IRC §911 foundations: tax home, earned income and partnerships

The §911 framework: problem and solution

United States citizens and resident aliens are subject to tax on their worldwide income, regardless of their place of residence. This global system of taxation creates significant challenges for US persons assigned to foreign posts or residing abroad, often resulting in double taxation — once by the foreign jurisdiction where the income is earned, and again by the United States.

The IRC provides an exception to mitigate this issue. IRC §911 allows qualifying individuals to elect to exclude a significant portion of their foreign earned income from US gross income. This provision is specifically targeted at income derived from personal services (labour), distinguishing it from passive or investment income, thereby providing relief to those actively working abroad.

Eligibility and exclusion limits

Eligibility for the foreign earned income exclusion and the excess foreign housing costs exclusion or deduction is contingent upon satisfying four key requirements. An individual must:

1. Have foreign earned income;
2. Have a tax home in a foreign country during the qualifying period;
3. Satisfy either the Bona Fide Residence Test or the Physical Presence Test; and
4. Make a valid election to exclude the income.

Upon meeting these qualifications, an individual may exclude their foreign earned income up to a statutory maximum, which is adjusted annually for inflation. For 2025 the maximum exclusion is $130,000, and for 2026 it is $132,900.

This analysis, the first in the series, deconstructs the foundational components of §911 eligibility. We focus on the critical definitions that determine initial qualification: what constitutes "earned income," the sourcing rules that make it "foreign earned income," and the specific rules applicable to partnership income.

What is earned income? (Reg. §1.911-3(b) & (c))

To be eligible for the exclusion, the individual's income must be foreign earned income. The first step is to determine what is included in "earned income."

Earned income includes wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, including the fair market value of any non-cash remuneration.

For professionals: earned income includes all fees received by an individual engaged in a professional occupation (such as a doctor or lawyer) in the performance of professional activities, even though the individual employs assistants — provided the patients or clients are those of the individual and look to the individual as the person responsible for the services rendered.

Exclusions from earned income

• Amounts received in the form of interest, gambling winnings, dividends, capital gains, alimony, social security benefits, and royalties from leasing oil and mineral lands and from patents are generally not earned income.
• Earned income does not include amounts in excess of a reasonable allowance for compensation for personal service that represent disguised dividends.
• Amounts US agencies pay to their employees are not eligible for the exclusion, but amounts they pay to independent contractors (where terms and objective indications demonstrate this status) are eligible.
• Rental income is unearned income unless personal services are performed in the production of that income, which is limited to 30% of net profits as explained below.
• To the extent income derived from personal services is attributable to capital, it is not earned income. However, special rules apply for individuals in a trade or business other than in corporate form — self-employed individuals, sole proprietorships, and partners. The income attributable to the capital investment is not considered earned income.
• In such situations, a reasonable allowance for the personal services actually rendered is considered earned income, but the total amount treated as the individual's earned income from such a trade or business shall not exceed 30% of the individual's share of the net profits of that trade or business.
• This 30% limitation does not apply to income from a corporation. Subject to reasonable compensation restrictions, a taxpayer living abroad who engages in business in corporate form can plan and pay themselves a salary and avoid the problem of allocating a portion of income to capital investment, rather than distributing dividends, if the amounts represent reasonable compensation for services.

What is foreign earned income? (Reg. §1.911-3(a))

Once income is determined to be "earned," it must also be "foreign." This is determined by sourcing the income under US tax law.

The primary rule is absolute: income is sourced to the physical location where you perform the services. Income from services performed physically in a foreign country is foreign-source income. The place where payment is made, the form of the payment, the location of the payor's residence, and the place where the services are contracted for are all irrelevant.

Apportionment: if compensation is not clearly segregated into US and foreign sources, it must be apportioned. For employees, compensation (other than fringe benefits) for labour or services performed both within and outside the United States is sourced based on the time — that is, the number of workdays — spent working in each location.

"Foreign country" defined: taxpayers must be careful, as not all non-US locations are "foreign countries." Income earned while working in US possessions (such as Puerto Rico or Guam), Antarctica, or in international waters or airspace is not considered foreign earned income and is not eligible for the exclusion.

Amounts not considered foreign earned income

• Amounts excluded from gross income as meals and lodging furnished for the convenience of the employer (under §119).
• Amounts received as a pension or annuity, including social security benefits.
• Amounts included in income because of an employer's contributions to a non-exempt employee trust or to a non-qualified annuity contract.
• Amounts received after the close of the first taxable year following the taxable year in which the services giving rise to the amounts were performed.
• Income earned in a restricted country.

Items with specific treatment

Moving expense reimbursements. Generally, a moving expense reimbursement is sourced to the new place of work. A reimbursement for a move to a foreign country is therefore foreign-source income, while a reimbursement for a move back to the US is US-source income. This US-source presumption for a return move can be overcome if a prior written agreement attributes it to the foreign assignment. For a move to a foreign country, the reimbursement is eligible for the §911 exclusion in the year of the move if the taxpayer is a "qualified individual" for at least 120 days during that year. Note that the deduction for moving expenses is suspended for most taxpayers for tax years 2018 through 2025.

Stock option income. Income from the exercise of a stock option, or a disposition of the underlying stock that is treated as compensation income realised in the year of exercise or disposition, is apportioned between US-source and foreign-source income based on the option period services performed by the individual. Any capital gain realised by the individual, however, is not eligible for treatment as foreign-source earned income.

Partnership income

• Earned income test: a partnership distribution is earned income if the partner performs personal services. If no personal services are provided, the distributions are unearned income.
• 30% rule: if capital is a material income-producing factor, the partner's earned income is limited to 30% of the partner's share of net profits.
• Sourcing: a partner is deemed to earn a pro-rata portion of each item of partnership income. Therefore, for a partner in a US partnership who works at a foreign location, their foreign-source earned income is limited to their proportionate share of the partnership's foreign earned income.
• Planning: a guaranteed payment or a special partnership allocation of the foreign-source income can be used to bypass this pro-rata limitation.
• Compliance: a partnership must separately state earned income for all partners if one partner is able to exclude foreign earned income.

Coming next

In the next article we discuss the remaining tests for eligibility: the Tax Home Test and the standards for the Bona Fide Residence and Physical Presence Tests. Read Part 2 →