IRS Form 2555 is an important tax form for U.S. citizens and resident aliens living abroad. With this form, you can claim the Foreign Earned Income Exclusion (FEIE), which can save you thousands of dollars on your taxes when used correctly.
When you’re a U.S. expat, your worldwide income is still subject to U.S. income tax. However, the FEIE allows you to exclude a portion of your foreign earned income from U.S. taxation. To claim this exclusion, you’ll need to file Form 2555.
At Gordon Law, we focus on complex tax preparation, including international tax forms. We’ve helped hundreds of clients like you save on taxes while avoiding IRS headaches.
In this guide, we’ll walk you through the essentials of Form 2555, including who qualifies, what information you need to provide, and common pitfalls to avoid.
What Is IRS Form 2555?
IRS Form 2555, formally known as “Foreign Earned Income,” is used to report and exclude foreign earned income from U.S. taxation under the Foreign Earned Income Exclusion (FEIE).
This prevents double taxation, since your foreign earned income may already be taxed by the country (or countries) where it was earned. The United States offers a variety of foreign tax credits and deductions so you can avoid being double taxed on your foreign income.
If you qualify for the FEIE, you can exclude up to $126,500 (for tax year 2024) of your foreign earned income. This can significantly reduce your taxable income and the amount of tax you owe.
Who Qualifies for the Foreign Earned Income Exclusion?
To qualify for the FEIE, and therefore for filing Form 2555, you must meet two essential criteria: the tax home test and either the bona fide residence test or the physical presence test.
- Tax Home Test: Your tax home must be in a foreign country. This is generally where you live and work.
- Bona Fide Residence Test: You must be a bona fide resident of a foreign country for an uninterrupted period that includes a full tax year. To qualify, you must be able to prove that you have stronger ties to the foreign country than the U.S.
- Physical Presence Test: Alternatively, you must be physically present in a foreign country or countries for at least 330 full days during a 12-month period. The days do not have to be consecutive.
What Counts as Foreign Earned Income?
Foreign earned income refers to wages, salaries, and other compensation you receive for services you perform in a foreign country. This can include:
- Salaries and Wages: Compensation for services provided in a foreign country.
- Self-Employment Income: Income you earn as a self-employed individual abroad.
- Housing Allowance: In some cases, you may also qualify to exclude amounts paid by your employer for housing, known as the
- Foreign Housing Exclusion.
- Passive income, such as interest, dividends, or retirement income, is not eligible for the FEIE and Form 2555. However, you may be able to use other tax benefits for this income.
Form 2555 vs. Form 1116
When it comes to reducing your U.S. tax liability on foreign income, there are two key forms to know: IRS Form 2555, which is used for the Foreign Earned Income Exclusion, and IRS Form 1116, which is used for the Foreign Tax Credit.
Both forms serve different purposes and offer distinct benefits. Here’s a breakdown of how they compare.
IRS Form 2555: Foreign Earned Income Exclusion
- Purpose: Form 2555 is used to claim the Foreign Earned Income Exclusion (FEIE), which allows U.S. citizens and resident aliens living abroad to exclude a portion of their foreign earned income from U.S. taxation. For 2024, the exclusion limit is up to $126,500.
- Eligibility: To qualify, you must meet either the bona fide residence test or the physical presence test, and your tax home must be in a foreign country.
- Benefit: The primary advantage of using Form 2555 is the ability to exclude a significant amount of foreign earned income. This reduces your taxable income and your overall tax liability.
- Limitation: You can’t use Form 2555 to exclude foreign passive income (such as interest or dividends) or any income that is not earned through active employment or business activities abroad.
IRS Form 1116: Foreign Tax Credit
- Purpose: Form 1116 is used to claim the Foreign Tax Credit (FTC). This credit can be used instead of the FEIE or, possibly, in addition.
- Eligibility: Any U.S. taxpayer can use Form 1116 if they have paid or accrued foreign taxes on income that is also subject to U.S. taxation. You don’t need to meet a residence test or physical presence test to claim the FTC.
- Benefit: The FTC can provide a dollar-for-dollar reduction in your U.S. tax liability based on the amount of tax paid to a foreign country. It can be used for passive income that is not eligible for the FEIE, or for any income that exceeds the FEIE threshold.
- Limitation: While you can use the FTC and the FEIE in the same tax year, you cannot apply both benefits to the same income. Additionally, the FTC is generally limited to the amount of U.S. tax attributable to your foreign income.
Key Considerations
- Combining Both: You cannot use Form 2555 (FEIE) and Form 1116 (FTC) for the same income, but you can use them together strategically. For instance, you might exclude a portion of your foreign earned income with Form 2555 and then use Form 1116 to claim a credit for foreign taxes paid on any remaining income.
- Tax Planning: Choosing between Form 2555 and Form 1116—or using both—depends on your specific financial situation, including the amount of foreign earned income, the types of income, the foreign taxes paid, and your overall tax liability. Consult with a tax professional to determine the best approach for maximizing your tax benefits.
Understanding the differences between Form 2555 and Form 1116 is essential for anyone living and working abroad. By selecting the right form(s) based on your circumstances, you can significantly reduce your U.S. tax burden while staying compliant with tax laws.
Form 2555 Instructions: How to File Step-by-Step
Part I – General Information: This section collects basic information about you, including your name, social security number, and whether you are claiming the FEIE or the Foreign Housing Exclusion.
Part II – Tax Home and Bona Fide Residence: You’ll declare your foreign tax home, and if applicable, establish your bona fide residence in a foreign country.
Part III – Physical Presence Test: If you’re claiming the exclusion based on the physical presence test, this section requires you to list the dates you were present in foreign countries.
Part IV – Foreign Earned Income: Report your foreign earned income. You’ll provide details about your employer, job location, and the income earned in each foreign country.
Part V – Housing Exclusion and Deduction: If you qualify for the Foreign Housing Exclusion, you’ll need to report your housing expenses and calculate the amount you can exclude.
Part VI – Foreign Housing Deduction: For self-employed individuals, this section helps calculate any housing deduction you can claim.
Common Pitfalls and Penalties
Failing to accurately file Form 2555 or claiming the exclusion without meeting the necessary requirements can result in IRS penalties. Some common issues include:
- Incomplete or Incorrect Information: Ensure all information is accurate and complete. Inaccuracies can lead to IRS penalties or rejection of your claim.
- Failure to Meet Residency Requirements: If you don’t meet the bona fide residence or physical presence tests, you cannot claim the FEIE.
- Late Filing: File Form 2555 with your regular tax return by April 15. Extensions are available, but you must file Form 4868 to get an extension.
Need Help Excluding Foreign Income with Form 2555? Contact Gordon Law!
Understanding Form 2555, the Foreign Earned Income Exclusion, and how to minimize your taxes on foreign income can be daunting.
At Gordon Law, our attorneys have more than a decade of experience in international tax compliance. We can help you accurately prepare and file IRS Form 2555, along with other international tax forms.
Avoid costly mistakes and ensure you’re taking full advantage of all the exclusions available to you! Contact us today at (847) 580-1279 for a confidential consultation.
