Foreign Earned Income Exclusion: The Magical Rule That Makes $120,000 Disappear

So you moved abroad, started sipping espresso in Spain or opening a laptop in Thailand and now you’re wondering: “Do I still have to pay U.S. taxes?”

Unfortunately, the answer is yes.

But fortunately, there’s a magical IRS loophole that lets over $120,000 of your income vanish from your taxable U.S. income.It’s called the Foreign Earned Income Exclusion (FEIE), and no, this isn’t a prank from your accountant.

What Is the Foreign Earned Income Exclusion?

The FEIE (Form 2555) lets U.S. citizens exclude a big chunk of foreign-earned income from U.S. tax over $120,000 in 2025, adjusted annually for inflation.

It’s like the IRS saying, “Okay, you’re far away, we’ll let this one slide… but only this much.”

It only applies to earned income so wages, salaries, contractor income. Not pensions, dividends, or crypto moonshots.

Who Qualifies?

You have to:

- Be a U.S. citizen or green card holder,

- Have a tax home in a foreign country, and

- Pass one of two tests:

Physical Presence Test:Live outside the U.S. for 330 full days in any 12-month period.

Bona Fide Residence Test:Be a legit, long-term resident of a foreign country (with proof — like a lease, visa, etc.)

Why It’s So Powerful (and Dangerous)

Because if you qualify, you can:

- Exclude $120K+ from U.S. income taxes- Also exclude housing costs (Form 2555 has a housing exclusion add-on)

- Combine with the Foreign Tax Credit (Form 1116) for extra magic

But... mess it up, and the IRS doesn’t do forgiveness. You can lose the exclusion for years if you revoke it or file late.

Social Security Catch

Here’s the kicker: if you're a W2 employee in a foreign country or you’re self-employed and using FEIE, you might not be paying into U.S. Social Security. Which means no, or lower, future Social Security check.

So if you haven’t already racked up your 40 quarters (10 years), you might want to rethink how you file or at least talk to someone who knows what they’re doing.

Pro Tips from People Who’ve Learned the Hard Way

- Don’t miss deadlines, expats get a 2-month extension, but interest still accrues

- File Form 2555 with your 1040, it’s not automatic

- Track your travel days, a one-day slip can cost you thousands

- Avoid short visits back to the U.S. if you’re using the physical presence test

- Work with a pro, FEIE and foreign tax credit rules are confusing, and they stack weird

Real-Life Scenario

Let’s say you’re an English teacher in South Korea making $70,000/year. You qualify under the physical presence test and file Form 2555.

You exclude the full $70,000 and owe zero U.S. income tax.

Now let’s say you’re a remote worker in Portugal making $150,000. You can exclude $120,000 and pay U.S. tax only on the excess $30K unless you also use Form 1116 to claim a credit for Portuguese taxes.

Magic? No. But definitely feels like it.

Summary

- FEIE can save you thousands in U.S. taxes if you qualify

- Use Form 2555 with your U.S. return

- Stay outside the U.S. 330+ days or establish foreign residency

- Know how this affects your Social Security if you’re self-employed or a W2 employee.

- Don’t DIY unless you like IRS letters and wine-induced stress

Not sure if you qualify?

Let us help you keep your $120K where it belongs in your wallet.👉 Book a tax strategy session with us now