As you are a US citizen, you must file both your US taxes and your Republic of Ireland taxes, but may claim the Foreign Earned Income exclusion.
The Foreign Earned Income Exclusion (FEIE) can be a lifesaver for U.S. expats looking to reduce their tax burden. It allows eligible individuals to exclude all or part of their foreign earned income from U.S. taxes.
However, it's important to understand the details before claiming the FEIE:
- The FEIE can lead to substantial savings on your U.S. taxes if utilized properly.
- It's not a one-size-fits-all solution, as certain foreign income may or may not be excluded.
- Eligibility for the FEIE is not automatic, you need to meet specific criteria and file Form 2555.
- The FEIE is just one of the many tax relief options available to you. Consult a Tax Advisor to determine the best option for your situation.
Which foreign earnings are eligible for exclusion with the Foreign Earned Income Exclusion (FEIE)?
Who is eligible for the Foreign Earned Income Exclusion?
To be eligible for the Foreign Earned Income Exclusion, you must have lived abroad for a specified duration within the tax year. If you have recently relocated to a foreign country or returned to the U.S. during the year, you may still qualify for partial-year exclusions.
Expats who meet either of the following criteria may qualify for the FEIE:
- Employment outside the U.S. by a U.S. or non-U.S. employer
- Self-employment or partnership work outside the U.S.
- Satisfaction of either the Bona Fide Residency Test or Physical Presence Test
Please note, employees of the U.S. government are not eligible for the foreign income exclusion. However, those employed by private companies under contract with the government may still be qualified.
Meet the Bona Fide Residency Test
To meet the requirements for the Bona Fide Residency Test, you need to show a stronger connection to your foreign country of residence compared to the US. This means you must reside there uninterrupted for a full tax year, intending to continue to reside there even after returning to the US temporarily. To qualify, you must:
- Be a US citizen or resident alien of a country with a tax treaty with the US.
- Have active income sources such as salary or self-employment income. Passive income like pensions or dividends are not eligible.
- Spend more than a year working abroad.
- Have a permanent place of work in your foreign country of residence.
Even if you haven't met the Bona Fide Residency Test for a full tax year, you may still be eligible for partial-year exclusions if you've lived abroad for a full tax year in the past.
Meet the Physical Presence Test
To meet the Physical Presence Test, you need to show that you have been physically residing outside the U.S. for 330 complete days within a 12-month period. Keep in mind that a full day is calculated as 24 hours starting from midnight, and you need to be present in the foreign country for the entire 24 hours.
How much of my foreign income can be excluded?
The Foreign Earned Income Exclusion allows eligible U.S. expats to exclude a portion of their foreign earned income from U.S. taxes. The maximum exclusion amount is adjusted annually for inflation and in 2022, it was $108,700, and it was increased to $112,000 in 2023. If you incurred housing costs, you may be able to exclude more. If you and your spouse both meet either the Bona Fide Residency Test or the Physical Presence Test, both of you can claim the FEIE individually.
Foreign Earned Income Exclusion vs. Foreign Tax Credit
It is crucial to make a well-informed decision when deciding between the Foreign Earned Income Exclusion and the Foreign Tax Credit. Changing your choice from the exclusion to the credit and back to the exclusion again within a five-year period will not be possible without a complicated and costly process with the IRS. Working with an experienced expat tax advisor can provide valuable guidance in making this decision.
Choosing the Foreign Tax Credit and filing Form 1116 may be a more favorable option if:
- You are paying foreign taxes at a rate that is higher than your U.S. tax rate
- You want to participate in an individual retirement account (IRA)
- You are eligible for certain family-related credits based on non-excluded income
- You intend to exclude or minimize taxes on passive or investment income.
Common issues faced by American expatriates with the Foreign Earned Income Exclusion and Form 2555
Many American expats face similar questions and challenges when it comes to filing for the Foreign Earned Income Exclusion (FEIE). Here are the most frequent issues encountered with the FEIE:
Not filing Form 2555: Some expats believe that the FEIE will automatically be included in their tax filing if they qualify. However, it is necessary to file Form 2555 to claim the FEIE.
Being a government employee: Regrettably, U.S. government employees are not eligible to claim the foreign income exclusion.
Incorrect calculation of the FEIE: If you miscalculate the FEIE, you may not receive the correct amount of exclusion, leading to inaccuracies in your tax filing.
Claiming the FEIE instead of the Foreign Tax Credit (FTC): For instance, if you are retired abroad and your income is solely from investments and passive sources, claiming the FTC may be more beneficial.
Inadequate tracking of time: To pass the Bona Fide Residency or Physical Presence tests, it's essential to keep an accurate record of your time spent abroad. Even a minor deviation from the required hours could impact your eligibility for the FEIE.
Lack of active income for the year: If your income is solely from investments or passive sources while living abroad, you won't qualify for the FEIE.
Neglecting to pay U.S. self-employment taxes: Even if you're claiming the FEIE, you're still required to pay U.S. self-employment taxes.
Last Words
In conclusion, the Foreign Earned Income Exclusion and Form 2555 can be complex and challenging for U.S. expats. Whether it's determining eligibility, navigating the calculation, completing the form, or keeping up with changes in tax law, many expats face significant hurdles when claiming the FEIE. For this reason, many expats choose to work with professional tax advisors to help them through the process, and to ensure that they are maximizing their tax savings while staying compliant with all relevant regulations.
