Claiming the Foreign Earned Income Exclusion and Foreign Housing Deduction with Form 2555

What is Form 2555?

Form 2555 is used by United States citizens who live and earn income abroad to claim an exclusion for foreign earned income. If you have a foreign employer or foreign-sourced self-employment income, you may qualify for the Foreign Earned Income Exclusion (FEI). 

All expats must fill out Parts I through V, while Part VI is only for taxpayers claiming the foreign housing exclusion and/or deduction. Part VII is for taxpayers claiming the FEI only, Part VIII is for both the foreign housing exclusion and FEI, and Part IX is for the foreign housing deduction only.

How do I qualify for the Foreign Earned Income Exclusion?

If you have a foreign employer, you may exclude up to $107,600 (as can your spouse, for a combined total up to $215,200) for the 2020 tax year. If you have foreign-sourced self-employment income, you may also be eligible for FEI but will still need to pay self-employment tax. 

If you are stationed overseas by the United States military or as a civilian by any federal government agency, your income is not considered foreign-sourced and is ineligible for FEI, even if you have a long-term foreign tax home.

You must also meet the bona fide residence test or physical presence test to qualify for the credit.

Bona Fide Residence Test

You may be eligible for FEI if you can prove you are a bona fide resident regardless of your eligibility for dual citizenship in your new home country. Actions that prove you are staying for the long term include buying a home or taking out a long-term lease, enrolling your children in local schools, joining local civic organizations and houses of worship, learning the language, and other indicators of permanent relocation.

Physical Presence Test

Regardless of how long you intend to stay in a foreign country (or countries), you may be eligible for FEI if you can prove you were not physically present in the United States for at least 330 full days of the year or for twelve consecutive months during the tax year. Partial days in transit leaving the United States do not count, such as arriving in a foreign country the day after your departure. However, days in transit between foreign countries are likely to count.

How do the foreign housing exclusion and deduction work?

Since living and working abroad can result in a drastic difference in a taxpayer’s cost of living relative to their income, the IRS grants a foreign housing exclusion or deduction to expats. This helps reduce reportable gross income, but similar to FEI, you must pass the physical presence or bona fide residence test to qualify. For instance, US government employees stationed overseas do not qualify for the deduction or exclusion.

The foreign housing deduction is for the self-employed, as self-employed taxpayers do not qualify for the foreign housing exclusion. It reduces your overall tax liability, but not the self-employment tax. The foreign housing exclusion only applies to housing allowances an employer pays that would otherwise be taxable as foreign income.

Applicable foreign housing expenses include rent (not buying a home), repairs, utilities, insurance, and parking. Lavish expenses, like cable TV, do not qualify nor do furniture purchases, though furniture rental does.