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I work for a public (state) US university but I live abroad. The university has not sent me abroad and the work does not require me to work abroad, it is purely my choice (and a deal I worked with my boss). My paycheck is direct deposited by the university into my US bank account, and I receive a regular W2.

I am a bona fide permanent foreign resident (IRS's physical residence test), and I am registered with the local tax authorities here abroad.

My question is, can I use the Foreign Earned Income Exclusion for my US taxes?

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Where your bank account is located does not determine the country the income is 'sourced' to. That is defined by where the work is performed - meaning, where your butt physically sits while you work.

Your country of residence would consider your income to be theirs to tax first. The US claims the right to tax it afterwards, on the basis of your citizenship (hooray! Only US and Eritrean citizens get such a wonderful opportunity from their government!). You have 2 options to avoid double-taxation (paying tax in both the US and the other country):

(1) Claim foreign tax credits on your US tax return, which basically just reduce your US tax bill (down to $0 if possible) based on how much tax you paid to the other country.

(2) Claim the FEIE, which basically removes the income from US taxation entirely.

Which option you choose has a bit of permanence to it, and can't be changed back and forth freely every year (there are some rules to follow), so make your choice wisely. If your tax rate is higher in your country of residence, then option 1 can be preferable, if a little burdensome. This is because unused FTC's can be claimed for up to 7 years down the road. This can help under various circumstances, primarily if you ever earn higher than the FEIE, you could still fully eliminate your US tax liability by claiming up your unused FTCs from prior years.

FTC method can be a bit more cumbersome, but could be worth it as well. Good luck with your double filings down the road!

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  • Grade 'Eh', thanks for the info. To clarify, this applies only to earned income, and not passive income such as from dividends or renting my house? Also, the FEIE applies regardless of whether the country I live in levies income tax or not? In other words, the IRS doesn't care whether I have actually paid that income tax to another government or not? Nov 26 '20 at 13:21
  • @Foreignresearcher Different types of income are all sourced by their own rules. How that sourcing is determined is primarily based on the Tax Treaty between the two countries - I am loosely assuming you are living in a country with a generic tax treaty with the US, which is most often the case. In that case, income from investments can be complex - capital gains are typically sourced first to the country of your tax residence, income from 'real property' (renting a house, that type of thing) is typically sourced to the country where the property is located, and other income types can vary. Nov 26 '20 at 13:45
  • Where the income is 'sourced' defines who has the first right to tax it - and with an effective tax treaty, the other country for a dual-filer can only tax the 'crumbs', effectively intending through legislation to make sure that when you add country A's tax + country B's tax, you end up with a combined tax rate that is equal to the higher tax rate between the two countries (doesn't always exactly work that way, but that's generally the intent). How that double-taxation is prevented on your 1040 is either through FEIE or FTC's. Most other countries just use a method like FTC's. Nov 26 '20 at 13:47
  • So, if you say own a house in the US that you rent out (whether as a US citizen or not) while you have your tax residence abroad, you likely need to pay tax in the US on that rental income, and then on your home country tax return, you likely include that as income there as well, and then claim US foreign tax credits to reduce your local taxes payable, accounting for the fact that the US has already taxed your income. Nov 26 '20 at 13:48
  • Finally, note that yes, FEIE only applies to 'earned income', which is basically just employment income. If you have other types of income and your situation gets more and more complex, it is quite frequently worthwhile to claim FTC's instead, but if you have the mental fortitude and patience, checking out what both options look like on 2 hypothetical tax returns before you decide, can be beneficial. Make sure you consider what 'carryforwards' are different between the two methods, not just what the difference in immediate tax payable is. Nov 26 '20 at 13:50

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