Foreign Earned Income Exclusion

Definition

The foreign earned income exclusion allows U.S. taxpayers who live and work abroad to exclude a certain amount of their foreign-earned income from their taxable income. This exclusion is designed to prevent double taxation, enabling individuals to keep more of their income earned in foreign countries without being taxed by the U.S. on the same earnings. This provision encourages American citizens to work overseas and helps them adjust to financial realities of living outside the U.S.

5 Must Know Facts For Your Next Test

1. For the tax year 2023, eligible taxpayers can exclude up to $120,000 of their foreign-earned income from U.S. taxation.
2. To qualify for the exclusion, individuals must meet either the physical presence test or the bona fide residence test.
3. The exclusion applies only to earned income, meaning wages or self-employment income, not unearned income like dividends or interest.
4. Taxpayers must file Form 2555 with their federal tax return to claim the foreign earned income exclusion.
5. If a taxpayer is eligible for both exclusions and other benefits, such as the foreign housing exclusion, they must carefully calculate how these interact with each other.

Review Questions

• What are the criteria for qualifying for the foreign earned income exclusion, and how do they relate to living and working abroad?
  • To qualify for the foreign earned income exclusion, individuals must meet either the physical presence test or the bona fide residence test. The physical presence test requires being outside the U.S. for at least 330 days within a 12-month period, while the bona fide residence test involves proving residency in a foreign country for an uninterrupted period. These criteria are designed to ensure that individuals genuinely live and work abroad, aligning with the purpose of excluding foreign-earned income from U.S. taxation.
• Discuss how the foreign earned income exclusion interacts with unearned income and what implications this has for U.S. taxpayers working abroad.
  • The foreign earned income exclusion specifically applies to earned income, which includes wages and self-employment earnings. Unearned income, such as interest or dividends, does not qualify for this exclusion and remains subject to U.S. taxation. This distinction means that U.S. taxpayers working abroad must consider their total income sources carefully when filing taxes. They may need to explore other tax credits or deductions to mitigate tax liabilities on unearned income while benefiting from the exclusion on their foreign-earned wages.
• Evaluate the impact of the foreign earned income exclusion on economic decisions made by U.S. citizens living overseas and its broader implications on international labor markets.
  • The foreign earned income exclusion significantly influences economic decisions for U.S. citizens living overseas by providing a financial incentive to work in international settings without facing double taxation. This encourages more Americans to seek employment abroad, contributing skilled labor to global markets and promoting cross-cultural exchanges. Additionally, this tax benefit can affect international labor dynamics as it may attract U.S. talent away from domestic job markets, potentially leading to shifts in workforce availability both at home and in host countries where these individuals are employed.

Related terms

Physical Presence Test: A criterion that determines eligibility for the foreign earned income exclusion based on the number of days spent outside the United States during a specific period.

Bona Fide Residence Test: An alternative test for qualifying for the foreign earned income exclusion, based on being a resident of a foreign country for an uninterrupted period.

Tax Home: The main place of business or employment, regardless of where an individual maintains their family home, which is important in determining eligibility for the foreign earned income exclusion.