Foreign Earned Income Exclusion

Definition

The Foreign Earned Income Exclusion is a U.S. tax law provision that allows U.S. citizens or resident aliens living abroad to exclude a certain amount of their foreign earned income from their U.S. federal income tax. The maximum amount is adjusted annually for inflation. This exclusion applies only to income earned for personal services performed in a foreign country.

Phonetic

The phonetics of “Foreign Earned Income Exclusion” is: Foreign: /ˈfɔːrən/Earned: /ərnd/Income: /ˈɪnkʌm/Exclusion: /ɪkˈskluːʒən/

Key Takeaways

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1. Qualification Criteria: To qualify for the Foreign Earned Income Exclusion, a person must meet the physical presence test (live more than 330 full days outside the U.S. in a 12-month period) or the bona fide residence test (be a bona fide resident of in a foreign country or countries for an uninterrupted period that spans an entire tax year).
2. Exclusion Limit: For the year 2021, the maximum foreign earned income exclusion is up to $108,700 per qualifying individual. If both spouses qualify, they can exclude up to $217,400 of their combined foreign earned income.
3. Tax Implications: The Foreign Earned Income Exclusion does not exclude or limit income from other categories such as dividend or interest income. Furthermore, even if you qualify for this exclusion, you must file a U.S. tax return each year if your gross worldwide income is over the filing threshold.

“`Those are the main points to know about the Foreign Earned Income Exclusion, but let me know if you have any other questions or need further clarification.

Importance

The Foreign Earned Income Exclusion (FEIE) is significant in the realm of business and finance largely because it provides U.S. expatriates with a tax break on a portion of their income earned outside of the United States. The FEIE allows those who qualify to exclude up to a specified amount of their foreign earned income from their U.S. federal income tax. This is fundamentally essential as it aids in preventing double taxation, which means expatriates not being taxed concurrently by both the U.S. and their resident country. This helps in reducing the financial burden for U.S. citizens and resident aliens who are earning income overseas, thereby fostering a greater sense of financial freedom and mobility.

Explanation

The Foreign Earned Income Exclusion (FEIE) is designed to relieve American expatriates from double taxation, whereby they would be in the burdensome position of shouldering tax obligations both in the United States and their country of residence. The essence of its purpose comes from the recognition that American citizens and resident aliens living and working in another country might encounter various additional costs which they otherwise wouldn’t incur within the U.S. Thus, the FEIE aids in balancing these potential costs by allowing them to exclude a certain amount from their taxable income.Moreover, the FEIE serves as a potentially important tool for encouraging international commerce and labor mobility. By offering the ability to exclude part or all of their foreign earned income, entrepreneurial and workforce movements across the borders are incentivized without fear of punitive tax liabilities. Consequently, the Foreign Earned Income Exclusion not only serves the immediate tax relief purpose for individual taxpayers, but also supports the broader purpose of facilitating economic globalization and labor market fluidity.

Examples

1. Example 1: A U.S. citizen works as a consultant in Germany for a full calendar year, making $115,000. Due to the Foreign Earned Income Exclusion, she is not required to pay U.S. income tax on about $105,900 (as of 2019) of that income. 2. Example 2: A freelance photographer from the U.S. spends more than 330 days in a 12-month period traveling around the world, earning $80,000 in that time. Since he meets the physical presence test with his travel and his income falls under the exclusion limit, he can exclude his full earnings from U.S. federal income tax under the Foreign Earned Income Exclusion.3. Example 3: A U.S. corporation sends an employee to their branch in Singapore. His annual compensation package totals $180,000 (salary, bonus, and housing). The first $105,900 (as of 2019) of his wages are excluded from U.S. tax under the Foreign Earned Income Exclusion. The rest of his income is subjected to US income tax. However, the U.S corporation can still have him deduct his housing expenses. This compliments the exclusion and reduces the tax further.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Tax Residency Status
• Physical Presence Test
• Bona Fide Residence Test
• Foreign Income
• Foreign Housing Exclusion

Sources for More Information

• Internal Revenue Service (IRS)
• Investopedia
• The Balance
• Tax Policy Center