U.S. citizens and resident aliens who work abroad may be able to exclude part or all of their foreign earned income from U.S. federal income tax. This article explains how the foreign earned income exclusion works, who qualifies, and what it does not cover.
What the Exclusion Does
U.S. citizens and resident aliens are taxed on their worldwide income, including income earned while living abroad. The foreign earned income exclusion, found in Section 911 of the Internal Revenue Code, allows a qualifying individual to exclude a limited amount of foreign earned income from U.S. federal income tax.
The maximum exclusion is adjusted for inflation each year. It is $130,000 for 2025 and $132,900 for 2026. The limit is figured on a daily basis, so a person who qualifies for only part of a year can exclude a proportionate amount. If both spouses work abroad and each qualifies, each may exclude up to the maximum.
The exclusion is not automatic. It is claimed by filing Form 2555 with the federal income tax return.
Who Qualifies
Three requirements must be met.
1. A tax home in a foreign country. Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. You are not treated as having a tax home in a foreign country for any period in which your abode is in the United States.
2. Foreign earned income. The income must be pay for personal services performed in a foreign country.
3. The bona fide residence test or the physical presence test. The bona fide residence test is available to U.S. citizens and to resident aliens who are citizens or nationals of a country with which the United States has an income tax treaty in effect. It requires bona fide residence in a foreign country or countries for an uninterrupted period that includes an entire tax year. Living abroad for a year does not by itself establish bona fide residence; the IRS looks at the facts, including your intentions and the nature of your stay.
The physical presence test is available to any U.S. citizen or resident alien. It requires physical presence in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. A full day is a 24-hour period beginning at midnight, and the 330 days do not have to be consecutive.
A short trip to the United States does not automatically disqualify someone under the physical presence test. What matters is whether 330 full days in foreign countries fall within some 12-month period. The minimum time requirements of both tests can be waived for people who must leave a foreign country because of war, civil unrest, or similar adverse conditions.
What Income Qualifies
The source of earned income is the place where the services are performed. Where or how you are paid does not change the source, so pay for work done abroad can be foreign earned income even if it is deposited in a U.S. bank account by an employer located in the United States. The reverse is also true: compensation for work performed while physically in the United States is U.S.-source income and does not qualify for the exclusion.
Foreign earned income includes wages, salaries, professional fees, and self-employment income for services performed abroad. It does not include interest, dividends, capital gains, pensions and annuities (including Social Security benefits), pay received as an employee of the U.S. government, or amounts received after the end of the tax year following the year in which the services were performed.
For example, suppose a U.S. citizen qualifies under the physical presence test for all of 2026, earns a $150,000 salary for work performed abroad, and receives $20,000 of dividends. Assuming no housing exclusion, she may exclude $132,900 of the salary. The remaining $17,100 of salary and all $20,000 of dividends remain subject to U.S. income tax.
What the Exclusion Does Not Do
It does not reduce self-employment tax. The IRS states that the excluded amount reduces regular income tax but not self-employment tax.
It affects the rate on remaining income. Tax on income that is not excluded is figured at the rates that would have applied had the exclusion not been claimed.
It limits other benefits. No foreign tax credit or deduction is allowed for foreign taxes on excluded income, although a credit may be available for foreign taxes on income above the exclusion. A taxpayer who claims the exclusion cannot claim the earned income credit or the additional child tax credit for that year, and deductions allocable to excluded income are not allowed.
It may not apply for state purposes. California does not follow the exclusion. The Franchise Tax Board’s Schedule CA (540) instructions direct California residents to add back the amount excluded on the federal return.
Once made, the choice to claim the exclusion stays in effect for later years unless it is revoked. A taxpayer who revokes it cannot claim the exclusion again for the next five tax years without IRS approval.
How to Claim the Exclusion
The exclusion is claimed on Form 2555, attached to Form 1040 or 1040-SR (or to Form 1040-X when amending). The initial choice usually must be made on a timely filed return, including extensions, or on a return amending a timely filed return. The IRS recognizes limited exceptions.
U.S. citizens and resident aliens who, on the regular due date, live outside the United States and Puerto Rico and have their main place of business or post of duty outside both receive an automatic two-month extension to file, to June 15 for calendar-year filers. Interest still runs on any tax not paid by the regular due date. A taxpayer who needs more time to meet the bona fide residence or physical presence test can request an extension on Form 2350.
Because eligibility turns on facts such as travel dates and where work was performed, it is prudent to keep records such as travel itineraries, passport entries, leases, and employment documents.
The Bottom Line
The foreign earned income exclusion can substantially reduce U.S. income tax for people who live and work abroad, but it has limits. It applies only to earned income for work performed abroad, it does not reduce self-employment tax, and it interacts with credits and state taxes in ways that are worth reviewing before filing.
Questions about the foreign earned income exclusion?
Tax attorney Cassra Minai, Esq. can review your eligibility in a confidential consultation.