Excluding Foreign Wages from US Taxes

People who live and work outside the United States may be able to exclude all or part of their foreign-source wages and self-employment income from the federal income tax through a provision called the foreign earned income exclusion. To qualify for the foreign earned income exclusion, a person needs to:

•Work and reside outside the United States, and

•Meet either the Bona Fide Resident or Physical Presence tests.

Persons who qualify are eligible to exclude up to $99,200 in foreign earned income annually, depending on the year. The amount of the foreign earned income exclusion changes each year. Here are the maximum allowable exclusions for tax years 1998 through 2014. Persons may also be eligible to exclude an additional amount for housing using the foreign housing exclusion or deduction. 

Types of Income to Which the Foreign Earned Income Exclusion Applies

The foreign earned income exclusion applies only to income arising from performing services either as an employee or as an independent contractor. "The term 'earned income' means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered (Internal Revenue Code section 911(d)(2)(A). Thus, wages and self-employment income may qualify for the foreign earned income exclusion. Other types of income cannot be excluded using this provision. 

From Which Tax is Income Excluded?

The foreign earned income exclusion functions to exclude earned income from the federal income tax. The foreign earned income exclusion does not exclude income from Social Security or Medicare taxes. Thus, the foreign earned income exclusion does not reduce the self-employment tax, which is the mechanism by which self-employed persons pay in the Social Security and Medicare taxes. Furthermore, self-employed persons are eligible to take the foreign housing deduction instead of the foreign housing exclusion. There are more details at Self-Employment & Foreign Exclusions. 

Persons must meet one of two qualification tests to claim the Foreign Earned Income Exclusion. 

A person must meet either the bona fide residence test or the physical presence test.