If you are a US expat, you have probably heard of the Foreign Earned Income Exclusion (FEIE). It’s a popular way for Americans overseas to save on taxes. However, you can’t claim it just with your standard 1040 tax form. You also need to file Form 2555.
Unfortunately, a lot of Americans abroad still overpay on taxes by not fully utilizing the FEIE. Or, even worse, they mistakenly think the exclusion applies without filing a tax return and the correct forms.
Let’s explore how Form 2555 can help you reduce your taxes effectively.
What Is The Purpose Of Form 2555?
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 taxpayers abroad benefit from huge tax savings. You can exclude up to $120,000 foreign earned income from US income taxes for 2023. The exact amount is adjusted every year for inflation. And, for the 2024 tax year (to be filed in 2025), it can be up to $126,500.
However, these exclusions are not automatic. Americans living abroad must claim them by submitting Form 2555.
Do I Need To File Form 2555?
The short answer: Only if you want to claim the FEIE and/or Housing Exclusion/Deduction.
Given the significant tax savings offered by the FEIE and the Foreign Housing Exclusion or Deduction, it’s likely that many expats will benefit from submitting Form 2555.
To claim the FEIE and the Foreign Housing Deduction or Exclusion, you must file IRS Form 2555.
However, be aware that the FEIE is not the only tax savings option for Americans abroad. In fact, in many cases, US expats might find that they can achieve greater savings and tax optimization with another tax provision, the Foreign Tax Credit. In some instances, they can even use both.
So, you don’t have to file the 2555 Form if you are not claiming the related benefits, even when you would qualify for them.
Foreign Earned Income Exclusion Vs. Foreign Tax Credit – Which Should You Use?
The Foreign Earned Income Exclusion is a great option for many Americans abroad. 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 accumulated 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 US taxes can save you hundreds of thousands of dollars in the short-term and the long-term.
You can schedule a consultation with our experts here.
Who Qualifies For The Foreign Earned Income Exclusion Claimed On Form 2555?
To qualify for the FEIE, US taxpayers must have their tax home outside the United States. In addition, they must meet one of the following two tests:
- Physical Presence Test: Spend at least 330 full days in a foreign country during a 12-month period.
- Bona Fide Resident Test: Become a bona fide resident of another country for one full calendar year.
Both tests have specific requirements, advantages and disadvantages.
In their first year, expats typically use the Physical Presence Test because they don’t meet the full calendar year requirement (January 1 to December 31) of the Bona Fide Residence Test.
How Do I File A 2555 Form?
IRS Form 2555 is submitted together with your tax return, Form 1040. Numbers calculated on 2555 must be entered into the correct field on 1040.
You can find the form on the IRS website. The Form 2555 instructions are nine pages long and provide detailed instructions for a variety of situations, albeit not always in laymen terms.
Form 2555 Filing Deadline
Your tax return including Form 2555 is generally due on April 15. However, as an expat you receive an automatic extension to June 15 – June 17 in 2024 because June 15 falls on a Saturday.
The extension applies to Americans that are abroad on the due date of their tax return and who’s tax home is abroad.
If you use 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, make sure to pay your estimated taxes by April 15 to avoid any interest.
What Information Is Required For Form 2555?
IRS Form 2555 addresses a range of subjects, from basic details about your life overseas to more detailed information about your income and employer.
One crucial section in Form 2555 is about your travel dates to and from the US. When living abroad, 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.
The form 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, you must disclose it 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, deductible expenses may include:
- Lease fees
- Property insurance
- Cost of rental furniture
- Parking
- Household repairs
- Some utilities.
On the other hand, non-deductible expenses include:
- Home improvements
- Phone bills
- Furniture purchases
- Fees for buying a house
Filing Form 2555 As Married Couple
As a married couple, 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.
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.
The most common mistakes include:
- Not applying the Foreign Housing Exclusion correctly or even missing it altogether.
- Solely relying on the FEIE and not considering the Foreign Tax Credit for tax optimization.
- Excluding income that does not qualify for the FEIE. Only foreign earned income qualifies. Passive income like interest, capital gains, dividends, doesn’t – even if it’s foreign.
- Filling out unnecessary sections of the form, creating extra work.
- For Schedule C filers, making mistakes in the expense allocation.
- Making an IRA contribution after excluding all income with the FEIE – you need unexcluded earned income for an IRA contribution!
Need Help With Form 2555?
The Internet is full of instructions on how to complete form 2555. And you can successfully fill it out on your own and navigate the potential pitfalls.
But, 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. Over the last 15 years, our US expat accountants have filed thousands of US expat tax returns.
We’ve seen all sorts of tax situations Americans abroad deal with. Let us prepare a personalized and secure tax solution just for you.
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