The Foreign Earned Income Exclusion Explained: Tests, Limits, and What It Covers
The Foreign Earned Income Exclusion is the single biggest reason the numbers work for remote workers and small-business owners who move abroad. It can erase federal income tax on a large slice of what you earn while living in San Miguel de Allende. It also has hard edges that surprise people, and the parts it does not touch cost the most when they get missed. This page goes deeper than the tax pillar on how you qualify and what actually gets excluded.
None of this is tax advice for your situation. Model your actual numbers with a cross-border CPA before you rely on any of it.
What is the Foreign Earned Income Exclusion?
The FEIE lets you exclude a large amount of income you earn from work while living abroad, up to an annual limit, so that income is treated as if it never existed for federal income tax purposes. For 2026 the limit is up to US$132,900 per qualifying person, and a married couple who both qualify can each claim it. You claim it on Form 2555, filed with your return.
Two facts keep it honest, and they are where most confusion lives. The FEIE applies only to earned income, and it eliminates federal income tax only. More on both below.
How do you qualify for the FEIE?
You qualify by meeting one of two tests: the Physical Presence Test or Bona Fide Residence. You only need one, and most families use them in sequence.
The Physical Presence Test
The Physical Presence Test asks for 330 full days outside the United States in any rolling 12-month window. Three details decide cases:
- The window does not have to match the calendar year. Any rolling 12 months works.
- A full day means 24 hours outside U.S. borders. Any calendar day you touch U.S. soil, an airport layover included, does not count as a day abroad.
- The days do not have to be consecutive. They just have to total 330 inside the window.
If you arrive mid-year and cannot reach 330 days before the filing deadline, you can file Form 4868 to push the deadline to October and qualify then.
Bona Fide Residence
Bona Fide Residence asks you to reside in a foreign country for a full calendar year and genuinely build a life there. It is a facts-and-circumstances test, so you cannot paperwork your way into it. Evidence that supports it includes:
- A residency card
- A long-term lease or a home you own
- Community involvement
- School enrollment for children
Because it requires a full calendar year, many families start under Physical Presence in their first partial year and shift to Bona Fide Residence once they are settled in San Miguel.
What does the FEIE cover, and what does it not?
The FEIE covers earned income, the money you make through labor: wages, salary, and self-employment income for work you perform while physically abroad. It does not cover unearned income. This distinction is the one that trips people up, so hold it clearly.
| Covered by the FEIE (earned) | Not covered (unearned or non-income-tax) |
|---|---|
| Wages and salary for work done abroad | Dividends and interest |
| Self-employment income for work done abroad | Capital gains |
| Rental income | |
| Business distributions | |
| Social Security and Medicare tax | |
| Self-employment tax (about 15.3% on net earnings) | |
| State tax, if you keep residency in a state that charges it | |
| Value-added tax on what you buy |
Read the right column twice. The FEIE eliminates federal income tax on earned income, and nothing else. Self-employment tax in particular runs about 15.3 percent on net earnings and the exclusion never touches it, so a location-independent business owner still owes it.
Is income from a U.S. company still foreign-earned?
What matters is where you perform the work, not where the payer sits. If you do the work while physically in Mexico, the income is generally foreign-earned even when a U.S. client or employer pays you. This is a point where casual advice online gets muddled, and it is worth confirming for your facts with a professional, but the governing question is the location of your labor.
What about the foreign housing exclusion?
On top of the FEIE, the foreign housing exclusion can remove more taxable income by letting you exclude qualified housing costs above a base amount, up to a location-specific cap. The math is your qualified housing costs, minus a published base amount, up to the local limit. Most Mexican localities carry a standard cap, with higher-cost cities assigned higher ones. For many expat families this adds another meaningful slice of excluded income. Your accountant can pull the current base and caps for the year you file.
Frequently asked questions
What is the FEIE limit for 2026? Up to US$132,900 per qualifying person, and a married couple who both qualify can each claim their own exclusion.
Does the FEIE eliminate all my U.S. tax? No. It eliminates federal income tax on earned income only. Self-employment tax, tax on investment income, and state tax where it applies all remain.
Physical Presence or Bona Fide Residence, which is better? Physical Presence is the cleaner test for a first partial year abroad because it counts days in any 12-month window. Bona Fide Residence suits settled residents but requires a full calendar year.
Do I still have to file a U.S. return if the FEIE zeroes out my tax? Yes. You claim the exclusion on a filed return using Form 2555. The exclusion is not automatic and does not remove the filing obligation.
Where to go next
The tax pillar covers how the FEIE fits alongside Mexican tax residency, the FBAR and FATCA filings you cannot skip, and the state-tax traps. Read Taxes and the FEIE next, and explore the full relocation guide and community for current figures and cross-border CPA referrals before you file.