Written by Marc R Barnes EA
December 21, 2009
If you are living and working abroad you may be entitled to the Foreign Earned Income Exclusion. Here are some important facts about the exclusion:

What it is

  • The Foreign Earned Income Exclusion: United States Citizens and resident aliens who live and work abroad may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs.
  • The General Rules: To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country, otherwise known as foreign earned income. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.
  • The Exclusion Amount: The foreign earned income exclusion is adjusted annually for inflation. For 2012, the maximum exclusion is up to $95,100 per qualifying person ($92,900 in 2011, $91,500 in 2010, $91,400 in 2009).
  • Claiming the Exclusion: The foreign earned income exclusion and the foreign housing exclusion or deductions are claimed using Form 2555, which should be attached to the taxpayer's Form 1040. A shorter Form 2555-EZ is available to certain taxpayers claiming only the foreign income exclusion.
  • Taking Other Credits or Deductions: Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered revoked.

How it works

Let's say you only take the standard deduction and personal exemption, and your additional income is a retirement pension of $25,000 and some interest of $1,000. I'll further assume you will have a foreign wages of $95,100. Thus your total income (without the exclusion) is $121,100, minus your deductions of $9,750 (standard deduction plus 1 exemption), and you have taxable income of $111,350, which puts you in the 28% tax bracket. Your actual taxable income (with the exclusion) is $16,250, and so your tax is likely to be 28% of that, or $4,550 for a tax savings of $20,088.

Basically, taking the foreign earned income exclusion has the effect of pushing your other income into a higher tax bracket that it normally would be in.
Topic: Credits and Deductions