Form 2555 - Great News For US Citizens Abroad

Published on October 25, 2023
by Clark Stott

Clark Stott has been with Expat Tax Online since 2015. Being a dual national based in the UK, Clark has unique experience helping US citizens (and Accidental Americans) become tax compliant via the Streamlined Tax Amnesty program. Clark likes to help Americans in the UK keep their tax situations as simple as possible to avoid harsh IRS treatment.

Form 2555. The Foreign Earned Income Exclusion

Living abroad as a US expat is an exciting journey filled with new experiences and tax responsibilities. One fundamental form that often surfaces for expats is Form 2555. So, what’s the deal with this form?

Form 2555, or the Foreign Earned Income Form, is your go-to document for claiming the Foreign Earned Income Exclusion (FEIE). This tax provision is a game-changer for U.S. citizens residing and earning abroad. It allows you to exclude a portion of your foreign income—up to $120,000 for the tax year 2023—from your U.S. taxable income. Remember that this amount is inflation-adjusted, so checking the IRS for the most current figures is wise.

Who’s eligible for the FEIE? The criteria are pretty straightforward:

  • Your income must be earned in a foreign country.
  • Your primary residence for tax purposes should be outside the United States.
  • You must meet either the Bona Fide Residence Test (you’ve been a resident in a foreign country for a full tax year) or the Physical Presence Test (you’ve spent at least 330 full days in a foreign country or countries within a 12-month span).

Limitations and How to Calculate Foreign Earned Income Exclusion

Understanding how to compute the FEIE can save you a considerable sum, so it’s worth getting familiar with the process.

First, identify your foreign-earned income, which encompasses wages, salaries, and fees for services you’ve rendered. Once you’ve got that number, the FEIE lets you exclude a specific portion from your U.S. taxable income. If your earnings are below the exclusion limit, you’re in luck—you can exclude the entire amount. If not, you’re capped at the exclusion limit.

However, the FEIE isn’t without any restrictions. It only applies to earned income, not unearned income like dividends, interest, or social security benefits. Also, if you opt for the FEIE, you can’t claim a foreign tax credit or deduction on that same income. Remember, income from the U.S. Government or its agencies are not eligible for exclusion.

Feeling overwhelmed? You’re not alone. Consulting a professional tax advisor can be a lifesaver. They can guide you through the complexities and ensure you’re optimizing your tax benefits. So, if you’re having trouble with Form 2555, it’s time to seek expert advice.

Tax Provisions: Foreign Earned Income Exclusion and Foreign Tax Credit

When it comes to U.S. taxation for expats, two key provisions often come into play: the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC). While both aim to prevent double taxation, they operate differently. The FEIE allows you to exclude a set amount of your foreign income from U.S. taxes, whereas the FTC lets you credit taxes paid to a foreign government against your U.S. tax bill.

Can you use both simultaneously? It’s a nuanced answer. While you can’t apply both the FEIE and FTC to the exact same income, they can complement each other. For instance, if your income exceeds the FEIE limit of $120,000 for 2023, you can use the FTC to offset taxes on the income above that limit.

To illustrate, imagine you’re an American educator in Spain earning $130,000. You could use the FEIE to exclude $120,000 from U.S. taxation, leaving $10,000 subject to U.S. tax. If you’ve already paid taxes on that $10,000 to Spain, the FTC can offset those against your U.S. tax liability.

Specific Scenarios for Form 2555

Form 2555’s applicability varies depending on your circumstances, such as your employment status and residency.

For U.S. government employees abroad, the FEIE generally doesn’t apply to your income. However, there are exceptions, like if you’re employed by a foreign government, an international organization, or a U.S. territory.

If you’re self-employed and living abroad, you’re in luck. You can claim the FEIE if you satisfy the bona fide residence or physical presence tests and have a tax home in a foreign country. But remember, while the FEIE will remove your foreign earnings from U.S. income tax, it won’t exempt them from U.S. self-employment tax.

Your residency status in a foreign country can also impact your eligibility for the FEIE. The key determinants are whether you meet the bona fide residence or physical presence tests.

Given the complexities of Form 2555 and the FEIE, it’s advisable to consult a tax professional to simplify these intricacies. Their expertise can help you optimize your tax benefits and ensure compliance.

Document Requirements and e-Filing Process for Form 2555

When it comes to filing Form 2555, documentation is key. You’ll need to assemble various records, such as:

  • Wage and tax statements from your overseas employer, which could be in the form of W-2 forms or their foreign equivalents.
  • Housing expense records if you aim to claim the foreign housing exclusion or deduction.
  • A comprehensive profit and loss statement if you’re self-employed.
  • Evidence of your foreign residency or physical presence, like lease agreements, utility bills, or visa stamps.

As for the e-filing process, it’s relatively straightforward but may differ slightly based on the tax software you use. Here’s a general guide:

  1. Collect all necessary tax documents, including those related to your foreign income.
  2. Opt for an IRS-endorsed e-filing service or software.
  3. Initiate a new tax return and adhere to the on-screen instructions.
  4. When prompted for income details, include your foreign earnings.
  5. During the credits and deductions section, you’ll encounter the foreign earned income exclusion. This is where Form 2555 comes into play.
  6. Complete Form 2555 as directed by the software.
  7. Review your return for any inaccuracies.
  8. Once satisfied, submit your e-filed return. And there you have it!

If you find the process overwhelming, consider consulting a tax professional. They can help you ensure everything is in order.

Why You Shouldn’t Use Form 2555

Form 2555 might not be the best choice for everyone. If you reside in a country with higher income tax rates than the U.S., you might be better off using Form 1116 for the Foreign Tax Credit (FTC). The FTC can be more beneficial in such cases, allowing you to offset higher foreign taxes against your U.S. tax liability.

Additionally, if you have retirement accounts like a UK pension or an Australian Superannuation, steer clear of Form 2555. Withdrawing funds from these accounts could result in unexpected U.S. tax liabilities. Using Form 1116 can help you mitigate these taxes, especially if you’ve diligently filed your US tax returns.

So, if you find yourself in these situations, Form 1116 might be the more advantageous route for you.

If you’ve been living outside the US for a short term, perhaps a year or two, the Foreign Earned Income Exclusion could still be your best filing method due to its simplicity.

Special Considerations for Form 2555

Let’s dive into some special scenarios, starting with married couples. If you and your spouse both meet the criteria for foreign-earned income exclusion, you can each claim it on your joint return. However, you’ll each need to complete your own Form 2555. And here’s something to note: if only one spouse qualifies, that spouse can still claim the exclusion individually.

Now, a nod to our military personnel stationed abroad. While their combat pay earned overseas is generally not part of their gross income, it doesn’t qualify for the foreign-earned income exclusion. Instead, this type of income has a separate exclusion on the tax return.

And for those who earn income from foreign investments or rental properties, you’re included. This income can also be eligible for the foreign-earned income exclusion, but you must pass the tax home test and either the bona fide residence or the physical presence test.

Further Resources and Information for Completing Form 2555

IRS regulations can be challenging, but you have a wealth of resources to help you along the way.

Firstly, the IRS website is an invaluable resource. It offers comprehensive instructions for Form 2555, providing a detailed roadmap for your filing journey.

Tax preparation software is another useful tool. These platforms simplify the process of filling out complex forms like Form 2555. While there’s usually a fee involved, the convenience and assurance they offer can be a worthy investment.

Online tax forums can offer community-based insights. These platforms allow you to learn from others who have experienced similar tax situations. However, it’s crucial to remember that these forums are not a substitute for professional advice.

Lastly, the expertise of a certified tax professional, particularly one experienced in expatriate taxes, can be invaluable. They’re well-versed in the latest tax regulations and can provide tailored advice to ensure you’re filing correctly while maximizing your benefits.

The information provided herein is for general informational purposes only and should not be considered professional advice. While we aim to provide helpful and accurate information, we make no warranties or guarantees about the accuracy, completeness, or adequacy of the information contained here or linked to from this material.

Always get professional advice from a US international tax specialist.