The U.S. Expat’s Guide to Form 2555 and Foreign Earned Income

Sep 5, 2023

What is Form 2555?

Form 2555, known as the Foreign Earned Income Exclusion form, is a critical U.S. tax form for American citizens or resident aliens residing in a foreign country. This form allows you to exclude a specific amount of your foreign earned income from federal income tax. For the calendar year 2023, the maximum exclusion is $120,000. By filing Form 2555, you can significantly reduce or even eliminate your U.S. tax liability on foreign income, making it an essential tool for U.S. expats.

Why Should U.S. Expats File Form 2555?

If you’re a U.S. citizen living in a foreign country, filing Form 2555 can offer you substantial tax benefits. The United States is unique in that it taxes its citizens on worldwide income, irrespective of their country of residence. By utilizing the foreign income exclusion through Form 2555, you can reduce your taxable income, thereby lowering your overall U.S. tax burden. Moreover, you can exclude self-employment income as well. If your foreign country of residence has an income tax treaty signed with the US, you won’t be subject to the self-employed income tax either.

When Does Form 2555 Provide the Best Benefits?

Form 2555 is most advantageous when you’re not paying a significant amount of taxes on income in your country of residence. If the foreign taxes you pay are lower than what you would owe in the U.S., the Foreign Earned Income Exclusion can help you avoid double taxation. On the other hand, foreign tax credits are another option that could be more advantageous depending on your circumstances. There’s no one-size-fits-all solution; it’s crucial to evaluate both options to determine which provides the most comprehensive tax benefit for your specific situation.

Related: FEIE vs. Foreign Tax Credit: Which One to Choose?

Requirements for Filing Form 2555

To be eligible for the Foreign Earned Income Exclusion, you must meet not just one, but three key tests during the qualifying period:

  1. Physical Presence Test: You must be physically present in a foreign country for at least 330 full days within a 12-month period. For example, if you spend 335 days in a foreign country from January to December, you pass the test. Conversely, if you spend 320 days abroad and 45 days in the U.S., you fail the test. Note that these 330 qualifying days do not have to be consecutive.
  2. Bona Fide Residence Test: This test is more challenging to meet as it requires you to prove your intent to reside in a foreign country for an uninterrupted period that includes an entire tax year. You must demonstrate that your foreign residence is long-term and not merely for a specific job assignment.
  3. 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. Your tax home is defined as your regular or principal place of business, employment, or post of duty, regardless of where you maintain your family residence. If you don’t have a regular or principal place of business due to the nature of your work, your tax home is your regular place of abode. Importantly, you aren’t considered to have a tax home in a foreign country for any period during which your abode is in the United States, unless you are serving in support of the U.S. Armed Forces in a designated combat zone.

Drawbacks of Using Form 2555

While Form 2555 offers numerous advantages, it also comes with limitations:

  1. Ineligibility for Certain Tax Credits and Deductions: If you claim the Foreign Earned Income Exclusion, you forfeit the ability to claim social security benefits, the Additional Child Tax Credit (ACTC), and IRA deductions.
  2. Five-Year Restriction: If you revoke the exclusion, you cannot claim it again for five consecutive months without IRS approval.

Common Errors in Filing Form 2555

Not Filing at All

One of the most frequent mistakes U.S. expats make is assuming that if their income is below the maximum exclusion limit, they don’t need to file an income tax return. This is incorrect. To claim the exclusion, you must file an income tax return and complete Form 2555. Failure to do so can result in penalties and missed opportunities for tax savings.

Incomplete Form 2555

Another common error is neglecting to complete Form 2555 when filing the income tax return. To claim the exclusion and any associated foreign housing costs, you must complete and attach Form 2555 to your federal income tax return.

Additional Considerations: Foreign Housing Exclusion

Section 911 allows qualified individuals to exclude foreign earned income and also either exclude or deduct foreign housing costs. For 2022, the base housing amount is 16% of the maximum foreign earned income exclusion of $112,000, resulting in $17,920. The general cap on housing expenses is 30% of this maximum, or $33,600 for 2022. These limits can be adjusted based on your country of residence due to geographic differences in housing costs.

Why Choose 1040 Abroad?

At 1040 Abroad, we specialize in helping U.S. expats navigate the complexities of filing U.S. taxes while living in a foreign country. Our team of experts is here to provide unlimited free email tax consultations, ensuring that you’re educated about your tax obligations and how to meet them efficiently. We aim to offer value-added services that empower you to make well-informed decisions regarding your U.S. tax obligations.

U.S. Taxes For American Expats E-book

FREE U.S. Tax Guide for Americans Abroad

The only e-book about U.S. Expat Taxes you need to read! Covers

1. Foreign Tax Credit vs. Foreign Earned Income Exclusion

2. The Additional Child Tax Credit. Get a $1,400 refund!

3.  What happens if I don't file?

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