Are you an American living your dream life overseas? Perhaps you’re a digital nomad exploring new cultures or an ex-pat working abroad for a few years.
While living overseas can be a fantastic experience, it’s essential to understand the IRS’s tax obligations.
Don’t worry; I’ve got you covered! In this article, we’ll dive into the ins and outs of Form 2555, a critical document that allows you to claim the Foreign Earned Income Exclusion and avoid double taxation.
- If you’re an American working abroad and want to avoid paying taxes on your foreign income, you must file Form 2555 to claim the Foreign Earned Income Exclusion.
- To qualify for the exclusion, you must pass either the Bona Fide Residency or the Physical Presence Test and work outside the U.S. as an employee or self-employed individual.
- For the entire tax year, the limit is $33,600 in most locations, which is 30% of the maximum Foreign Earned Income Exclusion of $112,000; it may be lower if you don’t qualify for the entire year.
What is the Form 2555 (Foreign Earned Income Exclusion)?
Form 2555 is your go-to form for claiming the Foreign Earned Income Exclusion – you can exclude up to $112,000 of foreign-earned income from your taxable income for the 2022 tax year.
The FEIE helps ex-pats avoid double taxation when they pay twice the taxes on the same income.
The U.S. offers a foreign tax credit, deduction (including foreign housing deduction), and exclusion to qualifying ex-pats to prevent this.
Do I Need to File Form 2555?
If you’re working overseas and want to exclude your foreign income from U.S. taxes, you must file Form 2555 to claim the Foreign Earned Income Exclusion.
You can claim the FEIE if you pass either the Bona Fide Residency or the Physical Presence Test and work outside the U.S. as an employee or self-employed individual.
However, it’s worth noting that U.S. government employees aren’t eligible for the FEIE, but private contractors working for the government might still be qualified.
Remember that if you’re not eligible for the FEIE, you may still be able to claim the foreign tax credit on your U.S. tax return.
Bona Fide Residency Test
Suppose you aim for the Foreign Earned Income Exclusion using the Bona Fide Residence Test. In that case, you need to demonstrate that you have stronger ties to a foreign country than to the U.S. and must have been a resident there for an uninterrupted tax year.
You need to be a U.S. citizen or a resident alien of a foreign country with an income tax treaty with the U.S.
Also, you should have a permanent place of work abroad, earn active income, and work there for more than a year.
You can be a Bona Fide Resident for part of the year if you previously spent at least one full tax year outside the U.S.
Physical Presence Test
If you’re looking to qualify for the FEIE using the Physical Presence Test, you must show that you’ve spent or physically present at least 330 full days outside of the United States in a year.
So that you know, a full day means you have to be in a foreign country for every minute of those 24 hours starting at midnight.
To clarify, if you’re living in Canada but hop across the border for a quick shopping trip, that time won’t count towards your 330 full days and could impact your ability to claim the foreign tax credit.
Form 2555 Instructions: The Ultimate Guide
Filing taxes can be daunting, especially if you’re an American living and working abroad. However, with the proper instruction, it can be a manageable process.
In this guide, we’ll walk you through the step-by-step process of filling out tax form 2555, which you’ll need to file to claim the Foreign Earned Income Exclusion.
Part I: General Information
The first part of Form 2555 is usually the easiest. It contains straightforward questions requesting information that you should already know without referencing additional paperwork.
Remember that there are no predefined answers, and you will answer as applicable to your situation.
Part II: Bona Fide Residence Test Qualifications
If you qualify for the Foreign Earned Income Exclusion under the Physical Presence Test, leave Part II blank and complete Part III.
Things could get complicated if you worked in the United States while residing abroad.
Any income earned while in the U.S. is considered U.S.-based income and not foreign earned, which reduces the amount of income eligible for the Foreign Earned Income Exclusion on your U.S. expat taxes.
If you earned income while in the United States and reported it in column (d), attaching a statement supporting calculating your U.S. expat taxes is necessary.
Although there isn’t a fixed format for this statement, include your name and social security number.
The IRS wants to know how you came up with the amount earned in the U.S. and typically expects you to provide the exchange rate used, which is available on the IRS website. Don’t worry; it’s more manageable than it may seem!
Part III: Physical Presence Test
If you’re using the Bona Fide Residence Test to qualify for the FEIE, you only need to fill out Part II of Form 2555 and leave Part III blank.
Regarding the Physical Presence Test, the 12-month period you select must have at least 365 days, with some of those days falling in 2022. Don’t worry if the period begins or ends in a year other than 2022.
Part IV: Foreign Earned Income and Housing Exclusion
Let’s continue with the section where you get to list all the income you’re eligible to exclude.
It’s not just your salary and wages but also includes other things like free housing provided by your employer or your children’s tuition fees that your employer paid for.
But remember that if you earned any income while working in the U.S., you couldn’t exclude that from your income taxes.
So, be sure to go through all your income carefully and include everything you’re eligible to exclude.
Part VI: Housing Exclusion and Deduction
Line 28 asks you to enter the total reasonable expenses paid for your foreign housing and that of your spouse and dependents, including a second foreign household, if applicable.
Reasonable expenses include rent, utilities, insurance, and household repairs. However, deductible interest and taxes, house purchases, or domestic labor costs are omitted.
Include housing expenses for periods where you meet the tax home test and either the Physical Presence or Bona Fide Residence Test so you can qualify for the foreign housing exclusion
Additionally, if you and your spouse qualify for the tax benefits, separate rules apply based on whether you lived in the same or different foreign households. For additional information, see Pub. 54 from IRS.
Line 29a asks you to enter the city and country where you incurred foreign housing expenses only if it’s listed in the instructions. If not, you can leave it blank.
Line 29b limits the number of foreign housing expenses you can claim. This limit varies depending on the location where you incur housing expenses.
Part VII: Calculate Your FEIE
Here’s how to calculate the Foreign Earned Income Exclusion amount you’re eligible for on your U.S. expat taxes.
The IRS has already filled in Line 37 with the maximum amount for 2022: $112,000. On line 38, enter the number of days you were outside the U.S. during the qualifying period.
Line 39 will calculate the percentage of time you spent abroad, which you’ll use to multiply against the maximum FEIE on Line 37. Enter the result on Line 40.
Next, on Line 41, enter your income abroad, excluding any income earned in the U.S. while maintaining a foreign residence.
Once you have calculated the Foreign Earned Income Exclusion (FEIE) amount, you are eligible by entering either Line 40 or Line 41 on Line 42.
Don’t forget to enter the FEIE amount on Tax Form 1040, Schedule 1, Line 8d, and Line 8 of Form 1040, “Other Income,” of your U.S. ex-pat income taxes.
4 Common Mistakes when Filing Form 2555
Filing your U.S. ex-pat taxes can be complex, and there are several common mistakes to avoid when filing Form 2555. Here are some of the most frequent errors:
#1: Mistakes on Line 16
If you’re claiming the FEIE under the Physical Presence Test, make sure that you calculate the 12 months correctly on Line 16.
The period must include 365 days, part of which must be in the tax year you are filing for. The dates can begin or end in a calendar year other than the tax year.
#2: Forgetting to attach supporting documents
If you worked in the U.S. while living abroad and included that income in column (d), you must attach a statement explaining how you calculated your U.S. ex-pat taxes.
Always include your name and social security number to ensure the IRS can identify your statement.
Also, include the exchange rate you used to calculate the U.S. income. Don’t worry; the IRS wants to understand how you arrived at the final amount!
#3: Incorrectly calculating your foreign income
When calculating your foreign income, ensure you only include earned income and not unearned income, such as pension payouts, interest, and dividends. If you’re unsure what to have, consult a tax professional.
#4: Not including all eligible income
Include all eligible income in Part IV of Form 2555. This includes salary, total wages, and other items like housing expenses paid for by your employer.
Filing U.S. ex-pat taxes can be complicated, especially if you’re claiming the Foreign Earned Income Exclusion. Form 2555 is the form you use to figure out and claim the FEIE.
Understanding the requirements for qualifying under the Bona Fide Residency Test or the Physical Presence Test is essential.
If you’re unsure how to complete Form 2555, claim for foreign income exclusion or have questions about your U.S. ex-pat taxes, consult a tax professional to ensure you’re filing correctly and taking advantage of all available deductions and exclusions.
Frequently Asked Questions (FAQs)
How do I claim foreign income on U.S. taxes?
Yes, as a U.S. citizen or permanent resident, you must pay U.S. taxes on income earned anywhere in the world. Unlike most countries that tax based on residency, the U.S. uses citizenship to determine tax liability. So, even if you made income in a foreign country, you still owe taxes to the U.S. government.
How much is income tax in the USA for foreigners?
If a foreign national earns income from a U.S. source, they are generally subject to federal withholding tax at 30%. However, if a tax treaty exists between their country of residence and the United States, they may be eligible for a reduced rate or exemption. Foreign nationals must be aware of these tax treaty provisions to avoid overpaying their U.S. tax obligations.