What Is the Foreign Earned Income Exclusion?

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What Is the Foreign Earned Income Exclusion?

Let me explain the foreign earned income exclusion directly: it's an IRS policy that lets you subtract income you've earned and already taxed in a foreign country from your U.S. taxable income. If you're an expat, you still have to file U.S. tax returns, no exceptions.

As a U.S. taxpayer, you're generally required to pay taxes on your worldwide earnings, not just what you make inside the U.S. But this exclusion steps in to stop double taxation for those of us living and working overseas.

Key Takeaways

The main point here is that the foreign earned income exclusion exists to shield Americans abroad from double taxation. If you're living and working in another country, you'll use IRS Form 2555 to exclude that foreign income from your U.S. taxes. There's also a deduction available for foreign housing costs paid with that foreign earned income.

Important Details on Exclusion Amounts

For the 2024 tax year, the maximum you can exclude under the foreign earned income exclusion is $126,500. That jumps to $130,000 for 2025. Keep these figures in mind when calculating your taxes.

Understanding the Foreign Earned Income Exclusion

You report the foreign earned income exclusion on IRS Form 2555, which is the same form for claiming the housing exclusion or deduction. This covers amounts your employer paid for housing in a foreign country.

To claim it, you need to meet specific qualifications. First, you must be a U.S. citizen or resident alien— that's a permanent resident without citizenship, meaning you have a current green card or had one in the last calendar year. Second, you need a qualifying presence in a foreign country, which you can meet by residing there for a full tax year or by being physically present for at least 330 days in a 12-month consecutive period. Third, you must have foreign earned income, like wages or self-employment income from work done in that foreign country. Note that income from pensions, investments, alimony, or gambling doesn't count as foreign earned income.

The Foreign Housing Amount

There's a maximum exclusion amount, and then there's the foreign housing amount that further limits what you can exclude. If your qualifying days in the foreign country are less than a full tax year, it's prorated accordingly.

The foreign housing amount is basically your housing costs paid with foreign earned income minus a base housing amount. That base is 16% of the maximum foreign earned income exclusion, calculated daily. For 2024, with the max exclusion at $126,500, the base comes out to about $55.45 per day—multiply that by your qualifying days to get your base.

The max exclusion rises to $130,000 for 2025. For most people, excludable housing expenses are capped at 30% of the maximum exclusion, but there are exceptions if you're in a high-cost area. Employees take this as an exclusion, while self-employed folks claim it as a deduction.

Example of Foreign Earned Income Exclusion

Let's walk through how this works with an example. Take Michael, an American working in Vietnam. He lived in Hanoi for 355 days of the tax year, with a 10-day trip home for Thanksgiving. He earned $225,000 in salary and spent $33,600 on leasing a flat. He paid $75,000 in Vietnamese income taxes.

Without the exclusion, housing amount, and foreign tax credit, he'd owe $81,000 in U.S. taxes. But since he's a U.S. citizen with 355 qualifying days and paid foreign taxes, he excludes $126,500 of his income for 2024. He also deducts a foreign housing amount of $15,040—that's his $33,600 in costs minus a $18,560 base amount.

His income exceeds the max, so he uses a nonrefundable foreign tax credit for the rest. By filing Form 2555 for the exclusion and Form 1116 for the credit, he avoids owing U.S. taxes on that foreign income.

Who Qualifies for the Foreign Earned Income Exclusion?

Generally, if you live, work, and pay taxes in a foreign country but still have to file U.S. taxes, you qualify. This includes U.S. citizens or resident aliens physically present in another country for 330 days or more in 12 consecutive months; U.S. citizens who are legal residents of a foreign country for an uninterrupted period including a full tax year; or U.S. resident aliens who are citizens or nationals of a country with a U.S. income tax treaty and are legal residents of a foreign country for an uninterrupted period including a full tax year.