How does the Foreign Earned Income Exclusion (FEIE) actually work?

The FEIE allows you to exclude a significant amount of your foreign earnings from U.S. tax, up to $130,000 for the 2025 tax year. Unlike a credit, which reduces your tax bill, the FEIE subtracts this amount directly from your reportable income, often bringing your taxable balance to zero.

The Three Key Rules:

1. This applies only to wages, salaries, bonuses, and self-employment income for work performed while physically abroad. It does not cover passive income like dividends, pensions, or rental profits.
2. Your main place of business or employment must be in a foreign country.
3. You must pass either the Physical Presence Test (spending 330 full days abroad in any 12-month period) or the Bona Fide Residence Test (living abroad for an uninterrupted period that includes an entire calendar year).

Housing Exclusion If you qualify for the FEIE, you can often exclude additional amounts for "reasonable" foreign housing expenses (like rent and utilities) that exceed a certain base limit. This is a massive benefit for expats living in high-cost cities.
One Important Catch: If you are self-employed, the FEIE only reduces your income tax. It does not eliminate the 15.3% Self-Employment tax (Social Security/Medicare) unless you are protected by a Totalization Agreement.

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