Form 673 is a document that allows U.S. citizens or residents working abroad to claim a foreign earned income exclusion (FEIE) on their tax return. The FEIE permits eligible taxpayers to exclude up to a specific amount of their foreign earned income from U.S. federal income tax, which was $108,700 in 2021.

To qualify for the FEIE, the employee must meet certain criteria, such as having a tax home in a foreign country and meeting either the physical presence test or the bona fide residence test. Form 673 is used to claim the FEIE and certify that the employee meets the criteria for the exclusion.

From an employer's perspective, it's important to be aware of Form 673 and to ensure that your employees are aware of it as well. If your employee is eligible for the FEIE, they will need to complete Form 673 and submit it to you to be exempt from U.S. federal income tax withholding on their foreign earned income. Not being compliant with U.S. tax laws and regulations when hiring abroad can lead to legal or financial issues down the line.

It's also essential to be aware of any relevant tax laws and regulations in the foreign country where you are operating, to ensure that you are compliant. If you have a permanent establishment in a foreign country, you may be required to pay corporate income tax in that country. Similarly, if you are paying talent in a foreign country, you may be subject to withholding tax or other taxes in that country.

How to fill out Form 673 the tax exclusion

To use Form 673, the employee must meet the criteria for the IRS’s foreign earned income exclusion (FEIE) or foreign housing exclusion. They must have foreign earned income or make money while living in a foreign country. Their tax home must be in a foreign country, and they must meet either the physical presence test or the bona fide residence test. The physical presence test applies to people who have been living in a foreign country for at least 330 days in a year, while the bona fide residence test applies to those who have been in a foreign country for a consecutive period of twelve months.

Once the employee completes Form 673 and chooses whether to go by the “Bona Fide Residence Test” or the “Physical Presence Test,” they give the form to their employer, who then withholds less or no money out of the employee's paycheck for U.S. income taxes. The employer keeps the form on file, and if the employee's situation changes, and they return to the US or fail to meet the qualifications for foreign income exclusion, usually because they have spent too many days in the US, they must fill out a Form W-4 to resume tax withholding.

Employers must keep in mind that their US citizen or resident alien employees living and working abroad must still fill out a Federal Tax Return, as well as a tax return in their country of residence, to be compliant with the tax laws of the country they’re residing in. Additionally, the employer may be required to pay corporate income tax in the foreign country where they have a permanent establishment or withhold tax or other taxes in the foreign country where they're paying talent.

As an employer hiring abroad, understanding Form 673, foreign earned income exclusions, and other tax-related requirements are crucial. Employers must ensure that their employees are aware of Form 673 and the criteria they must meet to claim the foreign earned income exclusion. Employers must also remain compliant with all relevant tax laws.

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