What is a Foreign Earned Income Exclusion?

The foreign earned income exclusion is a codicil in the United States tax code allowing people who are working and residing overseas to exclude all or a portion of their foreign income from taxation in the United States. Under normal circumstances, the Internal Revenue Service regards all income earned by citizens of the United States as taxable, but when people are overseas, they will be taxed in that nation, and the IRS wants to avoid taxing people twice. To qualify for the foreign earned income exclusion, people must live and work in a foreign country for at least a year.

As of 2010, the IRS allowed people to exempt up to $91,400 United States Dollars (USD) of foreign income from taxation using the foreign earned income exclusion. In addition, a separate exclusion for housing was provided to allow people to exclude provided housing benefits from taxation, recognizing that many US citizens living and working temporarily abroad are provided with housing as a benefit.

Employees of the United States government do not qualify for the foreign earned income exclusion. Members of the State Department working at foreign embassies, for example, must pay taxes to the IRS for their wages earned while doing this work. Their spouses, however, do qualify if they choose to work in the local community, as their income is not coming from the US government and they may be required to pay taxes to the local government.

People interested in taking the foreign earned income exclusion must be able to demonstrate that they qualify with either the physical presence test or the bona fide residence test. In the physical presence test, people spend at least 330 full days in a foreign country. Bona fide residents can show residency in a foreign country for a full tax year, backed up with activities like applying for drivers' licenses locally, joining community organizations, and so forth.

Handling income earned in other regions of the world can get complicated for US citizens. It is advisable to consult an accountant before taking up work overseas and to use the services of a skilled accountant when preparing tax documents to make sure they are filled out accurately. Some companies relocating their workers overseas provide accounting consultancy services as a benefit and employees can also ask for recommendations if they are trying to find a good accountant to handle their tax needs.