What allows eligible taxpayers to avoid paying federal income tax on foreign earned income?

The foreign earned income exclusion is a provision in the U.S. tax code that allows eligible taxpayers to exclude a certain amount of their foreign earned income from their taxable income. This exclusion is designed to alleviate the burden of double taxation on income earned outside the United States, as U.S. citizens and residents are taxed on their worldwide income.

To qualify for this exclusion, taxpayers must meet specific requirements, including having a tax home in a foreign country and meeting either the bona fide residence test or the physical presence test. The amount that can be excluded is adjusted for inflation, and for 2023, it allows taxpayers to exclude up to a specified limit, significantly reducing their taxable income and the overall tax bill.

Options such as the foreign tax credit and federal tax exemption do serve different purposes within the tax system but do not specifically provide a way to avoid paying federal income tax on foreign earned income directly as the foreign earned income exclusion does. The foreign tax credit allows for the reduction of U.S. tax liability based on taxes paid to foreign governments, rather than excluding income from taxation. The federal tax exemption is not a relevant option for this scenario.