and nonetheless owe U.S. taxes of $36,000, it stays double taxed. 

MP ought to take a $37,000 nonrefundable overseas tax credit score towards the $36,000 U.S. taxes they owe. So long as they well timed file Type 2555 to elect the overseas earned earnings exclusion and Type 1116 claiming the overseas tax credit score, they won’t owe U.S. taxes on the overseas earnings.