IRS Form 2555 Explained
IRS Form 2555 Explained
If you are an American who resides and works in a foreign country, you may qualify to reduce your tax bill by filing tax form 2555 to apply for foreign-earned income exclusion.
TABLE OF CONTENTS
What Is Tax Form 2555?
How Much Foreign Income Is Tax-Free?
Who Qualifies For Foreign Earned Income Exclusion?
Bona Fide Resident Test Vs. Physical Presence Test
When Will You Benefit From Foreign Earned Income Exclusion?
When Will You Not Benefit From Foreign Earned Income Exclusion?
What Type Of Income Qualifies For Foreign Earned Income Exclusion?
How To Fill Out IRS Tax Form 2555
Additional Tips For Filling Out IRS Tax Form 2555
When Is IRS Tax Form 2555 Due?
Are There Late-To-File or Fail-To-File Penalties With Tax Form 2555?
Key Takeaways:
- The tax form 2555, or Foreign Earned Income, is an IRS form that qualifying taxpayers with the appropriate residency status and citizenship can use to figure out their foreign earned income exclusion as well as their housing exclusion or deduction.
- To qualify for foreign-earned income exclusion, in general, taxpayers must be citizens of the United States, living and working abroad in a foreign country, must pass the tax home test, and must pass either the bona fide resident test or the physical presence test.
- The foreign earned income exclusion through filing form 2555 is only beneficial for qualifying people who work in a country where the income tax is lower than the income tax rate in the United States. If the qualifying individual works in a country where the income tax rate is higher than in the United States, they would find further tax breaks if they instead claim Foreign Tax Credits (FTCs) while filing taxes.
Quick Fact
- The amount of foreign income that is tax-free is related to the tax year in which the income was earned, such as $105,900 for 2019, $107,600 for 2020, $108,700 for 2021, and $112,000 for 2022.
What Is Tax Form 2555?
The tax form 2555, or Foreign Earned Income, is an IRS form that qualifying taxpayers can use to figure out their foreign earned income exclusion as well as their housing exclusion or deduction. If you file form 2555 and are eligible to claim the Foreign Earned Income Exclusion, you can exclude up to $112,000 of income earned in a foreign country for the 2022 tax year.
How Much Foreign Income Is Tax-Free?
The amount of foreign income that is tax-free is related to the tax year in which the income was earned as the rate is adjusted for inflation.
- 2019: $105,900
- 2020: $107,600
- 2021: $108,700
- 2022: $112,000
Who Qualifies For Foreign Earned Income Exclusion?
There are certain requirements people must meet in order to be considered for foreign-earned income exclusion. Here are the requirements for taxpayers who may qualify for foreign earned income exclusion, and therefore will need to file tax form 2555:
- U.S. citizen
- Lives and works abroad in a foreign country
- Meets the tax home test (their tax home, or the location where they work, must be outside of the U.S., and they cannot also have an abode in the U.S.)
- Meets the bona fide resident test (the taxpayer is a U.S. citizen who is a bona fide resident of at least one foreign country for an uninterrupted period of at least one full tax year) or meets the physical presence test (the taxpayer is a U.S. citizen, expat, or resident alien who is physically present for at least 330 full days in a row during a 12 month period in at least one foreign country)
Bona Fide Resident Test Vs. Physical Presence Test
Bona Fide Residence Test
The bona fide residence test is best for those who have lived outside of the United States for more than a year and prove that they do not intend to return from the foreign country within the foreseeable future.
Physical Presence Test
The physical presence test is used for expats or resident aliens who are temporarily residing and finding employment abroad in foreign countries. While the test requires that the taxpayer is physically present in the foreign country for 330 consecutive days, they do not have to be within the same tax year.
What Is The Difference Between A Resident And Nonresident Alien For U.S. Taxes?
While resident aliens are usually taxed based on their total earned income regardless of which country it was earned in. Non-resident aliens only owe taxes on income that was earned in the United States.
When Will You Benefit From Foreign Earned Income Exclusion?
The foreign earned income exclusion provides beneficial tax breaks for individuals who work in a country where the income tax is lower than the income tax rate in the United States. Some other circumstances in which this exclusion can be used are in the instance where an individual earns income in a foreign country but pays little to no income tax on those earnings.
When Will You Not Benefit From Foreign Earned Income Exclusion?
There are certain instances in which it would not be beneficial to file form 2555 in an attempt to claim the foreign earned income exclusion, such as when an individual with citizenship in the United States works in a high-income tax foreign country. The reason these residents usually will not benefit from this exclusion is that the taxes in that foreign country are likely higher than they would be for an equivalent salary in the United States. In this case, a worker usually achieves greater tax savings when claiming Foreign Tax Credits (FTC) as they file their income tax return.
What Type Of Income Qualifies For Foreign Earned Income Exclusion?
For income to qualify for foreign-earned income exclusion, which would require taxpayers to use tax form 2555, here are the general qualifications:
- Their foreign-earned income is due to wages, salary, tips, bonuses, or other financial incentives.
- Their foreign-earned income could include self-employed income.
- Meals and lodging may be included in foreign-earned income.
- Some foreign housing costs may be included in foreign-earned income, as long as they are not considered lavish or extravagant.
Some items that may not qualify for foreign-earned income exclusion include:
- Their foreign-earned income must not include non-earned or unearned income, including capital gains, dividends, and interest.
- income that was earned by working in a foreign country as an employee of the U.S. Government or an affiliated government agency will not apply.
Housing Expense Limits
Whether your work abroad is mostly in Canada, India, Mexico, Italy, South Korea, Japan, the United Kingdom, the Philippines, Germany, or France, there are different housing expense limits. To gather specific information about the limits for housing expenses in the country you work in, it is best to check the Instructions for Form 2555.
How To Fill Out IRS Tax Form 2555
In order to claim any deductions or exclusions related to income earned in a foreign country, taxpayers must fill out the IRS tax form 2555.
There are nine sections of IRS tax form 2555 that you will need to complete in order to apply for foreign-earned income exclusion.
Part I: Give basic information about your employer and previous claims for foreign income exclusion.
Part II or Part III: Fill out the necessary details based on whether you qualify for the bona fide residency test or physical presence test.
Part IV: State your annual foreign-earned income.
Part V: Indicate if you’re claiming the housing exclusion or deduction.
Part VI: Provide details about the housing exclusion or deduction.
Part VII: Give information about your claim for the foreign income exclusion.
Part VIII: Calculate the adjustments to your income for the exclusion or deduction.
Part IX: Compute the housing deduction that applies to your adjusted income.
Additional Tips For Filling Out IRS Tax Form 2555
The completed tax form 2555 must be submitted with IRS form 1040 when qualifying taxpayers submit their federal income tax returns every tax year. In order to make filling out these tax forms easier during tax seasons, it is beneficial for taxpayers to maintain detailed records of the dates they traveled and worked internationally, the income earning statements from their time in a foreign country, and 255 forms from previous tax years. Keeping details of this information can also be helpful in the case that you become subject to an IRS tax audit.
When Is IRS Tax Form 2555 Due?
The IRS tax form 2555 is due at the same time as all tax returns and, therefore, all 1040 forms are due. This year, Tax Day falls on April 18, 2023, in the United States.
Are There Late-To-File or Fail-To-File Penalties With Tax Form 2555?
Due to IRS form 2555 being completely optional for taxpayers, there are no penalties for filing late or failing to file form 2555 with their federal income tax return.
For those who have questions about the foreign earned income exclusion or how to best approach their tax situation, consulting with the experts at Ideal Tax will give you all the answers to make you feel confident in your tax savings this tax season.
