If you are a US expat, you may have heard of the Foreign Earned Income Exclusion, also known as the FEIE. This exclusion is incredibly popular with expats because of the tax savings. But expats can’t claim it on their regular 1040 tax form alone. They must file IRS Form 2555 as well.
Despite the FEIE’s popularity, many expats are not familiar with Form 2555 or how to request the exclusion.
What is the purpose of Form 2555?
IRS Form 2555 is used to claim the Foreign Earned Income Exclusion (FEIE). If eligible, you can also use Form 2555 to request the Foreign Housing Exclusion or Deduction.
These two exclusions help US expats capitalize on huge tax savings when working abroad. You can exclude up to over $100,000 foreign earned income from US income taxes. The exact amount is adjusted every year for inflation. In 2019, the maximum exclusion amount for foreign earned income was $105,900.
However, these exclusions are not automatic. Americans who live abroad must claim them by submitting Form 2555.
Do I need to file Form 2555?
The savings potential from the FEIE and the Foreign Housing Exclusion or Deduction mean that many expats will likely want to submit Form 2555.
Nonetheless, IRS Form 2555 is optional. It is not required. In fact, in some cases, US expats choose not to use it because they may be able to save more with other tax provisions, for example the Foreign Tax Credit.
Is the Foreign Earned Income Exclusion or Foreign Tax Credit or better?
The Foreign Earned Income Exclusion is a great option for many expats. However, there are situations in which the Foreign Tax Credit (FTC) is a better option.
For example, if you pay a higher tax rate in your country of residence than you would in the US, then the FTC may be a better choice for you. This is because the FTC gives you a $1 tax credit for each dollar you pay in taxes to a foreign government. These credits can be stockpiled and used at a later time.
If the country you currently live in has a lower tax rate than in the US, then you will most likely want to use the Foreign Earned Income Exclusion.
Other considerations are the ability to use the child tax credit or to make an IRA contribution. You won’t be able to contribute to your IRA if you exclude all your income under the FEIE. You can only contribute unexcluded income.
And if you use Form 2555 at all, you cannot receive the refundable portion of the child tax credit, even if you have unexcluded income.
If you’re not sure which option is best for you, consult with an expert expat tax accountant. We routinely help clients to determine the best filing approach for their situation. Correctly filing your expat taxes can save you hundreds of thousands of dollars in the short-term and the long-term.
Who qualifies for the Foreign Earned Income Exclusion claimed on Form 2555?
To use Form 2555 and qualify for the Foreign Earned Income Exclusion, expats must prove that their tax home is outside of the United States.
To demonstrate that your tax home is no longer in the US, you need to meet the IRS physical presence test or become a bona fide resident of a foreign country.
How do I file a 2555?
IRS Form 2555 can be found on the IRS website. You will need to submit this form to the IRS along with your Form 1040.
The IRS estimates that Form 2555 will take a non-tax specialist 2.5 hours to complete. The Form 2555 instructions however are eleven pages long. The instructions provide detailed answers for a variety of situations.
Previously, some expats could choose to file a shortened version of Form 2555, called Form 2555-EZ. Unfortunately, this form was phased out at the end of 2018 and is no longer accepted by the IRS.
Form 2555 instructions – Due date
Your tax return including Form 2555 is generally due on April 15. However, as an expat you receive an automatic extension to June 15.
You can use this extension if you are abroad on the due date of your tax return and if your tax home is abroad.
If you take this extension, you must attach a statement to your Form 1040. This statement should explain that you meet the requirements for the extension. Even with the extension, you should still pay your estimated taxes by April 15 to avoid accruing any interest.
What information is required for IRS Form 2555?
IRS Form 2555 covers a variety of topics. Some of the information covered in Form 2555 is basic information about your life abroad. However, Form 2555 also captures more in-depth information about your income and your employer.
One crucial section in Form 2555 is about your travel dates to and from the US. As a US expat, you must keep careful records of your travel dates. Keeping a digital or physical file with your flight itineraries and a spreadsheet can be helpful.
If you are using the Bona Fide Residence Test, remember that the IRS reviews these on a case by case basis. If incorrectly filed or if you do not qualify, the IRS could decide you are ineligible for the FEIE.
Form 2555 also asks questions about any benefits or reimbursements received from your employer. For example, if your employer has reimbursed you for the cost of living or housing, it must be disclosed on Form 2555.
You can also claim the Foreign Housing Exclusion in Part VII of IRS Form 2555.
Claiming the Foreign Housing Exclusion or Deduction
In Part VII of the form, you list the total housing expenses that you can exclude or deduct from your income.
You can only deduct or exclude expenses that the IRS considers “reasonable.” The IRS does not accept any expenses which it considers to be lavish or extravagant. (Keep receipts in case of an audit.)
For example, you can deduct expenses such as lease fees, property insurance, the cost of rental furniture, parking, household repairs, and some utilities.
On the other hand, you cannot exclude expenses such as home improvements, phone bills, or furniture purchases. Likewise, fees for buying a house cannot be excluded or deducted.
Filling out Form 2555 as a married couple
As a married couple, IRS Form 2555 can be a bit more complex.
If both spouses qualify independently for the FEIE, they each can claim up to the yearly maximum amount on their separate 2555 forms. If only one spouse qualifies, only that spouse can claim the exclusion and only on their own income. The other spouse cannot claim the FEIE and must include all their income on their US tax return. (We will publish more on this topic soon.)
If you and your spouse shared the same home but are filing separately then only one of you can claim the Foreign Housing Exclusion or Deduction.
If you and your spouse live in the same home outside of the US and are filing your taxes jointly, then you can calculate your housing expenses together.
Common mistakes when filling out Form 2555
While Part I of the form is rather straightforward, the later parts are more complicated.
We see many self-preparers make mistakes when it comes to the tax calculation. Especially if expats have other taxable income that doesn’t fall under the FEIE, almost everyone calculates the tax incorrectly when doing their own return. (As part of our service, we review your last 3 years tax returns and file amendments when needed.)
Often people try to fill out even those sections of the form that they don’t need to fill out, creating needless work for themselves.
For Schedule C filers, we also often see mistakes in the expense allocation.
Furthermore, many self-preparers struggle doing the Foreign Housing Exclusion correctly or even miss it altogether.
Skip the paperwork, but still receive the benefits
If paperwork and checking off boxes in IRS forms doesn’t sound like the ideal way to spend your weekend, reach out to our team at Online Taxman. Not only will you be able to spend more time relaxing, but you can also breathe easy knowing that your taxes are taken care of correctly by expert expat accountants.