Foreign Earned Income Exclusion: How to earn up to $108,700, tax free, in 2020
How to earn up to $107,600, tax free,
in 2020
- AUTHOR
Simon Black - LAST UPDATED
February 22, 2021 -
At Sovereign Man, we often talk about how lowering, or eliminating, your taxes is one of the best investments you can make in your life.
By cutting your taxes, you can earn 20% or more (depending on how much you save in taxes) in totally risk-free return on investment just from the savings you make.
I know of no other investment that allows you to do that.
And one of the best ways Americans can save on taxes is by moving abroad.
By moving overseas, US citizens can take advantage of the Foreign Earned Income Exclusion (FEIE), a special provision in the US tax code that allows US citizens living abroad who file Form 2555 along with their tax return to earn up to $107,600 per year (and growing) tax-free.
Although the US is only one of two countries in the world to tax its citizens on their worldwide income (the other country is Eritrea), the Foreign Earned Income Exclusion can make moving abroad to a lower tax jurisdiction very lucrative for Americans.
It’s a strategy that’s often used by the overseas staff of big US companies – but any American citizen can take advantage of it to save tens of thousands of dollars in taxes per year.
And if you qualify for the Housing Deduction or Exclusion, you can save even more.
Saving on your taxes is one of the best investments you could ever make. Tens of thousands of dollars or more, compounded over years, and decades, can results in millions more saved for retirement.
To qualify, all you’ve got to do is fill out Form 2555 with the IRS.
Now, you may ask yourself questions like – do US citizens have to pay taxes on foreign income? Or – how do I qualify for the Foreign Earned Income Exclusion?
In this article, we’ll answer all the questions you may have about the Foreign Earned Income Exclusion and the Housing Exclusion/Deduction. You’ll also learn exactly how to qualify, what income qualifies, and a lot more.
Learn even MORE no-brainer strategies
to legally reduce your taxes…
- How ANYONE can earn up to $200,000 per year — TAX-FREE
- How business owners and self-employed professionals can legally slash their tax bills by up to $2.2 million each year with minimal changes to their business AND without moving abroad
- How day traders & investors can legally cut their investment income tax rate to 0%
- And much, much, more
You’ll learn all of these and many other useful strategies such as how to obtain a valuable second passport (potentially even for free) inside this free guide.
The Foreign Earned Income Exclusion is a special provision in the US tax code that allows US citizens living abroad to exclude a certain amount of earned income from their US taxes.
For the 2020 tax year (which is filed in 2021) the amount is $107,600. Plus, you can save tens of thousands of dollars more if you also take advantage of the foreign housing exclusion.
But why does this opportunity exist?
The Foreign Earned Income Exclusion is a special provision in the US tax code that allows US citizens living abroad to exclude a certain amount of earned income from their US taxes.
For the 2020 tax year (which is filed in 2021) the amount is $107,600. Plus, you can save tens of thousands of dollars more if you also take advantage of the foreign housing exclusion.
Ever since 1913, the United States has had a mandatory income tax to be paid every year.
Traditionally however, income tax around the world is only levied on residents of a country – not citizens.
But the US is one of just two countries in the world that taxes its citizens, no matter where they live in the world.
The other country is Eritrea, a small African nation. But unlike the US, Eritrea has no resources to even try to enforce compliance.
The citizenship-taxation law dates back to 1861, when the United States was struggling to raise funds for its civil war.
At the time, the people in power argued that Americans living outside the country were evading their patriotic duty of helping pay for the war.
As a result, they should pay taxes just for being American citizens.
Although the war ended, the taxes didn’t (hint: they never do).
For a moment, the US tax reform of 2017 was actually the first to seriously consider removing citizenship-based taxation. But ultimately, that got shelved, and Americans look likely to pay taxes based on their citizenship for another while.
As you can imagine, this has very unique consequences for American citizens. They are the only people in the world today (together with Eritreans) who have to pay taxes to their home country no matter where they live.
That means that if you are American, and all of a sudden move to Chile, or Costa Rica, or France – you will still have to pay taxes to the United States.
However, there is a way you can limit the amount of taxes that you pay, up to a certain point, thanks to the Foreign Earned Income Exclusion.
The Foreign Earned Income Exclusion is a provision in the US Tax code that allows US citizens who live abroad to fill out Form 2555 each year and earn a certain amount of their income tax free.
That amount varies and is indexed to inflation. So for example, in 2017, it was $102,100. In 2019, it was $105,900. And in 2020, it is $107,600.
That means that as a US citizen living abroad, you can earn a little over $100,000 each year and not pay American taxes on it.
If you qualify, you may be able to exclude even more of that income through the Foreign Housing Exclusion & Deduction (more on that below).
As usual, the IRS has strict guidelines on how to qualify, and what income qualifies.
“Foreign” refers to income that is earned outside of the United States. That means the product or service is delivered in a foreign country. As such, it does not include work performed in the US, even if it is finally delivered to a foreign customer.
Instead, the work must be performed and delivered in a foreign country. But a US citizen who works for an American company could move abroad and seek to qualify for the Foreign Earned Income Exclusion because his work is technically performed overseas.
“Earned income” refers to active income that is earned through a salary or wage – even for self-employed people.
This means that investment income (dividends, capital gains, interest, etc.) is excluded from the Foreign Earned Income Exclusion, and does not qualify for exclusion from your income taxes.
(Keep in mind also that if you operate a US company as self-employed, you will still have to pay self-employment tax.)
And finally, “exclusion” refers to the maximum amount of earned income you can deduct from your reportable taxes for the year – and that you won’t pay taxes on.
You will need to report your foreign earned income to the IRS by filing out Form 2555 along with your regular 1040 income tax form. Any income above $107,600 will be taxed at regular levels (starting in the 24% tax bracket if you are filing as single).
In order to qualify for the Foreign Earned Income Exclusion, you will need to prove to the IRS that your ‘tax home’ is in a foreign country.
The IRS uses two methods to assess whether you have a tax home abroad. So if you are a US citizen who lives abroad and wants to qualify for the Foreign Earned Income Exclusion, you will need to meet either one of two tests: the physical presence test and the bona fide residence test.
In order to qualify under the physical presence test, you must be a US citizen who is physically present in one or several foreign countries for at least 330 days over 12 consecutive months.
These must be full days. If you leave the US at 3pm on a Sunday, that day will not count towards your time abroad – it must be full 24-hour days. Instead, the count will start the next day.
This means you can only be in the US for 35 or 36 days in a year.
The purpose of your stay or the type of residency you obtain abroad does not matter. What matters is that you must not be in the US for 330 days or more over a 12 month-period.
That means you could also go on a really long vacation abroad and qualify. Again, what you chose to do abroad does not matter.
It’s important to note that the 330 days do not have to be consecutive. You can take breaks in between and go back to the US if you want.
But even if you spend more than 35 days in the US, you could still qualify for the Foreign Earned Income Exclusion through the bona fide residence test.
To qualify under the bona fide residence test, you must prove to the IRS that you really have set up a home abroad – and legitimately moved out of the US.
This is a more subjective test, that will require the IRS to look at your situation in more detail. Do you rent or own a home abroad? Do you have a local bank account, phone contract, etc.?
The IRS will also see whether you maintain a home in the US (it’s better if you don’t), and whether your family lives with you abroad. However, if you actually live abroad and have moved your life with you, you shouldn’t have any trouble meeting the test.
Note that in order to qualify, you must meet the requirements for an entire 365- day tax year.
However, there are no strict requirements as to how much time you can spend in the US each year – so for people wanting to go back more often, qualifying under the bona fide residence test might make more sense.
If you meet either of these two tests, you are likely eligible to qualify for the Foreign Earned Income Exclusion.
The IRS provides this interactive questionnaire that you can use to determine if you are eligible for the Foreign Earned Income Exclusion.
The Foreign Earned Income Exclusion refers specifically only to income that you actively work to earn – in other words wages and salaries (even if they come from self-employment).
Unearned income like dividends, capital gains, interest, etc. and other types of income like social security and pension benefits are NOT included in this exclusion, and you will need to pay your full tax bill on those.
Variable income like rents, royalties and other business profits are subject to individual consideration, and whether you can apply for the Foreign Earned Income Exclusion is dependent on your level of involvement with the business, and the source of income (it must be from abroad).
Ultimately, the decision to exclude or not variable income is at the discretion of the IRS.
If you are self-employed, you will still have to pay US self-employment tax, even if you qualify for the Foreign Earned Income Exclusion.
Overall, the Foreign Earned Income Exclusion means that if you qualify, you can exclude $107,600 of earned income from wages from your tax declaration during the year.
For example, if you live in Chile full-time and earn $200,000 per year, you may deduct $107,600 from your reportable income in 2020.
That means you’ll pay tax on only $92,400 of the total $200,000.
TIP: Save even more if your spouse qualifies…
If you are married, you and your spouse can BOTH qualify for the Foreign Earned Income Exclusion, meaning you’ll be able to deduct a total of $215,200 from your income tax bill if you qualify and file jointly.
However, the Foreign Earned Income Exclusion gets even better when you factor in the Housing Exclusion or Deduction.
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The Foreign Earned Income Exclusion gets even better thanks to one addition: the Housing Exclusion and Deduction.
The Housing Exclusion and Deduction are essentially the same thing, with one small distinction:
- 1. The Housing Exclusion applies to those who are employees
- 2. The Housing Deduction applies to those who are self-employed
In both cases, if you live abroad, the Foreign Housing Exclusion or Deduction lets you exclude housing costs from your taxable income. The amount you are allowed to deduct will vary from place to place.
For example, if you live in Amsterdam, your maximum housing exclusion is $52,900 for the year. And if you live in London, the exclusion is $69,290. In Hong Kong, it’s a whopping $114,300 per year.
You can find the list of countries and cities with their respective maximum housing exclusions in the instruction document for filling out Form 2555.
However, you will only be able to claim the housing exclusion on housing expenses that you actually incur – and not automatically the full amount up to the limit in each city.
On top of that, you will need to deduct from that amount what the IRS estimates you would have paid if you had lived in the US, which is set at 16% of the Foreign Earned Income Exclusion (or $17,216 in 2020).
So if you rent a house in London for example, for $3,000 a month, you will be able to deduct ($3,000*12)-$17,216 = $18,784.
If your city is not listed, the maximum housing exclusion will be 30% of the current Foreign Earned Income Exclusion limit.
That means that in 2020, you would be able to deduct maximum 30% of $107,600 = $32,280 MINUS $17,216 = $15,064.
(To see how that looks on the actual form you need to file, you can head to Form 2555 which you will find here, and head to the last page, Part 6).
To benefit from the housing exclusion, you must deduct qualified housing expenses. By qualified expenses, the IRS includes:
- Rent
- Utilities
- Homeowner’s or renter’s insurance (abroad)
- Parking rental
- Furniture rental
- Repairs
However, phone, TV and Internet expenses are not included – and you will not be able to deduct them from your income.
Mortgage payments do not count either. Neither does money you pay to a maid, or use to BUY furniture.
It’s also important to note that the Housing Exclusion amount cannot exceed your foreign income for that year.
Furthermore, you must have paid for your housing expenses out of the employer-provided funds… meaning out of the active income you made, and not out of unearned income like dividends.
If your employer reimburses you, or pays outright for some of your housing expenses, you must report those expenses on your tax return for the year as well.
For example, if you earned $100,000 last year, and your employer paid your $3,000/month rent, then you must report your Foreign Earned Income as $136,000. [$100,000 + ($3,000 x 12)].
You would then exclude your qualified housing expenses from that $136,000, resulting in a negligible tax bill.
If you live abroad, the Housing Exclusion/Deduction really makes a difference.
If you add your Housing Exclusion to the $107,600 you can exclude with the Foreign Earned Income Exclusion, the total amount of money you can exclude from your taxes is significant.
In fact, it’s possible you could earn more than $150,000 (and twice that with your spouse) and end up with a completely trivial tax bill after excluding your earned income and qualified housing expenses.
Foreign Earned Income Exclusion
(and the Housing Exclusion/Deduction)
Filing for the Foreign Earned Income Exclusion, and the Housing Exclusion/Deduction, is a straightforward step.
Along with the income tax return that you are required to file each year – Form 1040 – you will need to file Form 2555 along with it to qualify for the Foreign Earned Income Exclusion (and Housing Exclusion/Deduction).
In the form, you will detail how much income you earned abroad, and the housing expenses you want to deduct.
You can file this form on your own, but as always, we recommend that you speak with a trusted tax advisor to make sure this is done properly.
Consider these incredible alternatives…
Until recently, Americans had to move away from the United States to receive preferential tax treatment.
But a few years ago, Puerto Rico, an American territory, introduced some of the most attractive tax incentives in the world.
In short, any investor who moves to the island can slash the tax they pay on dividends and capital gains to 0%.
And entrepreneurs can qualify for a corporate tax rate of just 4%.
That’s an unbelievable deal – and US citizens don’t even need a passport to take advantage of it. Moving to Puerto Rico is just like moving from New York to Florida.
Right now, Puerto Rico’s tax incentives are one of the best opportunities I’ve come across in the world.
In fact, I even moved here myself to take advantage of them. And now I live on an island in paradise and pay 0% tax.
My team recently spent months putting together the most comprehensive report on Puerto Rico’s tax incentives available out there.
This information is usually only available to premium members of Sovereign Man: Confidential, our flagship international diversification service.
However, this information is so important that we put together a free article that you access here.
If you are sitting on unrealized capital gains – stocks, real estate, art, crypto… – Opportunity Zones may offer amazing tax benefits.
It’s a brand-new program that was buried inside President Trump’s 2018 tax reform legislation.
Through the program, you can sell your appreciated assets, defer capital gains tax, and invest the proceeds into one of 9,000 designated distressed communities across America.
Most of Detroit and Baltimore is an Opportunity Zone… and even parts of Manhattan.
Your investment in real estate, an existing business, a new business, etc. located in an Opportunity Zone can grow completely tax-free for decades.
The program is still new, but it is already a huge success with billions of dollars pouring into America’s distressed communities.
You can learn more about Opportunity Zones and my personal experience with it in this in-depth article.
Taxes are an enormous benefit of living overseas. Your life can be MUCH richer. In addition to having more freedom and greater lifestyle opportunities, you can save a boatload of money.
It’s definitely something to consider.
But it’s not the only way to save taxes and I invite you to explore our other resources…
Learn even MORE no-brainer strategies
to legally reduce your taxes…
- How ANYONE can earn up to $200,000 per year — TAX-FREE
- How business owners and self-employed professionals can legally slash their tax bills by up to $2.2 million each year with minimal changes to their business AND without moving abroad
- How day traders & investors can legally cut their investment income tax rate to 0%
- And much, much, more
You’ll learn all of these and many other useful strategies such as how to obtain a valuable second passport (potentially even for free) inside this free guide.
Our intelligence reports cover everything from new residency or foreign banking options to how to reduce, defer, or even eliminate your taxes, to incredible investment picks outside the mainstream.
And of course, members have access to many in-depth reports on all four ways to get a second passport & citizenship.
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Simon Black is an international investor, entrepreneur and permanent traveler. His daily letter is both educational and entertaining, and we suggest that those who want unbiased, actionable information about global opportunities sign up for Sovereign Man’s free, actionable newsletter at http://www.SovereignMan.com.
From Simon Black of SovereignMan.com
Source: https://www.sovereignman.com/trends/this-is-the-only-no-risk-way-i-know-about-to-guarantee-a-20-return-15381/
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