Foreign Earned Income: The Tax Situation

If you live overseas, you will likely find yourself in a special tax situation and may need to file Form 2555, Foreign Earned Income. You may be eligible for an exclusion that allows you to exclude a certain amount of income from taxation ($107,600 in 2020 and $108,700 in 2021).

Who qualifies for the foreign earned income exclusion? You qualify to exclude foreign earned income from gross income if you pass both of the following conditions:

• The tax home test. Your tax home must be in a foreign country or countries throughout your period of bona fide residence or physical presence, whichever applies. For this purpose, your period of physical presence is the 330 full days during which you were present in a foreign country or countries, not the 12 consecutive months during which those days occurred. The 330 days do not have to be consecutive.
• Either the bona fide residence test or the physical presence test. A bona fide resident is a U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year — Jan. 1 to Dec. 31 — if you file a calendar-year return. The physical presence test means you must be a U.S. citizen or resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 months in a row. A full day means the 24-hour period that starts at midnight.

You can also enter on the form the total reasonable expenses paid or incurred during the tax year by you, or on your behalf, for your foreign housing and the housing of your spouse and dependents if they lived with you.

There are also strict definitions of what it means to work overseas. For example, income from working abroad as an employee of the U.S. government does not qualify for the exclusion. If this is your status, do not file Form 2555.

Special pandemic rules

If your residency plans were thwarted by the pandemic, you may be entitled to relief. If your tax home was in a foreign country and you reasonably expected to meet either the bona fide residence test or the physical presence test during 2019 or 2020 but failed to do so, you may be entitled to the waiver. To request this waiver for 2020, write “Revenue Procedure 2020-27” across the top margin of your Form 2555. There are other rules surrounding this relief; see the form instructions for details.

This is just a summary of a complicated series of rules — there are additional provisions and exceptions. If you live overseas or are planning to move, keep detailed records and consult with a tax professional.