Foreign Income Exclusions Guide

Introduction

For digital nomads and expats, understanding foreign income exclusions can result in significant tax savings. This guide covers the primary methods for legally reducing or eliminating taxes on income earned while living and working abroad.

While this guide focuses primarily on US citizens who can benefit from the Foreign Earned Income Exclusion (FEIE), we also cover strategies available to citizens of other countries including the UK, Canada, Australia, and Ireland.

US Foreign Earned Income Exclusion (FEIE)

What is the FEIE?

The Foreign Earned Income Exclusion allows qualifying US citizens and residents to exclude up to $120,000 (2023) or $126,500 (2024) of foreign earned income from US federal income tax. This exclusion applies only to earned income (wages, self-employment income) and not to passive income (dividends, interest, capital gains).

Qualifying for FEIE

To qualify for the FEIE, you must meet one of two tests:

1. Physical Presence Test

You must be physically present in a foreign country or countries for at least 330 full days during any 12-month period. These days do not need to be consecutive, and the 12-month period can begin on any day of the year.

Travel days to/from the US generally don't count
Days in international waters don't count
You can be in multiple foreign countries
Keep detailed records of your location

2. Bona Fide Residence Test

You must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. This test is more subjective and considers factors like:

Your intention to remain abroad
Nature and length of your stay
Establishment of a home abroad
Nature of your employment
Family and economic ties

How to Claim the FEIE

To claim the FEIE, you must:

File Form 2555 or Form 2555-EZ with your federal tax return
Have foreign earned income
Have your tax home in a foreign country
Meet either the physical presence or bona fide residence test

⚠️ Important Considerations

The FEIE only excludes income from federal taxes, not self-employment tax
State taxes may still apply depending on your state of last residence
Once you revoke the FEIE election, you cannot claim it again for 5 years without IRS approval
The exclusion amount is prorated based on qualifying days

Foreign Tax Credit vs. FEIE

Instead of (or in addition to) the FEIE, you may be able to claim the Foreign Tax Credit (FTC) for income taxes paid to foreign governments. Understanding when to use each strategy is crucial for tax optimization.

When to Use Foreign Tax Credit

You pay high foreign taxes (higher than US rates)
You have significant passive income
You want to contribute to retirement accounts
You may return to the US and want to carry forward excess credits

When to Use FEIE

You pay little or no foreign tax
Your income is below the exclusion threshold
You primarily have earned income
You don't need US retirement account contributions

Foreign Income Strategies for Other Countries

United Kingdom

UK citizens who become non-resident can potentially avoid UK tax on foreign income entirely. Key strategies include:

Meeting the Statutory Residence Test (SRT) for non-residence
Split-year treatment for the year of departure
Avoiding UK workdays while non-resident
Managing ties to the UK carefully

Canada

Canadian citizens who sever residential ties can become non-resident for tax purposes:

File departure tax forms when leaving
Sever primary and secondary ties
Avoid Canadian-source income
Consider tax treaty tie-breaker rules

Australia

Australian citizens can become non-resident but must navigate complex residency tests:

Pass all four residency tests to become non-resident
Foreign income generally not taxed for non-residents
Be aware of deemed disposal rules for some assets
Maintain clear intention to reside abroad

Ireland

Irish citizens have unique advantages through the remittance basis:

Non-domiciled individuals can use remittance basis
Foreign income only taxed if brought to Ireland
Must spend less than 183 days in Ireland
Consider the 280-day test over two years

Common Mistakes to Avoid

1. Not Keeping Adequate Records

The IRS may audit FEIE claims years later. Keep detailed records of travel dates, accommodations, and foreign addresses. Use apps or spreadsheets to track your days meticulously.

2. Mixing Vacation with Qualifying Days

Days in the US for vacation, business, or family emergencies can disqualify you from the physical presence test. Plan US visits carefully and understand what constitutes a "full day" abroad.

3. Claiming FEIE on Non-Qualifying Income

FEIE only applies to earned income. Investment income, rental income, and capital gains cannot be excluded and must be reported and taxed normally.

4. Forgetting State Tax Obligations

Some states continue to tax former residents even after they move abroad. Research your state's rules and consider formally establishing residency in a no-tax state before leaving.

Practical Tips for Maximizing Exclusions

Timing Your Travel

Start your 330-day count strategically
Minimize US presence in high-income years
Consider partial year exclusions
Plan major income events while qualifying

Documentation Best Practices

Keep passport stamps and boarding passes
Save accommodation receipts
Document employment contracts
Track days with multiple sources

Income Optimization

Convert passive to active income when possible
Time bonuses and commissions
Structure business income appropriately
Consider housing exclusion in addition to FEIE

Professional Assistance

Work with expat tax specialists
Get advice before major changes
Review elections annually
Plan multi-year strategies

Conclusion

Foreign income exclusions can provide substantial tax savings for digital nomads and expats, but they require careful planning and meticulous record-keeping. Whether you're using the US FEIE, managing UK non-residence, or navigating other countries' systems, understanding the rules is crucial.

Remember that tax laws change frequently, and individual circumstances vary greatly. Always consult with a qualified international tax professional who understands both your home country's rules and the implications of your nomadic lifestyle.

Official Sources