The Foreign Earned Income Exclusion (FEIE) is the low-hanging fruit of the U.S. expat tax world, but it isn’t always the best choice for U.S. taxpayers abroad. Here are a few questions you should consider before taking the FEIE.

Before taking the FEIE, you need to ask two important questions:

1. Am I eligible to take the FEIE?
2. Is taking the FEIE the best outcome for me?

These days more people are working remotely, some are working in locations that they didn’t intend to be, others are using it as an opportunity to relocate.

What is foreign earned income?

Earned income is typically sourced to the place where you perform the work. If I sit in an office in Paris, the work I do while in that office is considered foreign source. When I fly to the U.S. and do the same job in an office in Boston, the income I earn while there is U.S. source earned income. It doesn’t matter where the company is located that pays my compensation, the currency I am paid in, or where I deposit the money.

What is the foreign earned income exclusion?

It is an amount that you can deduct from your total income to reduce the U.S. tax on your Federal income tax return. You report your foreign earned income (wages or self-employment) and then make a negative adjustment for up to $107,600 (tax year 2020) per person, potentially more if you claim housing expenses or deductions.

Excluding income with the Foreign Earned Income Exclusion

First rule:

You must have a foreign tax home, a regular place of business in a foreign country or your abode is in a foreign country.

Second rule:

You must pass either the

1. Physical Presence Test – 330 days outside the U.S. in a 365 period, or
2. Bona Fide Residence Test (BFR) – based on facts and circumstances. Wondering how to tell if you are a bona fide resident? Check out our blog, “What Is The Bona Fide Residence Test?”

Remember when I said that excluding your income may not be the best outcome? If you have a foreign tax home, foreign earned income and qualify to exclude your income, you may also be paying taxes to another country. Foreign tax credits may offset the income on your U.S. tax return, potentially resulting in zero U.S. income tax. If you have more credits than you can use, you can carry them forwards and sometimes backwards. Foreign tax credits are a tax asset. You don’t hear that term very often! Finally, excluding your income may deny you other (refundable!) tax credits or prohibit contributions to U.S. based retirement accounts.

The International Tax Services group at KLR treats each client situation as unique. We look at your available options and help you choose between using tax credits and/or excluding income. We’ll look at both the year in play and your longer-term plans. Plus, we’ll give you peace of mind with the knowledge that you have experienced expat tax professionals keeping you out of the trouble with the IRS.

Contact us for further guidance.