DISCLAIMER: This article is for informational purposes only. It is not intended to substitute for professional tax advice tailored to your situation.
While most expats you ask think the best financial benefit of living in Mexico is the lower cost of living, I’d argue that the tax savings are just as important if you are still working. But those benefits are much less understood in my experience.
Many Americans falsely assume they’ll be double-taxed if they move abroad. But international tax treaties, the Foreign Earned Income Exclusion (FEIE), and Foreign Tax Credits (FTC) are three things that can all but eliminate this problem for U.S. expats.
This article focuses on the FEIE as one of the easiest ways expats can save on U.S. taxes when filing their tax returns to the IRS. But before we dive in…
Last year, I wrote a tax primer for U.S. expats new to living in Mexico. If you’ve got basic questions about your tax obligations when living abroad, this is an excellent place to start.
For those who already have a solid foundation, let’s take a closer look at the FEIE. Specifically, I’ll cover how much it can save you, who qualifies, and how to claim it.
And I know what some of you are thinking: Taxes are a headache I leave to someone else!
While I understand this sentiment well (I don’t DIY my taxes either), it’s wise to have a basic understanding of the FEIE so that you can ask your tax pro about it. Plus, in a year that will be remembered for stock market crashes and massive volatility, the FEIE is one way you can keep more of your hard-earned money. Any port in a storm I say!
How Much Income Can You Exclude from Taxes Under the FEIE?
For tax year 2024, the most income a single person can exclude is $126,500, up from $120,000 the prior year. If you are a married couple working abroad and filing your taxes jointly, you can exclude up to $253,000 for the 2024 tax year.
If you were living and working abroad for only part of the year, then you must adjust the limit based on the number of “qualifying” days you were outside the U.S. If this applies to you, here’s how you calculate a partial-year FEIE…
Take the number of days you were living abroad and multiply it by the maximum exclusion amount ($126,500 for an individual in tax year 2024), then divide it by 366 because 2024 was a leap year. (divide by 365 in non-leap years) If you need more information, check out the IRS website on calculating the FEIE.
Which Types of Income Qualify for an FEIE Exclusion?
The FEIE applies to a variety of earned income sources, i.e., the kind that requires labor. Here are the most common examples:
- Wages & salaries
- Sales commissions
- Year-end bonuses
- Professional fees
- Self-employment income
The FEIE does NOT apply to passive income from investments, e.g., interest from high-yield savings accounts or Treasury bills, stock dividends, capital gains, or rental income. It also can’t be used with pensions or social security income.
Who is Eligible to Claim the FEIE?
To qualify, U.S. taxpayers must meet either the “bona fide residence” test or the “physical presence” test and work in a foreign country.
There are three ways to pass the “Bona Fide Resident” test. According to the IRS website, you must be at least one of the following:
- A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year.
- A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
- A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
In case you were wondering, Mexico and the U.S. have had a bilateral tax treaty since 1993.
Even if Mexico isn’t your full-time residence, you might still be able to claim the FEIE exemption if you can pass the “physical presence” test. To qualify, a taxpayer must spend 330 full days in a foreign country during a single calendar year.
The vast majority of U.S. expats can meet at least one of these criteria to qualify for the FEIE exclusion on earned income.
Who CANNOT Claim the FEIE?
Three common cases do not qualify for the FEIE.
First, U.S. retirees with passive income only, e.g., income generated from investments, social security, pensions, or annuity payments, cannot qualify for the FEIE.
Second, anyone claiming a foreign tax credit on their tax return. When you do this, you forsake the FEIE because U.S. citizens living abroad can claim one or the other – not both.
Just like pretty much everything in life, you’ve gotta choose!
For the inexperienced expat, it isn’t always obvious which one will save you the most money, so consult a tax professional to figure out which one yields the most savings for you – at least in your first year filing a U.S. tax return while living abroad.
Finally, anyone unable to pass either the bona fide resident test or the physical presence test outlined in the previous section may not claim the FEIE.
How Do You Claim the FEIE?
To reduce your taxes using the FEIE, expats must file Form 2555 with their U.S. tax return.
A couple with two incomes can each claim this amount (for a total of $253,000 USD) providing they file Form 2555 separately.
BONUS TAX TIP: Expats Can Skip the April 15 Deadline, but SHOULDN’T if they owe money. Expats receive an automatic 2-month extension to June 15 without having to request it. However, if you owe the IRS money and do not file by April 15, interest will be assessed on the amount you owe.
Sources: the IRS, VYNMSA