The Foreign Earned Income Exclusion in Plain Words

By Neil Solomon · 2 min read

Picture two remote workers, Mateo and Sunita. Both are American, both live abroad, and both have heard that there is a rule that lets them earn without paying American tax on it. They are both partly right.

The rule is called the Foreign Earned Income Exclusion. Foreign earned income means pay for work you do while living abroad, whether it is a salary or fees from your own clients. The exclusion lets you leave out of your American income a set amount of that pay, about $130,000 per person, adjusted each year. The rule is meant to ease the tax on Americans who work overseas.

There are two ways to qualify. One is to pass the physical presence test: you are outside the United States for at least 330 full days in a twelve-month period. The other is to be a genuine resident of a foreign country for a full tax year. Either way, your tax home has to be abroad.

Two people, one rule (an illustration)

	Mateo	Sunita
Pay for work done abroad	$140,000 salary	$90,000 consulting
Other income	None	$20,000 interest
Days outside the US in 12 months	340	300
Passes the 330-day test?	Yes	No
Amount excluded	Up to about $130,000	$0

Mateo meets the test and leaves out about $130,000 of his pay. He still files a return, and he owes tax on the part above the limit. Sunita lives abroad most of the year, but 300 days is short of 330, so she gets no exclusion this year. If she stays abroad longer, or settles as a resident for a full tax year, that could change.

Look at Sunita’s other line. The exclusion covers pay for work. It does not cover interest, dividends, a pension or gains on investments. For a retiree living on savings, that is the line that matters, and the exclusion does not reach it. Our calculator treats the tax on interest separately for that reason.

You might say the rule sounds like a gift. For people who work abroad and pass the test, it can be a large one. It also asks you to count days, keep records, and file each year.

You could count your days outside the country over the last twelve months. You could also write down which part of your income is pay for work and which part is interest or investments. The rules have details, and a tax preparer who works with people abroad can confirm how they apply to you.

Did you know about this rule before you read this, and did it change your plans? Tell us in the comments. Someone reading may be counting days right now.