Working for a U.S. Company While Living Abroad: Taxes

Working for a U.S. company while living abroad means you are paid through a U.S. payroll, receive a Form W-2, and may have federal and state tax withheld as if you still lived in the U.S. — while the IRS treats your wages as foreign earned income because the work is performed outside the country. The mismatch between how you're paid and how you're taxed is where most of the problems sit.

On this page

1. Are my wages U.S. income or foreign income?
2. Can I claim the foreign earned income exclusion on W-2 wages?
3. Why is my employer still withholding U.S. tax?
4. Does my old state keep withholding too?
5. Where am I covered for Social Security?
6. What about the local country's taxes?
7. Should I become a contractor instead?
8. Frequently asked questions
9. Next step

Are my wages U.S. income or foreign income?

Foreign. Compensation is sourced where the services are performed, not where the employer is or where the pay is deposited. Work done from an apartment in Lisbon is Portuguese-source income under U.S. rules even if the paycheck comes from Chicago. That matters because it makes the wages eligible for the foreign earned income exclusion and puts them in the foreign-source basket for the foreign tax credit.

Can I claim the foreign earned income exclusion on W-2 wages?

Yes, if you meet the bona fide residence or physical-presence test and your tax home is abroad. The exclusion does not care who signs the paycheck. Form 2555 is filed with your return, and the excluded wages come off your taxable income up to the annual limit, plus a housing amount.

Why is my employer still withholding U.S. tax?

Because payroll systems default to U.S. withholding. You can give your employer Form 673, a statement that you expect to qualify for the exclusion, which lets them stop withholding federal income tax on wages you expect to exclude. Many employers will do this; some won't, in which case you recover the over-withholding as a refund when you file.

Does my old state keep withholding too?

Often, until you tell payroll otherwise. If you've genuinely broken state residency, ask your employer to stop state withholding and update your address in their system; otherwise you'll be filing a nonresident state return each year just to recover the money — and a sticky state may argue the withholding proves you're still a resident.

Where am I covered for Social Security?

By default, a U.S. employer keeps you on U.S. Social Security and Medicare, and continues withholding FICA. In a country with a totalization agreement, the agreement decides: a temporary assignment usually stays U.S.-covered for up to five years; a permanent move or local hire shifts to the local system, and you need a certificate of coverage to stop the double contribution. In a country without an agreement, you may owe into both systems.

What about the local country's taxes?

Living and working in another country generally makes you a tax resident there, with local income tax due on the same wages. Your U.S. employer usually won't withhold it, so you may need to register and pay local tax yourself. The foreign tax credit then offsets U.S. tax on any wages above the exclusion. Your employer may also have its own exposure — a permanent establishment or payroll registration requirement in your country — which is their problem to solve, but it sometimes becomes yours when they decide to convert you to a contractor.

Should I become a contractor instead?

Converting from employee to independent contractor shifts you onto Schedule C, removes your employer's withholding and FICA, and makes you responsible for U.S. self-employment tax (unless a totalization agreement exempts you) plus local taxes. It can be simpler for the employer and worse for you. Compare the full picture — benefits, retirement plan, both countries' tax — before agreeing.

Frequently asked questions

Next step

Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. If you work remotely for a U.S. employer from another country and want withholding, state tax, and coverage sorted before filing season, our U.S. Tax Desk can set it up with you. See pricing or book a free fit call.