Key Takeaways
- Form 2555 allows eligible US citizens or resident aliens to exclude up to USD 126,500 (2024) of foreign earned income under IRC Section 911.
- Clients must have a foreign tax home and satisfy either the Bona Fide Residence Test (full calendar year) or the Physical Presence Test (330 full days in any 12-month period).
- Foreign housing benefits are calculated separately, with a base amount of 16% of the FEIE limit and higher caps for IRS-designated high-cost cities.
- Overlapping 12-month periods can be strategically used to maximize FEIE in partial-year or transition cases.
- Multiple qualifying periods separated by gaps may require disclosures or even paper filing when e-filing cannot accommodate complexity.
- FEIE is not always optimal; in high-tax countries, the Foreign Tax Credit (Form 1116) often produces better long-term results.
Introduction
As more Indian CA firms expand into US tax compliance, Form 2555 becomes one of the most frequently encountered — and misunderstood — international forms. Clients working abroad often assume that “non-US income is not taxable,” but as practitioners, you know US taxation is citizenship-based, not residence-based.
This article is written for Indian Chartered Accountants advising US-connected clients, not for taxpayers themselves. The goal is to help you confidently determine eligibility for the Foreign Earned Income Exclusion (FEIE), choose the correct qualifying test, compute exclusions accurately, and avoid common audit triggers.
We walk through FEIE rules under IRC Section 911, explain the Bona Fide Residence and Physical Presence tests using a practical flowchart approach, cover housing exclusions, and provide calculation examples. We also compare FEIE with the Foreign Tax Credit so you can make informed planning recommendations across multi-year engagements.
What Is the Foreign Earned Income Exclusion (FEIE)?
Definition of FEIE under IRC Section 911
The Foreign Earned Income Exclusion is a statutory exclusion under IRC Section 911 that allows qualifying taxpayers to exclude a portion of foreign earned income from US taxable income. It is claimed by filing Form 2555 with the individual return.
Importantly, FEIE is an exclusion, not a deduction or tax credit. Excluded income is removed from gross income entirely and does not enter the tax computation.
What income qualifies as foreign earned income
Foreign earned income includes wages, salaries, bonuses, and professional fees for services performed outside the United States. The location of payment or employer is irrelevant.
Both employees and self-employed individuals can qualify, subject to tax home rules.
Income that does NOT qualify for FEIE
Unearned income such as dividends, interest, capital gains, rental income, and pensions does not qualify. Employer-paid allowances not attributable to services (e.g., reimbursements) are also excluded.
The annual exclusion limit is adjusted for inflation and is USD 126,500 for 2024. For official definitions, refer to IRS guidance on the Foreign Earned Income Exclusion.
Who Qualifies to Use Form 2555?
General eligibility requirements
Only US citizens or resident aliens can claim FEIE. Nonresident aliens cannot use Form 2555.
In dual-status years, eligibility depends on the period of US residency; careful coordination with dual-status filings is required.
Tax home requirement explained
A taxpayer must have a foreign tax home. Tax home generally means the main place of business, not personal residence.
A frequent misconception is that living abroad automatically creates a foreign tax home. If the assignment is temporary and the US remains the regular place of business, the tax home remains in the US.
Employees vs self-employed taxpayers
Employees can claim FEIE and housing exclusion. Self-employed taxpayers can claim FEIE and a housing deduction, but must still compute self-employment tax.
Practitioner Tip: Tax home disqualification is a common audit trigger. Document assignment letters and duration clearly.
Qualification Flowchart: Do You Pass the FEIE Tests?
Step 1: Is your tax home outside the US?
If the tax home is in the US, stop — FEIE is not available. This applies even if the client spends significant time abroad.
Step 2: Bona Fide Residence Test
If the client is a bona fide resident of a foreign country for an entire calendar year, they qualify without day-count tracking.
Step 3: Physical Presence Test
If bona fide residence is not met, test whether the client was physically present abroad for 330 full days in any 12-month period.
Practitioner Tip: Only one test is required. Choose the test that provides earlier or longer coverage.
Bona Fide Residence Test Explained
Core criteria for bona fide residence
The taxpayer must be a resident of a foreign country for a full calendar year, January 1 to December 31.
Factors the IRS evaluates
The IRS looks at intent, length of stay, visa type, family location, social ties, and whether the individual integrates locally.
Countries with no income tax (e.g., UAE cases)
The absence of local income tax does not disqualify FEIE. UAE and Qatar cases commonly qualify under bona fide residence.
Practitioner Tip: This test is subjective and riskier than physical presence, but valuable for long-term Middle East assignments.
Physical Presence Test Explained
183-day myth vs actual 330-day rule
There is no 183-day rule for FEIE. The statutory requirement is 330 full days outside the US.
Counting qualifying days correctly
Any day with presence in the US for even one minute is a non-qualifying day. Travel days require careful tracking.
Overlapping 12-month periods
Any rolling 12-month period can be used, even overlapping within the same tax year. This is critical for partial-year cases.
Example: A client abroad from March 15, 2024 to March 14, 2025 can claim FEIE for part of 2024 using that 12-month window.
Foreign Housing Exclusion: Rules and Calculations
What qualifies as housing expenses
Rent, utilities (excluding telephone), and residential insurance qualify. Purchase costs and domestic labor do not.
Exclusion vs deduction
Employees claim a housing exclusion. Self-employed individuals claim a housing deduction.
High-cost locality limits
The base housing amount is 16% of the FEIE limit. Excess costs are excludable up to IRS city-specific caps.
Practitioner Tip: Always verify whether the city appears on the IRS high-cost list before capping expenses.
How to Fill Out Form 2555 Step by Step
Key parts of Form 2555
Parts I–III establish qualification. Parts IV–VII compute income, exclusion, and housing benefits. Part VIII summarizes totals.
Multiple qualifying periods and gaps
If there are two qualifying periods separated by a gap, disclose both. Only days within qualifying periods count toward exclusion.
Paper filing vs e-filing constraints
When multiple Forms 2555 are required for the same year, e-filing may not be supported, necessitating paper filing.
Refer to IRS Instructions for Form 2555 for technical completion rules.
Calculation Examples: Full-Year and Partial-Year FEIE
Full-year exclusion example
A client earning USD 120,000 abroad for all of 2024 can exclude the full amount, subject to the annual limit.
Prorated exclusion for partial years
Exclusion = Annual limit × (Qualifying days ÷ 365). For 200 qualifying days in 2024: 126,500 × 200/365.
Currency conversion best practices
Use IRS-accepted yearly average exchange rates consistently. Spot rates often trigger notices.
FEIE vs Foreign Tax Credit (FTC): Which Is Better?
Conceptual differences between FEIE and FTC
| FEIE | FTC |
|---|---|
| Excludes income | Credits foreign tax paid |
| No carryforward | 10-year carryforward |
Scenarios where FTC outperforms FEIE
In high-tax jurisdictions, FTC preserves deductions and credits while avoiding lost benefits.
Using both strategically (ordering rules)
FTC cannot be claimed on excluded income. Planning should consider multi-year implications.
See our Foreign Tax Credit Form 1116 guide for deeper analysis.
Common Mistakes to Avoid With Form 2555
Reporting ineligible income
Contractor income sourced to the US is often incorrectly excluded.
Using the wrong currency conversion rate
Inconsistent exchange rates are a common notice trigger.
Misunderstanding tax home rules
Practitioner Tip: Always document why the tax home is foreign, especially for short-term assignments.
Conclusion
Form 2555 is central to advising globally mobile US clients, but it demands precise technical analysis. For Indian CAs, mastering FEIE rules strengthens your ability to deliver high-quality US individual tax services.
Focus on tax home determination, test selection, and accurate day counts. Evaluate FEIE against FTC annually, not in isolation. With consistent processes and documentation, Form 2555 becomes a planning tool rather than a compliance risk.
FAQs
Can FEIE be claimed in the first year of moving abroad?
Yes, using the Physical Presence Test. The exclusion is prorated based on qualifying days. Bona fide residence requires a full calendar year.
Can a client switch between FEIE and FTC?
Yes, but revoking FEIE triggers a five-year restriction unless IRS consent is obtained. Planning ahead is critical.
Does income earned in the US qualify if paid abroad?
No. Source is based on where services are performed, not where payment is received.
Is FEIE available for partners in foreign partnerships?
Yes, if the income is earned for services performed abroad and other requirements are met.
How are gaps between assignments handled?
Only qualifying periods count. Gaps reduce qualifying days and may require multiple disclosures.
Can housing exclusion exceed FEIE?
No. Housing benefits are capped and computed separately but cannot exceed statutory limits.
Is FEIE allowed in no-tax countries?
Yes. UAE and Qatar assignments commonly qualify if residency tests are met.
What happens if the client fails both tests?
FEIE is denied entirely. FTC may still be available.
Is self-employment tax eliminated by FEIE?
No. FEIE does not reduce self-employment tax.
Are amended returns allowed to claim FEIE?
Yes, within the statute of limitations, provided eligibility existed in the original year.
