Using the Foreign Earned Income Exclusion, taxpayers can exclude up to a set amount each year from taxable income when working outside the US.
The exclusion requires being outside the US for a specified number of days in a calendar year or permanently residing in a foreign country. Permanent foreign residence requires living in a foreign country for a period to exceed an entire calendar year.
Once residency is established for a full calendar year, the income earned in the partial first year can qualify for a prorated exclusion. An extension can be filed using from 2350 to extend the filing deadline until the residency requirement has been met.
The exclusion does not apply to US government or military employees.
The exclusion applies to income earned from an employer or self-employment income. However, self-employed income is not exempt from self-employment tax (Social Security and Medicare).
State treatment of foreign earned income varies.
The exclusion can reduce taxable income to $0. This would eliminate other possible tax benefits, like retirement contributions. Because taxable earned income is required to make a contribution.
Alternatively, a credit for foreign taxes paid on the foreign income can be used. This provides a better savings for some taxpayers who are paying taxes in the country where they reside. It should be compared with the Foreign Earned Income Exclusion to evaluate which provides the greater benefit, taking into account both federal and state taxes.