US Citizen Living Abroad? 4 Ways to Reduce Taxes on Foreign Income
Need help onboarding international talent?
Every US citizen—even those living abroad—must file an income tax return to the Internal Revenue Service (IRS). US citizens who live overseas and work for a non-American employer must still report income to both the US and their country of residence.
But US expats qualify for many opportunities to reduce US taxes on income from a foreign source. There are four programs that reduce US taxes on foreign income:
- Foreign tax credit
- Foreign earned income exclusion
- Foreign housing exclusion/foreign housing deduction
- US tax treaties
Here’s which of these incentives you may qualify for and how much you can save on your taxes.
1. Foreign tax credit: skip some US taxes you paid to a foreign country
The foreign tax credit (FTC) lets Americans working abroad reduce their US tax liability. Any US citizen who already paid income tax to a non-US country can claim a credit and save on their US tax filing.
The FTC is straightforward. Suppose your income tax bill owed to the US is $1,000 USD but you already paid $500 in tax to your country of residence. You are eligible for a foreign tax credit of $500 and your total tax debt towards the US government will amount to $500.
The credit amount will depend on the amount of your foreign income and the income tax you already paid abroad.
Who's eligible for the FTC?
Every US expat working and paying income tax in a foreign country can claim the Foreign Tax Credit. An eligible foreign tax must meet the following criteria:
- Tax on income (no capital gains tax, for instance)
- Paid or owed to the foreign country
- Mandated by law in the foreign country
You cannot claim a credit for taxes you exclude via tax treaty or foreign income and housing exclusions (which we cover below). Only taxes you actually paid to a foreign country can become a tax credit for the US government.
How to claim the FTC
Tax forms and regulations are complex. Read the IRS's Foreign Tax Credit Compliance Tips to understand the law in full detail.
Automate your tax document collection
Focus on your business, not your taxes. Deel automatically collects and stores all your tax documents so you never have to worry whether you missed filing a form.Learn more
2. Foreign earned income exclusion: exclude over $100k on expat income
Foreign earned income exclusion (FEIE) is another method US citizens use to exclude some, if not all, of the US expat tax (US taxes on foreign-earned income). You can exclude up to $100,000 of taxable income earned in a foreign country, including:
- Self-employment income
Who's eligible for FEIE
US citizens who live abroad for at least 330 days within the tax year can claim foreign earned income exclusion. This includes:
- US citizens working abroad for a US-owned or foreign company
- US citizens who are self-employed and work outside the United States
In addition, employees from both categories must also pass the Physical Presence Test or Bona Fide Residence Test to qualify for this benefit. Both of these tests determine whether you actually live abroad. Spending one too many days in the US could disqualify you from the exemption.
If you are married and relocating with your spouse, you can both claim the foreign earned income exclusion during married filing. The only exception is if one or both of you are employees of the United States government. But workers in the private sector under contract with the US government may be eligible for FEIE, too.
How much can you save?
According to the IRS, expats working abroad qualifying for the FEIE can exclude up to $112,000 in 2022. The exclusion amount is adjusted annually to account for inflation.
Check out our guide on IRS Form 673 for foreign-earned income exclusion to learn more about how to qualify and file.
3. Foreign housing exclusion/deduction: save on rental costs while living abroad
As the name suggests, foreign housing exclusions and deductions let US expats exclude and deduct housing costs while living abroad. These expenses are excluded or deducted from the taxpayer's gross income on their US tax return.
Expats can claim foreign housing exclusion and deductions in addition to foreign-earned income exclusion (FEIE). However, they cannot claim a foreign tax credit (FTC) for excluded or deducted amounts, or amounts not paid.
Who is eligible for foreign housing exclusion/deduction
The qualifying requirement for the foreign housing exclusion deduction is that your tax home is the same as the foreign country in which you live.
As the IRS describes, “having a ‘tax home’ in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes.” If you live in northern France and commute across the border to work in Belgium, for example, you do not qualify.
Foreign housing exclusion and foreign housing deduction are not synonyms:
- Exclusion lets employed expats avoid paying income tax on foreign-earned income that went toward housing costs for the taxpayer and dependents
- Deduction lets self-employed expat deduct housing costs as business costs when filing self-employment tax
Like the FEIE, a US expat who wants to claim the foreign housing exclusion must meet particular requirements:
- Bona Fide Residence Test: you are a taxpaying resident in the foreign country the entire tax year
- Physical presence test: you are physically present in your tax home for 330 full days in a calendar year
Also, like we said, your tax home must align with the foreign country in which you pay taxes.
What can you exclude with the foreign housing exclusion?
The foreign housing exclusion helps the head of household cover housing expenses. You can exclude yearly housing expenses minus the base housing amount prescribed by the IRS, which is based on your foreign-earned income. Currently, the base housing amount is set at 16% of your FEIE.
Therefore, if qualified, you can exclude the following costs in your tax return:
- Parking rental
- Furniture rental
- Utility bills (expect the phone bills, internet, T.V./streaming services)
- Homeowner's insurance
- Leasing or property fees
- Renal repairs
How do you file for foreign housing exclusion?
To file for foreign housing exclusion, you'll use Form 2555. You'll also need to:
- Calculate the qualified overseas housing expenses incurred within the tax year
- Determine 16% of the FEIE amount you plan to claim for that year
- Open the IRS' instructions for Form 2555 and find the city you reside in to determine the maximum amount you can exclude
4. US tax treaties: avoid double taxation in select countries
US tax treaties with foreign countries let expat workers avoid double taxation on worldwide income. These treaties give residents of foreign countries reductions or exemptions from the US government’s federal income taxes on specific earnings from non-US sources.
The rates and exclusions differ between countries and types of income and the US hasn't set up treaties with every country. If the country you live in doesn’t have a treaty with the US, you will pay income tax described in the IRS's tax return instructions.
In addition, to prevent misuse, some income treaties have ''saving clauses,' which restrict the use of tax treaties based on developments in the worker’s residence and citizenship status. For more information about the treaties between the US and other countries, visit the US Department of the Treasury page.
Does a nonresident alien pay income tax in the US?
Yes. A nonresident alien working in the United States must pay tax income at the same rate as US residents or citizens. A nonresident alien is an individual who is not a green card holder, therefore, is not considered a US citizen.Yes. A nonresident alien working in the United States must pay tax income at the same rate as US residents or citizens. A nonresident alien is an individual who is not a green card holder and therefore not considered a US citizen.
Tips for finding information about taxes on foreign income
Thinking of working overseas? Congratulations! Expat life is full of adventure and excitement. Unfortunately, it’s also full of complicated forms and tax obligations. Spend some time with the resources described below to orient yourself.
Tax authority references
If you’re a US citizen preparing to work abroad, visit the IRS' US Citizens and Resident Aliens Abroad page. It describes when, where, and how to file an income tax return.
Also, the IRS introduced reporting requirements for US citizens with foreign bank accounts to prevent tax evasion. Read the IRS’s pages on the Foreign Account Tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (FBAR) to understand your obligations.
When you go through a transition such as moving overseas and working for a foreign employer, keep as much information as possible because these expenses may become an exclusion on your income tax.
An income tax calculator will come in handy. There are plenty of options online, so try a couple and compare the income tax estimations you get after entering your income and expenses.
Consultation with a tax expert
Taxes are complicated. We created this tax guide to give you an overview on foreign income saving but we can’t create a comprehensive resource.
We suggest finding a tax expert with experience in international taxes to help you examine your options. When searching, use terms like ''international tax preparation,'' ''cross-border tax planning,'' and ''expat tax consulting” to find specialized services.
This post is provided for informational purposes and should not be considered legal advice. Talk to a legal or tax professional for more info.