Section 899 Foreign Tax: Essential Guide to Minimize Your Liability

What Is Section 899?

Section 899 of the Internal Revenue Code is the foundation for the Foreign Earned Income Exclusion (FEIE), which allows U.S. citizens and resident aliens working abroad to exclude a portion of their foreign earned income from U.S. taxation. For 2024, you can exclude up to $120,000 of foreign earned income—a significant benefit if you’re working overseas.

Here’s the reality: the U.S. taxes its citizens on worldwide income, regardless of where they live or work. That means without the FEIE, you’d owe federal income tax on every dollar you earn internationally. Section 899 is the IRS’s way of preventing double taxation and keeping American expats from getting crushed by overlapping tax obligations.

The exclusion applies only to “earned income”—wages, salaries, and self-employment income. It doesn’t cover investment income, rental income, or passive returns. This distinction matters enormously when you’re structuring your international career or business.

Foreign Earned Income Exclusion Explained

The Foreign Earned Income Exclusion is your primary tool for reducing taxable income as an expat. To qualify, you must meet one of two tests: the Physical Presence Test or the Bona Fide Residence Test. We’ll dive deeper into both, but here’s the short version: you need to prove you’re genuinely working abroad, not just taking a vacation with a side gig.

The exclusion amount adjusts annually for inflation. In recent years, it’s climbed from $107,600 (2021) to $120,000 (2024). If you’re married and both spouses have foreign earned income, each can claim the exclusion independently—potentially doubling your tax-free earnings.

One crucial point: the exclusion is dollar-for-dollar. If you earn $150,000 abroad, you exclude $120,000 and report $30,000 as taxable income to the IRS. You still file Form 1040 and Form 2555, but your tax liability shrinks significantly. This is why many expats pay little to no federal income tax despite earning solid incomes overseas.

Foreign Tax Credit Basics

If you’re paying taxes to a foreign country and your income exceeds the FEIE limit, the Foreign Tax Credit (FTC) becomes your second line of defense. This credit allows you to reduce your U.S. tax liability dollar-for-dollar by the foreign taxes you’ve already paid.

Here’s a practical example: You earn $180,000 in Germany and pay $45,000 in German income tax. You exclude $120,000 under section 899, leaving $60,000 taxable to the U.S. Your U.S. tax on that $60,000 might be $12,000. But you can claim a $45,000 foreign tax credit, which completely wipes out that $12,000 liability and leaves you with a $33,000 credit carryforward.

The FTC is capped at your U.S. tax liability on foreign-source income, which prevents you from using excess foreign taxes to offset U.S. taxes on domestic income. You’ll file Form 1118 to calculate and claim the credit. Many expats use both the FEIE and FTC strategically—excluding income under section 899 and crediting taxes on amounts above the exclusion threshold.

Physical Presence Test Requirements

The Physical Presence Test is the more flexible of the two qualification methods. You need to be outside the U.S. for at least 330 days during a 12-month period. That’s roughly 11 months abroad, but the 12-month window doesn’t have to align with the calendar year—it can start and end whenever you want.

Here’s what counts: Any full day you spend outside the U.S. counts toward the 330 days. A day where you’re in the U.S. for even part of it (like arriving at midnight) doesn’t count. Short trips home can eat into your days quickly, so many expats track their movements carefully using passport stamps, airline records, or travel logs.

The beauty of the Physical Presence Test is that you don’t need to establish residency in any particular country. You could bounce between countries, travel constantly, or work remotely from multiple locations—as long as you hit 330 days outside the U.S., you qualify. This makes it ideal for digital nomads, contractors, and people on temporary assignments abroad.

Bona Fide Residence Test

The Bona Fide Residence Test is the alternative to the Physical Presence Test. Instead of counting days, you establish tax residency in a foreign country for an uninterrupted tax year. This means you need to prove you’re a bona fide resident of that country—not just passing through.

The IRS looks at factors like where you own or rent a home, where your family lives, where you have a job, where you maintain bank accounts, and where you have social ties. You don’t need to be physically present every single day (like if you take a work trip to the U.S.), but you must maintain bona fide residency status.

This test is often easier for people with permanent assignments abroad, those who’ve moved their families internationally, or expats planning to stay in one country for years. Once you establish bona fide residency, you can claim the FEIE for the entire tax year, even if you spend time traveling or return to the U.S. for brief visits.

Calculating Your Foreign Income

Calculating foreign earned income sounds straightforward, but currency conversions, stock options, and bonuses complicate things. The IRS requires you to convert all foreign income to U.S. dollars using the exchange rate on the day you received it (or an average rate for the year, if you prefer consistency).

If you earned 100,000 euros in Germany and the exchange rate on payday was 1 EUR = 1.10 USD, your income is $110,000. If the rate was 1.08 USD the next month, that month’s earnings convert differently. This is why many expats use an annual average rate—it’s simpler and less prone to manipulation.

Self-employed expats have it trickier. You calculate your net self-employment income (gross revenue minus business expenses) in foreign currency, then convert the net amount to dollars. You still pay self-employment tax on this amount, even if you exclude it under section 899. That’s a surprise many people don’t anticipate—the FEIE excludes income tax but not Social Security and Medicare taxes.

Housing costs deserve special attention. If you’re self-employed or your employer provides housing, you may qualify for the Foreign Housing Exclusion or Deduction, which is separate from the FEIE. This can exclude or deduct your excess housing expenses (rent, utilities, insurance) beyond a baseline amount. It’s a powerful tool that many expats overlook.

Common Mistakes to Avoid

One of the biggest mistakes expats make is not filing at all. “I’m not earning enough to owe taxes,” they think. Wrong. You must file Form 1040 and Form 2555 to claim the FEIE, even if you’ll owe zero after the exclusion. Failing to file triggers penalties, interest, and potential loss of the exclusion.

Another costly error: miscounting days under the Physical Presence Test. People forget that a single day in the U.S.—even a quick flight home—breaks the day count. If you need 330 days and you’re at 329, one trip home can disqualify you. Use a spreadsheet or app to track your days meticulously.

Many expats also fail to report foreign financial accounts. If you have more than $10,000 in foreign bank accounts at any point during the year, you must file an FBAR (FinCEN Form 114). Failure to file carries penalties up to 50% of the account balance. The FATCA reporting requirements add another layer—Form 8938 if you have substantial foreign assets.

Finally, don’t mix up the FEIE with the Foreign Housing Exclusion. The housing benefit is separate and can be claimed in addition to the FEIE, but only if you meet specific requirements. Many people claim one and forget about the other, leaving money on the table.

Tax Planning Strategies

Smart expats use a combination of tools to minimize their tax burden. First, stack the FEIE with the Foreign Housing Exclusion. If you can exclude $120,000 in income and another $20,000 in housing costs, you’re looking at $140,000 in tax-free benefits.

Second, consider the timing of income recognition. If you’re self-employed and have flexibility, you might defer invoicing or bonuses until a year when you’ll have fewer days abroad, or accelerate income into a year when you’ll qualify for the full FEIE. This requires planning, but the tax savings justify the effort.

Third, use the Foreign Tax Credit strategically. If your foreign country has high tax rates (like Denmark or Sweden), you might benefit more from the FTC than the FEIE. Run both scenarios—exclude income and use the FTC on the remainder, or claim the FTC on all foreign income without the FEIE. The math determines which is better.

Fourth, don’t ignore state taxes. While section 899 deals with federal taxes, many states still tax expats. California, for example, taxes residents on worldwide income. If you’re a California expat, you might need to formally establish residency elsewhere to escape state tax. States like Florida, Texas, and Nevada have no income tax—a strategic advantage if you can claim residency there.

Finally, work with a CPA who specializes in expat taxes. The complexity of foreign income, currency conversions, and multiple tax regimes makes this a poor DIY situation. The cost of professional tax preparation by a CPA is money well spent if it saves you thousands in taxes or keeps you compliant with the IRS.

Frequently Asked Questions

Can I claim the FEIE if I work remotely for a U.S. company?

Yes, as long as you meet the Physical Presence Test or Bona Fide Residence Test. Your employer’s location doesn’t matter—only where you perform the work and where you’re physically located. If you’re in Thailand working remotely for a U.S. startup and you hit 330 days abroad, you qualify for the FEIE on your salary.

Do I have to pay self-employment tax on excluded foreign income?

Yes. The FEIE excludes income from federal income tax, but not from self-employment tax. If you’re self-employed and earn $150,000 abroad, you exclude $120,000 from income tax but still owe self-employment tax on the full $150,000 (minus the self-employment tax deduction). This catches many people off guard.

What happens if I move back to the U.S. mid-year?

You can still claim the FEIE or FTC for the portion of the year you were abroad and qualified. If you were in Germany for six months and earned $60,000, you can exclude that $60,000. You’ll report the income from your U.S. employment after returning without any exclusion. You’ll need to calculate your exclusion based on the actual days or months you qualified.

Can my spouse claim the FEIE if they don’t work?

No. The FEIE applies only to earned income. If your spouse is a homemaker or doesn’t have foreign earned income, they can’t claim an exclusion. However, if both spouses work abroad, each can independently claim up to $120,000 (2024), doubling the family’s exclusion to $240,000.

Is there a deadline to claim the FEIE?

You must file Form 2555 by the tax filing deadline (April 15 or with an extension) to claim the FEIE. If you miss the deadline, you can file an amended return (Form 1040-X) within three years, but it’s better to file on time. An extension to file doesn’t automatically extend the time to claim the FEIE—you must actually file the form by the deadline.

How do I handle foreign taxes paid if I claim the FEIE?

If you exclude all your income under the FEIE, you typically can’t claim a Foreign Tax Credit on that same income—you can’t benefit twice. However, if your income exceeds the exclusion amount, you can claim the FTC on the excess. You can also claim the FTC on investment income, even if you exclude your earned income. The rules are nuanced, so run the numbers carefully.

Final Thoughts on Section 899 Foreign Tax Rules

Section 899 and the Foreign Earned Income Exclusion are powerful tools for expats, but they require careful planning and meticulous record-keeping. The difference between claiming the FEIE correctly and missing out can be tens of thousands of dollars annually.

The key takeaway: don’t assume you owe nothing just because you’re abroad. File your forms, document your days or residency, track your income in dollars, and consider whether the FEIE or Foreign Tax Credit (or both) work best for your situation. If you’re earning significant income internationally, invest in professional tax advice. The complexity of currency conversions, multiple tax jurisdictions, and IRS compliance rules makes this one area where a CPA’s expertise pays for itself many times over.

Stay compliant, minimize your liability, and keep more of what you earn. That’s the expat tax advantage when you know how to use it.