Are you an American citizen living abroad? In most cases you still have to file taxes, even if you pay taxes in the country where you live. However, depending on your income, you are probably not liable to pay anything to the US, only to file. Read on to learn how to properly file your taxes and take the Foreign Earned Income Exclusion if you live abroad.
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Do I have to file taxes if I live abroad?
So, for a long time I thought if I didn’t get a W2, I didn’t have to file taxes. However, that’s not true.
If you are an American citizen or green card holder (legal permanent resident), there’s a very strong chance you have the obligation to file taxes, even if you don’t have any income in the US or have no actual tax obligations in the US.
But, don’t take my word for it, this is quoted from this page from the IRS on tax obligations for people abroad: “If you are a U.S. citizen or resident alien, your worldwide income generally is subject to U.S. income tax, regardless of where you are living. Also, you are subject to the same income tax filing requirements that apply to U.S. citizens or resident aliens living in the United States.”
So, if you make enough to have to file living in the US (for tax year 2019, $12,200) then you have to file even if all your income is abroad. For reference, this amount is equal to the standard deduction.
An important disclaimer, this article is based on my experience and discusses how I file my taxes, however, I am not an accountant nor am I a tax professional or financial advisor, and this article should not be considered financial or tax advice or instructions.
However, hopefully it can help give you insight on how to file your taxes if you if live in another country, including how you can file form 2555 to take the earned foreign income exclusion.
Do you live abroad and want to have an easy and cost efficient way to transfer money back to the US or vice versa?
Check out the following great transfer options:
- World Remit makes it easy and has better exchange rates and lower fees than many banks offer on wire transfers. You can even get your first 3 transfers free!
- Transferwise also has great exchange rates and low fees (it’s a good idea to compare rates!)
- MoneyGram is also an option, although it only allows from transfers from the US to abroad and not vice versa.
What about filing online?
So, I fill out the paper form 1040 and form 2555 and mail them every year, but mostly that’s because I tried to do Turbotax a few years back and couldn’t figure out how to properly do it to file taxes living abroad. I’m also kind of old school.
The rest of this article is going to be about using those paper forms. But, if you want to make your life easier, you may want to check out E-File. Not only is filing online easier and more convenient, but you may be able to file for 50% off or even see if you qualify to file for free.
You can also try with Turbotax via Amazon. Speaking of things available on Amazon, you may also be interested in checking out J.K. Lasser’s complete 2019 tax guide, Taxes Made Simple, or Tax Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes.
However, if you’d rather just pay for the price of postage and are ok doing your expat taxes with pen and paper or you just want to learn about the Foreign Earned Income Exclusion, then read on in this practical guide to filing form 2555 and how to exclude your earned income abroad from your taxes.
When do I have to file taxes if I live abroad?
So, for 2020 (tax year 2019), the tax deadline has been extended for everyone until July 15.
By the way, if you are an expat and you haven’t gotten your economic stimulus payment yet, be sure to check out my guide to getting your economic impact payment.
For American citizens living abroad filing taxes, you can get an automatic 2 month extension from the normal April 15 deadline if you are out of the country at the deadline. However, this extension is just for filing not for paying, so you may owe interest if you actually owe taxes.
Likewise, if you file form 4868 you can get a 6 month extension. Be sure to double check your eligibility for these extension here.
What tax deductions can I take as a US citizen living abroad?
So there are basically three tax deductions you can take if you live abroad. They are:
- The Foreign Earned Income Exclusion (FEIE) – allows you to effectively reduce the amount of income earned abroad you are liable to pay taxes on up to a certain amount.
- The Foreign Tax Credit – if you paid taxes to a foreign country, you can subtract this from any taxes you have to pay to the US (but only on income not excluded from the FEIE). This will generally be most useful to US citizens living in other countries that tax at a higher rate than the US and have higher incomes ($100k+).
- Foreign Housing Deduction or Exclusion – you may be able to deduct or exclude what you spend on housing abroad as well.
Note that you can take 1, 2, or all 3 of these, although what reduces your tax obligation the most may differ for each individual tax payer.
To be very clear, you need to look into your individual situation, and it may be worth consulting with a professional if you are unsure what is the best method for filing or combination. For example, it may behoove some to take only the foreign tax credit, even if they qualify for the others.
In my case, because all of my income is abroad and it does not exceed the limit of the Foreign Earned Income Exclusion, I simply take that and have not had a reason to ever take the other two, so I am only going to offer up how to do the FEIE here by filing Form 2555.
What is the Foreign Earned Income Exclusion?
The Foreign Earned Income Exclusion allows you to exclude a certain amount of income earned in a foreign country from your adjusted gross income, the amount that determines what you pay in taxes.
Effectively, it allows you to not pay any taxes on money you earn abroad up to certain limit, on the condition that the money was in fact earned while you were abroad and you meet certain qualifications. Hence the name of the Foreign Earned Income Exclusion, you are excluding the money from the figure that determines your tax obligation.
How do I qualify for the Foreign Earned Income Exclusion?
You must meet 2 conditions to qualify for the FEIE:
- Your tax home is in a foreign country or countries
- You meet the Bona Fide Residence Test or the Physical Presence Test
Foreign Tax Home
The IRS defines your tax home the following way, “Your tax home is 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 because of the nature of your trade or business, your tax home is your regular place of abode (the place where you regularly live).” That quote is from the instructions for Form 2555.
The Bona Fide Residence Test
This means you have made your home in a foreign country for an entire tax calendar year without interruption. That translates into simple language as you may travel to the US or elsewhere on short term trips but have made your residence in a foreign country from January 1 to December 31st.
See more about the Bona Fide Residence Test at this IRS page.
The Physical Presence Test
This is what it sounds like, it means you were physically outside the US. It is defined as being outside the US for 330 days during any consecutive 12 month period, which includes at least part of the tax filing year.
In other words, you may be able to use a period from say April 2018 to May 2019, even though your time during the actual filing year is much less than 330 days, since you were out of the country for 330 days total.
Learn more about the Physical Presence Test at this IRS page.
For either test, you’ll find a section on Form 2555 where you justify your use of it in order to qualify for the earned foreign income exclusion.
Just to be clear regardless of which test you qualify under, the income you can exclude is only on income you earned while abroad. In other words if you use the above, your income in the states after May would be taxed normally and cannot be claimed under the FEIE.
Likewise any money made in the US, even if you qualify under the Bona Fide Residency Test, would also be taxed normally and cannot be excluded under the FEIE.
What is the benefit of the Foreign Earned Income Exclusion?
The Foreign Earned Income Exclusion allows you to deduct income you earn abroad (be that wages, commissions, tips, or other legal payments) from your Adjusted Gross Income.
Please do note that if you take the FEIE, you do not qualify to take the following deductions or tax credits:
- Additional Child Tax Credit
- Earned Income Credit
There are also special restrictions put on what you can deduct for IRA contributions as well as taking the foreign tax credit or deduction (more on the latter below).
How much income can I deduct under the Foreign Earned Income Exclusion?
The exact limit changes each year. For 2020 (tax year 2019), the limit is $105,900.
That means that if you make $105,900 or less abroad, while meeting the tests mentioned above, you can take all of it off your taxes. In other words, this money doesn’t count as income in the eyes of the US government and you don’t have to pay any taxes on it.
Now, things are slightly different if your income is considered self employment income, in which case you might be required to pay self employment tax and/or social security.
It’s also different if any of that income is made in the US, even if only in the country for a short time and still meeting the tests above.
Again, it’s always worth double checking. But if you have been living abroad the entire calendar year and been paid by a foreign company, and did not make more than the limit, then you can effectively exclude all of that foreign earned income from your tax bill.
It should be noted that people working for the US government usually do not qualify for the exclusion on foreign earned income.
Foreign Earned Income Exclusion vs Foreign Tax Credit
So as noted above, the Foreign Earned Tax Credit also allows you to deduct any taxes you pay to a foreign country or countries from your US tax bill.
If you make under the FEIE limit, then there’s no real need to take the Foreign Earned Tax Credit as you can just exclude all of your income.
Now, if you make more than the exclusion limit (say you made $120,000), you’re going to need to look into your situation to see what’s best. You can still exclude up to the limit, however, the difference is taxed at the rate for your full income (in this example at the rate for $120,000).
You can still claim the Foreign Tax Credit on that difference, but prorated at the same percentage of your income that the difference represents. However, you can alternatively claim the Foreign Tax Credit on all of your taxes paid to the foreign country or countries if you do not claim the FEIE.
Depending on what country you live in and your tax burden there, it may actually save you more to not take the FEIE and just take the Foreign Tax Credit (this will generally be the case in countries that have higher tax rates than the US).
You’re just going to have to do the math and play around with the numbers to know what’s best.
Ok, I qualify, how do I file for the Foreign Earned Income Exclusion?
So, to beat a dead horse, I must say here again, I am not a professional, and you should double check your tax obligations and the forms you have to file.
That out of the way, to file for the Foreign Earned Income Exclusion, you must at the minimum file the following forms:
- Form 1040 (you must use 1040, not 1040 EZ)
- Form 2555 (there used to be a Form 2555 EZ but it was phased out this year)
- Schedule 1 (this allows you to show the adjustment to income from the earned foreign income exclusion)
- Any other forms you are required to file (for example, I have to file Schedule D because I have some stock investments)
How to file form 2555?
So, you’ll want to start by filling out the top of Form 1040 like normal. You should include line 1 all your foreign earned income whether you have a W2 for it or not.
You should fill out the rest of the next few lines normally, including any interest from foreign bank accounts. Depending on your foreign bank account balances, you may also need to report them on Form FinCEN 114 (on balances over $10,000 total in 2019). Double check any other form filing obligations here.
Likewise, include your capital gains like normal in line 6.
You will see on line 7a, a mention of other income from Schedule 1, line 9. This is where you need to include your foreign earned income.
Fill out Form 2555 first, following the instructions. If you are going to take the Foreign Housing Deduction or Exclusion, it is also included here.
On Form 2555, you’ll fill out one section if you qualify for under the Bona Fide Residence Test or another if you qualify under the Physical Presence Test. For the Bona Fide Residence Test, you will need to include the dates your bona fide residency began as well as the type of visa you entered the country under. You will then need to record any travel to the USA with dates and if you were conducting business there.
For the Physical Presence Test, you’ll need to include the 12 month period in which you qualify (the 12 months you were out of the US for 330 days or more). You’ll also need to note the dates you traveled during that period to what countries and how many days you were in each country (including the US). Any income while in the US you cannot exclude below.
Next, you’ll fill out your foreign earned income. This includes salary, commission, or other compensation for goods and services, including living expenses or meals.
Do note that you cannot exclude dividends, capital gains, interest, pension, Social Security, or alimony as foreign earned income.
Next, you’ll have the option to fill out the section for taking the Foreign Housing Exclusion or Deduction. If, like me, you don’t need to take that, skip that section down to the next part.
Here, you’ll compute what you get to exclude based on the number of days that qualify under the tax year.
At the end of Form 2555, you’ll get a number on line 45. You’ll then enter that number in parenthesis (to signify a negative) on line 8 of the 1040 Schedule 1 (this is titled other income, and you should enter Form 2555 on the line where it says list type and amount).
Interestingly enough, this is all considered “additional income” even though you are subtracting it from your income.
Depending on your situation, you may have other adjustments to income to list on Schedule 1 (like if you take the housing exclusion).
Regardless, you’ll enter what you came up with on line 9 of Schedule 1 (most likely negative) on line 7a of the 1040. This effectively subtracts the income that qualifies for the FEIE from your total income to give you your Adjusted Gross Income (AGI).
Unless you’re a high earner, someone with high capital gains, or someone who makes income both abroad and in the US, your AGI is now likely to be below any of the thresholds to pay taxes, but do double check and complete the rest of Form 1040 as normal.
Forms to File for the Foreign Earned Income Exclusion (for tax year 2019):
- Form 1040. See Instructions here.
- 1040 Schedule 1.
- Form 2555. See Instructions here.
- Publication 54 (instructions for taxpayers abroad)
Again, I can’t stress enough to verify this information based on your own unique situation and if doubt consider consulting a tax professional, which I am not. Also, it may be worth being less hard headed than me and just using E-File. Definitely, at least check to see if you qualify for free file.
If you do in fact have any money due back to you, I highly recommend the Capital One 360 Bank Account as a good online banking option. You can read my review of it or sign up and get a deposit bonus. I also highly recommend their SavorOne and Quicksilver credit cards (review here and here)
There you have it. A practical guide to filing the Foreign Earned Income Exclusion. I hope it helped you have a better idea of how to file your taxes if you are a US citizen abroad.
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