The Foreign Earned Income Exclusion for 2025 and 2026: How It Works and What It Does Not Cover

The foreign earned income exclusion is the reason many Americans abroad owe little or no U.S. income tax. It lives at 26 U.S.C. 911. If you qualify and elect it on Form 2555, you can exclude foreign earned income up to an annual limit.

The limit is adjusted for inflation every year. The IRS sets the numbers in its annual revenue procedure:

• 2025: $130,000, under Rev. Proc. 2024-40.
• 2026: $132,900, under Rev. Proc. 2025-32.

Those are per person. A married couple who both work abroad and both qualify can each exclude up to the limit on their own foreign earned income.

Here is how it works, and where people go wrong.

Who qualifies

Section 911(d)(1) defines a qualified individual as someone whose tax home is in a foreign country and who meets one of two tests:

• The bona fide residence test: a U.S. citizen who has been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire taxable year. Publication 54 notes that a U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty may also use this test. See the bona fide residence guide.
• The physical presence test: a U.S. citizen or resident who is present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. See the physical presence guide.

The tax home piece matters too. Section 911(d)(3) says your tax home is your home for purposes of the travel expense rules, and that you are not treated as having a tax home in a foreign country for any period in which your abode is in the United States. There is a narrow exception for people serving in a combat zone in support of the U.S. Armed Forces.

What counts as foreign earned income

Section 911(b)(1) defines foreign earned income as amounts received from sources within a foreign country that are earned income attributable to services you performed during the qualifying period. Earned income means wages, salaries, professional fees and other compensation for personal services.

Source follows where you do the work. Publication 54 says the source of earned income is the place where the services are performed. Income for work performed in a foreign country is foreign source, even if your employer is American and pays into a U.S. bank account. Days you spend working in the United States produce U.S. source income that the exclusion cannot touch.

Section 911(b)(1)(B) lists amounts that are not foreign earned income even if they otherwise look like it:

• Amounts received as a pension or annuity.
• Amounts paid by the United States or a U.S. agency to its employees.
• Amounts included in income under sections 402(b) or 403(c), which deal with certain nonqualified trusts and annuities.
• Amounts received after the close of the taxable year following the year in which the services were performed.

Investment income is not earned income. Interest, dividends, capital gains and rental income are taxed normally. The exclusion is for pay, not portfolios.

If you run a business in which both personal services and capital are material income-producing factors, section 911(d)(2)(B) treats no more than 30 percent of your share of the net profits as earned income.

Proration for partial years

The exclusion is computed on a daily basis. Section 911(b)(2)(A) limits the excludable amount to foreign earned income computed at an annual rate equal to the exclusion amount, for the days in your qualifying period. If you qualify for only part of the year, such as the year you move abroad, the limit is prorated by days.

Example: you qualify under the physical presence test for 200 days of 2026. Your maximum exclusion for 2026 is roughly $132,900 multiplied by 200 over 365, about $72,800. Form 2555 does the arithmetic.

The stacking rule: excluded income still affects your rate

Here is the part most people miss. Section 911(f) says that if you exclude income, the tax on your remaining taxable income is computed as if the excluded income were still there, and then the tax on the excluded amount is backed out. In practical terms, your non-excluded income is taxed at the rates that would apply if it sat on top of the excluded income.

So someone who excludes $132,900 of salary and has $40,000 of other income does not pay tax on that $40,000 at the lowest brackets. It is taxed at the higher rates that would apply above $132,900.

What the exclusion costs you

Electing the exclusion is not free. Publication 54 spells out the trade-offs:

• No foreign tax credit on excluded income. Once you elect, you cannot take a credit or deduction for foreign taxes on the income you exclude. Section 911(d)(6) bars any deduction, exclusion or credit allocable to excluded amounts. You can still claim a foreign tax credit for foreign taxes on income above the limit. See foreign tax credit vs. FEIE.
• No additional child tax credit. If you elect the foreign earned income exclusion or housing exclusion, or take the housing deduction, you cannot take the additional child tax credit for that year.
• No earned income credit. If you elect the exclusion, you do not qualify for the earned income credit for that year.
• Self-employment tax still applies. The IRS says self-employed U.S. citizens and residents abroad must pay self-employment tax on all net profit, even if they claimed the exclusion. See totalization agreements.

Making, keeping and revoking the election

You elect on Form 2555. Under 26 CFR 1.911-7(a)(2), a valid election can be made with a timely filed return, including extensions; with an amended return that amends a timely return within the refund period; with an original return filed within one year after the due date, without regard to extensions; or with a later return if it is filed before the IRS discovers the failure to elect, with specific requirements described in the regulation.

Once made, the election applies to that year and all later years until revoked, under section 911(e)(1). Publication 54 warns that claiming a foreign tax credit or deduction, the additional child tax credit or the earned income credit in a later year is treated as revoking the election for that year. And under section 911(e)(2), after a revocation you cannot elect again before the sixth taxable year after the year of revocation without IRS consent. See revoking the FEIE election.

Common traps

• Counting U.S. workdays as foreign. A week of work at the home office in New York produces U.S. source income, even if you are paid by a foreign payroll.
• Forgetting the year of the move. The first and last years are usually partial years with prorated limits.
• Assuming the exclusion is automatic. It must be elected on Form 2555 with a valid return.
• Claiming a credit on excluded income. Foreign taxes on excluded wages cannot also be credited.
• Ignoring the state. Some U.S. states may still treat you as a resident after you move abroad. State rules vary and are outside federal law, so check them separately.

You still have to file

The exclusion reduces taxable income. It does not eliminate the requirement to file a return, and you must file to claim it. People who assume they owe nothing and therefore do not file can lose the election on late returns if the IRS discovers the failure first, under the timing rules in 26 CFR 1.911-7.

And the exclusion has nothing to do with your FBAR or Form 8938 obligations. A person who excludes every dollar of salary can still owe an FBAR for every year. See who must file an FBAR.

If you have been abroad for years without filing because you assumed the exclusion covered you, the Streamlined Foreign Offshore Procedures may be the cleanest way back. Let's talk.