Form 2555 Foreign Earned Income Exclusion – An Introduction
Provided an individual is able to establish that his tax home is outside the U.S. and can satisfy either the “bona fide residence test” or the “physical presence test,” such individual can exclude a portion of their earned income earned overseas. Earned income includes income in the form of compensation (whether from employment or self-employment) but does not include income from investments, such as interest, dividends, capital gains, pensions and rental income.
In addition to the FEIE, a U.S. expat can also exclude or deduct from their gross income their housing cost amount in a foreign country provided they qualify under the bona fide residence or physical presence tests. The foreign housing exclusion (“FHE”) is applicable whenever an individual has wages. The deduction is applicable whenever the individual is self-employed.
In order to claim FEIE or FHE, an individual must file Form 2555 with their U.S. federal income tax return.
What is the maximum FEIE?
For 2018, the maximum foreign earned income exclusion is up to $103,900 per qualifying person. The maximum amount is adjusted annually for inflation.
If filing individuals are married and both work abroad and meet either the bona fide residence test or physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $207,800 for the 2018 tax year. Certain nuances and limitations may apply in the case of married couples.
What is the maximum FHE?
In general, an individual can exclude or deduct additional income based on his housing costs. This is limited to a maximum amount based on the individual’s geographic location. The instructions to Form 2555 include the per city limitation which is based on cost of living estimates and adjusted for inflation.
What is a tax home?
In order for an individual to qualify for the FEIE, his or her “tax home” must be in a foreign country. The general rule is that a “tax home” is located in the vicinity of the taxpayer’s regular or principal (if more than one regular) place of business or employment, regardless of where you maintain your family home.
Your tax home is the place where you are “permanently” or “indefinitely” engaged to work as an employee or self-employed individual. If you do not have a regular or principal place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither (no regular place of business or living), then you are considered an “itinerant” and your tax home is wherever you work.
The “tax home” rule is subject to an important overriding exception – an individual is not considered to have a tax home in a foreign country for any period during which the individual’s “abode” is in the United States. “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling. Thus, in contrast to “tax home,” “abode” has a domestic rather than vocational meaning. The location of your abode often will depend on where you maintain your economic, family, and personal ties.
What are the bona fide residence and physical presence tests?
Bona fide residence test – A U.S. citizen will satisfy the bona fide residence test if they reside in a foreign country for an uninterrupted period that includes the entire tax year. It is important to keep in mind that merely being in a foreign country for one full year does not automatically qualify an individual. The test is highly factual and based on the circumstances of each case. For example, if an individual relocates to a foreign country in order to work on a particular job for a specified period of time, he or she will not satisfy the bona fide presence test despite presence in the foreign country for more than one year fulfilling the work assignment. The length of your stay overseas and its nature are only two of several factors the IRS will examine. Other factors include whether you intend to return to the U.S., have purchased a home overseas, any declaration you may have made to the foreign authority indicating that you are not a resident of the country, and whether your family lives with you aboard.
Physical presence test – An individual will qualify under the physical presence test if they are present in a foreign country for 330 full days during any period of 12 consecutive months. The 330 days do not need to be consecutive.
What is the due date of the Form 2555?
Your initial choice of the exclusion on Form 2555 generally must be made with:
- a timely filed return (including any extensions),
- a return amending a timely filed return, or
- a late-filed return filed within 1 year from the original due date of the return (determined without regard to any extensions).
You can choose the exclusion on a return filed after the above periods, provided you owe no federal income tax after taking the exclusion into account.
If you owe federal income tax after taking the exclusion into account, you can choose the exclusion on a return filed after the periods described above, provided you file before the IRS discovers that you failed to choose the exclusion.
If you owe federal income tax after taking the foreign earned income exclusion into account and the IRS discovers that you failed to choose the exclusion, you must request a private letter ruling that grants the late exclusion.
Does the Form 2555 need to be filed annually?
Once you choose to claim an exclusion, the choice remains in effect for that year and all future years unless it is revoked. However, you need to include the form each year with your tax return in order to claim the benefit of that year. To revoke your choice, you must attach a statement to your return for the first year you do not wish to claim the exclusion. If you revoke your choice, you cannot claim the exclusion for your next 5 tax years without the approval of the IRS.