Foreign Earned Income Exclusion Explained: Form 2555
The two qualifying tests, the annual limit, the housing exclusion, and why Canadians often choose the credit instead
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
The foreign earned income exclusion lets a U.S. citizen or resident living abroad exclude foreign earned income — wages and self-employment income — up to an annual limit, plus a housing amount, using Form 2555. For U.S. citizens in Canada, where tax rates are higher than U.S. rates, the foreign tax credit usually produces a better result than the exclusion.
On this page
Qualifying tests
| Test | Requirement |
|---|---|
| Bona fide residence | A bona fide resident of a foreign country for an uninterrupted period including a full calendar year |
| Physical presence | Present in foreign countries at least 330 full days in any 12-month period |
| Tax home | A tax home in a foreign country under either test |
What it covers
Earned income only — wages, salaries, self-employment income, professional fees — up to the annual limit (indexed — US$132,900 for 2026, up from US$130,000 for 2025), plus a housing exclusion (a deduction for the self-employed) for housing expenses above a base amount — for 2026, 16% of the limit (US$21,264), with expenses generally capped at 30% of the limit (US$39,870) unless the IRS sets a higher cap for the city. It doesn't cover investment income, pensions, or rental income, and excluded income doesn't reduce self-employment tax (though under the totalization agreement a self-employed person resident in Canada is covered only by the CPP/QPP and is exempt from U.S. self-employment tax by attaching a certificate of coverage, such as form CPT56, to the U.S. return each year — the totalization guide).
Exclusion or credit?
| Exclusion (Form 2555) | Foreign tax credit (Form 1116) | |
|---|---|---|
| Works best when | Foreign tax rates are low | Foreign tax rates are higher than U.S. rates — Canada |
| Excess foreign tax | Lost on excluded income | Carries back one year and forward ten |
| Refundable child tax credit | Not available with the exclusion | Available |
| Revoking | Revoking bars re-electing it for the next five tax years without IRS approval (a ruling request) | Year by year |
In Canada, the credit usually eliminates U.S. tax on Canadian wages and preserves excess credits; the exclusion is rarely better.
Frequently asked questions
Should U.S. citizens in Canada use the foreign earned income exclusion?
Usually not — Canadian tax rates are higher, so the foreign tax credit typically eliminates U.S. tax and preserves excess credits.
What is the exclusion limit?
Indexed annually — US$132,900 for 2026 (US$130,000 for 2025), per qualifying person.
Does the exclusion cover my pension or investment income?
No — only earned income.
Can I switch from the exclusion to the credit?
Yes, but revoking the exclusion bars re-electing it for five years without IRS consent.
Official sources
The IRS explains: “If you meet certain requirements, you may qualify for the foreign earned income exclusion, the foreign housing exclusion, and/or the foreign housing deduction.” — Internal Revenue Service, Foreign earned income exclusion, https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk and Canadian Tax Desk handle exclusion-versus-credit analysis and Form 2555 and 1116 preparation for U.S. citizens living in Canada. See pricing or book a call.
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U.S. and Canadian filings prepared together by our U.S. and Canadian Tax Desks.
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