Nov 9, 2025
IRS Raises Foreign Earned Income Exclusion: Tax Planning Considerations for U.S. Expats in Costa Rica
1. Technical Framework: What the FEIE Is and Who Qualifies
The Foreign Earned Income Exclusion (FEIE) allows U.S. citizens and lawful permanent residents to exclude from U.S. taxable income a portion of wages or compensation earned from personal services performed outside the United States, provided they meet the eligibility criteria under Section 911 of the Internal Revenue Code.
For 2025, the maximum exclusion amount is US $130,000, applicable to employment or self-employment income earned abroad. In addition, qualifying taxpayers may exclude certain housing costs under the Foreign Housing Exclusion, subject to the IRS-specified minimum and maximum limits.
To qualify, taxpayers must meet either of the following tests:
Bona Fide Residence Test: The taxpayer must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year.
Physical Presence Test: The taxpayer must be physically present outside the United States for at least 330 full days during any period of 12 consecutive months.
Taxpayers claim the exclusion by filing Form 2555 together with their annual Form 1040 U.S. income tax return.
2. Implications for U.S. Expatriates Residing in Costa Rica
Costa Rica operates under a territorial tax system, taxing only income derived from Costa Rican sources. As a result, U.S. expatriates residing in Costa Rica are generally not subject to Costa Rican income tax on income earned abroad. However, those same earnings remain subject to U.S. federal income tax, unless effectively reduced through the FEIE or offset via the Foreign Tax Credit (FTC).
In practice:
A U.S. citizen employed by a U.S.-based company but residing in Costa Rica may exclude up to US $130,000 of salary under the FEIE, provided they meet either the residence or physical-presence tests.
If the individual also earns Costa Rican-source income subject to local tax, those taxes may be credited against their U.S. tax liability via Form 1116 (Foreign Tax Credit), thereby preventing double taxation.
Costa Rican employers that hire U.S. citizens should confirm their employees’ tax residency status, ensure appropriate local withholding and reporting, and document the correct application of the FEIE or FTC in coordination with U.S. compliance requirements.
3. Corporate and Compliance Perspective
The higher FEIE threshold presents an opportunity for multinational employers with globally mobile staff and for U.S. professionals residing in Costa Rica to optimize their overall tax position. However, effective coordination between both jurisdictions remains essential.
Key considerations include:
Inter-jurisdictional coordination: Understanding how Costa Rica’s territorial taxation interacts with the United States’ worldwide taxation framework.
International employment contracts: Clearly defining the source of income, tax obligations, and compliance responsibilities in both countries.
Documentation and record-keeping: Expatriates must maintain accurate logs of foreign residency periods, travel days, income earned abroad, and housing expenses to substantiate eligibility.
Comprehensive IRS compliance: U.S. citizens abroad must continue filing Form 1040, Form 2555 (FEIE), and, where applicable, FBAR (FinCEN 114) and Form 8938 (Statement of Specified Foreign Financial Assets).
Internal training and governance: Employers with expatriate staff should ensure that HR and finance teams are aware of dual reporting obligations and payroll implications in both Costa Rica and the United States.
4. Strategic Recommendations
For U.S. expatriates residing in Costa Rica:
a) Confirm annual FEIE eligibility and calculate the correct proportion of exempt income.
b) Consider combining the FEIE and Foreign Tax Credit to minimize global tax exposure.
c) Engage professional advisors familiar with both U.S. and Costa Rican tax systems to maintain compliance and optimize outcomes.
For local or multinational employers:
a) Review compensation and mobility policies to reflect the new US $130,000 FEIE threshold.
b) Align payroll systems and withholding procedures with Costa Rican obligations and applicable U.S. exclusions.
c) Implement structured reporting and documentation protocols to ensure compliance with both the Dirección General de Tributación (DGT) and the IRS.
The increase of the Foreign Earned Income Exclusion to US $130,000 for 2025 reinforces the importance of proactive international tax management for U.S. expatriates residing in Costa Rica. Proper application of the exclusion—combined with a clear understanding of Costa Rica’s territorial tax regime—can substantially reduce the overall tax burden while preventing double taxation and potential non-compliance penalties.
References
IRS Revenue Procedure 2025-XX – Annual FEIE inflation adjustment (October 2025).
Internal Revenue Code, Section 911 – Foreign Earned Income Exclusion.
Form 2555 – Foreign Earned Income Exclusion (2025 version).
Form 1116 – Foreign Tax Credit.
BrightTax (2025) – IRS Tax Changes for Expats 2025.
Taxes for Expats (2025) – U.S. Expat Tax Rules and Forms for 2025.