Foreign Earned Income Exclusion

The foreign earned income exclusion needs an acronym or a nickname or something, because that is a mouthful and I am not aware of any common shortcuts.  I guess I will try FEIE, but I admit that seems lame.

The FEIE is a spectacular way to pay less United States taxes if you are working in a foreign country.  A U.S. Citizen is required to file a return and report their worldwide income, even if you are spending the whole year teaching kids in Haiti, or working for a tech company in Germany, or playing hockey in Russia.  It doesn’t seem fair that you pay taxes to both the U.S. and the country where you are working, so there are two options available to reduce your U.S. tax liability.

The first option is the foreign tax credit; basically you get a credit for the taxes you paid to the foreign country on the income that is also being taxed by the U.S..  If the tax in Haiti is 10%, but the US tax is 25% then you end up paying the U.S. only 15%.  If the tax in Germany is 25% and the U.S. tax is 25% then you won’t pay any U.S. tax; it would all be offset by the credit.  Not a bad choice, but the FEIE is even better.

The FEIE allows you to exclude up to $95,100 of earned income from a foreign country (for 2012) if you meet the requirements.  That would mean if you make $80K in Haiti you would pay the Haitian tax, but you would be able to pay 0% to the U.S. because the income would be excluded – no need for the foreign tax credit.  Other than the requirement for it to be earned income, there is really only one big hurdle and there are two ways to clear it.  You can either qualify as the bona fide residence test or the physical presence test.  Bona fide residence means you have established a permanent residence in the foreign country.  The physical presence test is, you guessed it, a counting of the days you were physically in a foreign country.  Once you get to more than a year you can use the FEIE.

As with everything tax related, it’s much better to understand the tax consequences before you do something major like move to another country for a job.  There can be some huge tax savings by meeting the requirements for the FEIE.  It’s better to understand it before you head off for your foreign adventure.

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2 comments on “Foreign Earned Income Exclusion

  • Interesting. Wonder why SARS in South Africa is taking aim at this unilateral exemption!

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