Legal Definitions - foreign-earned-income exclusion

The foreign-earned-income exclusion is a specific provision within U.S. tax law that allows eligible U.S. citizens or resident aliens who live and work outside the United States to exclude a limited amount of their income earned abroad from their U.S. taxable income. This means that, up to an annual limit set by the Internal Revenue Service, they do not have to pay U.S. income tax on that portion of their earnings. To qualify, individuals must meet certain tests related to their physical presence or bona fide residency in a foreign country. Taxpayers must choose between using this exclusion or claiming a foreign tax credit for taxes paid to a foreign government; they generally cannot use both for the same income.

Here are some examples illustrating the foreign-earned-income exclusion:

• Example 1: Corporate Employee on an International Assignment

  Sarah, a U.S. citizen, accepts a three-year assignment as a project manager for her company's subsidiary in Singapore. She moves to Singapore, establishes residency there, and receives her salary directly from the Singaporean entity. Because Sarah is living and working in a foreign country and earning income there, she can elect to use the foreign-earned-income exclusion. This allows her to exclude a significant portion of her Singaporean salary from her U.S. taxable income, provided she meets the IRS's residency or physical presence tests.

• Example 2: Freelance Consultant Living Abroad

  Michael, a U.S. citizen, decides to live in Portugal and work as a freelance marketing consultant. He performs all his services from his home office in Lisbon for clients located across Europe and the U.S. Since Michael's income is generated from work performed while he is physically present and residing in Portugal, it qualifies as foreign-earned income. He can choose to apply the foreign-earned-income exclusion to a portion of his consulting fees, reducing his overall U.S. tax liability on that income.

• Example 3: Educator at an Overseas School

  Dr. Anya Sharma, a U.S. resident alien (green card holder), takes a position teaching at an international university in Dubai, United Arab Emirates. She lives in Dubai and receives her salary from the university. As a U.S. resident alien earning income in a foreign country, Dr. Sharma can utilize the foreign-earned-income exclusion. This allows her to exclude a specific amount of her teaching salary from her U.S. taxable income, assuming she satisfies the necessary time-based residency requirements in the UAE.