What to Expect, How to Prepare, and How to Win

A professional guide from a CPA with 20 years of expat audit experience

Being selected for an IRS examination is never fun. When the item under the microscope is your Foreign Earned Income Exclusion (FEIE) and (possibly) the foreign housing exclusion/deduction, the scrutiny tends to be exacting and intensely factual: Where did you live? Where did you work? For how many days? Who paid you, and for what services, performed precisely where?

Across two decades representing U.S. citizens and long-term residents working abroad—contractors, tech employees, consultants, teachers, NGO workers, offshore energy professionals, airline crew, and more—I’ve seen the same patterns repeat. This guide lays out:

• What typically triggers FEIE examinations
• The letters and notices you’ll receive, and what each means
• The questions examiners ask and why
• The documents that actually resolve cases
• Common failure points (and how to avoid them)
• Real-life scenario examples that mirror what happens in practice
• Practical response strategy from first notice to resolution

Why FEIE Claims Get Examined

Although some cases are selected randomly, most FEIE exams arise from one or more of these conditions:

1. Large exclusions or unusual patterns (high excluded wages plus low U.S. taxable income, layered with credits or housing claims).
2. Mismatch notices (e.g., third-party Forms W-2/1099 don’t reconcile to your return because you excluded income, or a Form 2555 was omitted or incomplete).
3. Inconsistencies (dates of presence abroad don’t track with passport stamps, travel history, payroll records, or your claimed tax home).
4. Technical eligibility risks, for example:
   • Using bona fide residence while spending substantial time in the U.S.
   • Claiming physical presence but miscounting “330 full days” or including days in international waters/airspace that don’t qualify as presence “in a foreign country.”
   • Employer/payor issues (U.S. government wages are not excludable; U.S.-based work days are not excludable even if you live abroad).
5. Process flags (missing or late responses to earlier IRS notices, or inconsistent reporting across years).

Bottom line: the FEIE is generous; the IRS expects you to prove you meet every statutory and regulatory requirement each year you claim it.

What IRS Letters and Notices Look Like (and What to Do)

Most expat FEIE audits are correspondence examinations handled through mail and, often, secure fax. Expect some mix of the following:

• Initial Examination Letter (e.g., Letter 566/Letter 525)
  Tells you which return items are under review (e.g., Form 2555, housing). Usually provides ~30 days to respond and lists the documents requested. You may also see an Information Document Request (Form 4564) and/or a short questionnaire tailored to FEIE (dates abroad, housing, employer details).
  Action: Calendar the due date, request extra time if needed, and start assembling a clean, indexed response package.
• CP2000 (Underreporter)
  Not technically an “audit,” this proposes changes because information from third parties doesn’t match your return (common if FEIE wasn’t properly reflected or Form 2555 wasn’t attached).
  Action: Respond with your reconciliation and the supporting Form 2555/worksheets; many FEIE matters die here if you clearly document the exclusion.
• 30-Day Letter / Examination Report (Form 4549)
  If the examiner proposes adjustments (e.g., partial or full disallowance of FEIE/housing), you’ll receive a report and appeal instructions.
  Action: Engage promptly. You can agree, submit additional documentation, or send a protest to request Appeals.
• Notice of Deficiency (CP3219A / Letter 3219)
  If no agreement is reached, the IRS issues a statutory notice giving you 90 days (or 150 days if addressed to you outside the U.S.) to petition U.S. Tax Court.
  Action: Do not ignore this. Either petition Tax Court by the deadline or resolve with the examiner/Appeals before the clock runs out.
• Resolution Letters
  “No change,” “agreed tax due,” or closing agreements. If tax remains due, you’ll receive billing notices and can establish an installment agreement if needed.

The Questions Examiners Ask (and What They’re Testing)

Think of the FEIE exam as a structured interview with receipts. The questions map directly to the statute:

1) Residence/Presence and Tax Home

• Which test are you using? Bona fide residence or physical presence (330 full days in any 12-month period).
• Tax home: Where was your main place of business/employment? Did you maintain a U.S. abode?
• Dates: Exact entry/exit dates for each country; days in the U.S.; any moves during the year (or prior year) relevant to establishing status.

Why it matters: You must have a foreign tax home and meet one of the two tests. For physical presence, the count is full days—partial travel days usually don’t count. For bona fide residence, examiners look for an intent to reside plus objective ties (long-term lease, local taxes, community integration, etc.).

2) Where Services Were Performed

• Where did you physically perform services?
• Any U.S.-work days? International waters or airspace?
• Employer location and nature (U.S. government pay is not excludable).

Why it matters: FEIE applies to income for services performed in a foreign country. Services performed in the U.S. are taxable. Services performed in international waters/airspace typically do not qualify as performed “in a foreign country,” and those days don’t count for the 330-day test.

3) Employer/Compensation Structure

• Employer identity and location; if self-employed, client base and where services were performed.
• Comp elements: salary, allowances (housing, COLA, education), bonuses, equity/RSUs, tax equalization.
• Housing: employer-provided quarters vs. out-of-pocket costs.

Why it matters: The FEIE and housing rules have caps, pro-rations, and employer-paid adjustments. Examiners reconcile pay records to what you excluded.

4) Foreign Housing Exclusion/Deduction (if claimed)

• Housing period and location; actual costs (rent, utilities, insurance), who paid what, and high-cost city limitations.
• Evidence: lease, receipts, employer statements, reimbursement breakdowns.

Why it matters: Housing claims are often mis-computed (double-counting employer payments or exceeding local caps).

5) Consistency and Compliance

• Foreign filings/taxes (not required to claim FEIE, but corroborative).
• Prior-year Form 2555 if your qualifying period spans years.
• Election issues, revocations, and timing (e.g., late elections).

Why it matters: Consistency strengthens credibility; gaps trigger follow-ups.

The Documents That Win FEIE Audits

Organize your response in a logical binder (physical or digital) with a simple table of contents. Send copies, not originals.

Core identity & timeline

• Passport ID and all relevant visa pages
• Stamped entry/exit pages (and any available travel itineraries/airline receipts)
• Travel log (clean spreadsheet listing every entry/exit by country; totals of foreign vs. U.S. days)

Foreign residence & tax home

• Lease/mortgage abroad (full term), utility bills, local bank/credit statements mailed to foreign address
• Employer assignment letter or employment contract stating work location and period
• If self-employed: client contracts/invoices stating where services were performed

Income & payroll

• Foreign wage statements / year-end summaries
• Pay stubs showing work location/allowances; employer letter confirming where services were performed
• Bank statements (salary deposits highlighted); bonus/equity statements

Housing (if claimed)

• Itemized housing worksheet with receipts (rent, utilities, insurance, parking, furnishings)
• Employer reimbursement statements or payslip notations for allowances

Foreign tax corroboration (if applicable)

• Foreign return and tax receipts/assessments (helps demonstrate bona fides and source)

Computation support

• Your Form 2555 worksheets; pro-ration for partial-year qualification; housing cap calculations; any FEIE/FTC interaction adjustments (if you also claimed foreign tax credits on non-excluded income).

Presentation matters: Label everything, paginate, and cross-reference. A tidy set often shortens the exam.

Frequent Failure Points (Learn These Before You File—Not During an Audit)

1. Counting days incorrectly (physical presence): forgetting that travel days are often not full days, mis-aligning the 12-month period, or including international waters/airspace days.
2. Over-reliance on bona fide residence while spending extensive time in the U.S. each year; or maintaining a stronger U.S. abode than foreign ties.
3. U.S. work days sneaking into foreign payrolls (e.g., remote days in the U.S., rotations, trainings).
4. Housing: double-counting employer-paid amounts; not applying high-cost limits; claiming in a location or period that doesn’t qualify.
5. Missing Form 2555 or errors in the election/timing; inconsistent positions across years.
6. Documentation gaps: no leases, no travel proof, no employer letter—forcing the examiner to assume the worst.
7. Silence: failing to respond on time turns winnable cases into default assessments.

Strategy: How to Respond—Step by Step

1. Read the letter carefully and note each requested item. Start a checklist.
2. Ask for time if you need it—before the due date.
3. Build a clean narrative (one or two pages) that:
   • States your test (bona fide vs. physical presence), tax home, and qualifying period
   • Summarizes the nature and place of services performed
   • Explains any U.S. trips (brief, temporary) and any international-waters/airspace exposure (carved out if applicable)
   • Reconciles payroll to Form 2555 (including housing and any employer reimbursements)
4. Attach organized proof, indexed to your narrative (A: Travel; B: Residence; C: Employment; D: Income; E: Housing; F: Foreign tax; G: Computations).
5. Keep to scope: answer precisely what’s asked; don’t volunteer unrelated years/issues.
6. If proposed changes arrive (Form 4549), analyze calmly:
   • Agree where they’re right;
   • Refute with targeted evidence where they’re wrong;
   • Appeal if needed.
7. If a Notice of Deficiency is issued, calendar 90/150 days and decide: settle, appeal internally (if still available), or petition Tax Court.

Real-Life Scenarios (From the Trenches)

Scenario A: The Borderline 330-Day Consultant

• Facts: U.S. consultant stationed in Lisbon for a year, frequent client travel across the EU, three U.S. trips (total 29 days).
• Issue: Physical presence—“full days” vs. partial days; two travel days initially miscounted as full.
• What worked: A corrected travel log and flight records demonstrating 330 full days abroad within a shifted 12-month window (legally permissible). Housing receipts reconciled to employer stipend.
• Outcome: No change after examiner verified day counts and housing pro-ration.

Scenario B: The Offshore Engineer

• Facts: Salaried engineer assigned to West Africa, paid by non-U.S. affiliate; significant time on a vessel outside territorial waters.
• Issue: FEIE applies to services in a foreign country—days in international waters did not qualify; examiner asked for ship logs and port calls.
• What worked: Conceded non-qualifying days/income; recomputed FEIE and housing for in-country days only; supported with employer letter and port documentation.
• Outcome: Partial allowance; assessment reduced; penalties abated for reasonable cause due to complex facts and cooperative conduct.

Scenario C: The Bona Fide Resident With Too Many Stateside Weeks

• Facts: Airline crew member based abroad with a long-term lease, foreign taxes paid, but ~110 days in the U.S. each year for family visits and recurrent training.
• Issue: Examiner challenged intent to reside abroad; U.S. time appeared more than “temporary visits.”
• What worked: Switched to physical presence test for the audited year using a favorable 12-month window; produced meticulous travel proof and employer duty schedule; removed a handful of U.S. training days from exclusion.
• Outcome: Allowed under physical presence; small adjustment; no penalties.

Scenario D: The Omitted Form 2555 (CP2000 Case)

• Facts: Remote software engineer in Korea; e-file glitch omitted attached Form 2555; IRS issued CP2000 proposing to tax all wages.
• Issue: Mismatch between W-2 equivalent and return; not a full audit.
• What worked: Reply package with signed Form 2555, presence calendar, employer letter, and lease.
• Outcome: Adjustment withdrawn; case closed.

Penalties, Appeals, and When to Get Help

• Penalties (e.g., accuracy-related) are not automatic. If you kept good records, acted in good faith, and respond diligently, you can often secure penalty relief.
• Appeals is independent within the IRS and can be pragmatic, especially on close factual calls (residence intent, day counts, housing substantiation).
• Tax Court preserves your rights if a statutory notice arrives—use the 90/150-day window. Many cases settle before trial.
• Professional help is worth it if facts are messy, time is short, or you’re unsure how to present computations (particularly FEIE/foreign tax credit coordination and housing pro-rations).

Quick Prep Checklist (Print This)

• Identify your test (bona fide vs. physical presence) and tax home
• Build a precise travel log; verify 330 full days if using physical presence
• Compile passport stamps, tickets/itineraries
• Gather lease/utility/bank proofs for foreign residence
• Obtain employer letter confirming where services were performed and any allowances
• Collect pay stubs, year-end wage statements, and bank deposit proofs
• Prepare housing worksheet with receipts and employer reimbursement details
• Reconcile Form 2555 computations (and housing caps) to payroll facts
• Draft a 2-page narrative tying the evidence to the law
• Index and transmit only what’s requested, on time (ask for an extension if needed)

Final Word

FEIE exams reward precision. If you can demonstrate where you lived, where you worked, for how long, and how you computed the exclusion—and you support each claim with tidy, labeled proof—your odds are excellent. Most adverse outcomes I’ve seen were avoidable: missed deadlines, weak day-count support, or muddy housing records. Treat your first response as your best day in “court,” and you’ll often be done after one round.

Frequently Asked Questions (FAQ) About FEIE Audits

Q1: How likely is it that my Foreign Earned Income Exclusion will be audited?
While overall audit rates for individuals have declined, expat returns with FEIE claims are still audited more often than average. This is because FEIE claims often eliminate nearly all U.S. taxable income, which naturally raises IRS scrutiny. Automated mismatch notices (like CP2000) are also common triggers.

Q2: What is the first letter I’ll get if the IRS questions my FEIE?
Most taxpayers first see a Letter 566 or Letter 525—a correspondence audit notice asking for proof of your FEIE eligibility. Sometimes, if it’s a data mismatch, you’ll see a CP2000 proposing additional tax before a full audit begins.

Q3: What happens if I ignore the audit notice?
If you don’t respond, the IRS will treat your FEIE as disallowed and issue a Notice of Deficiency. At that point, you’ll owe full U.S. tax on the income, plus interest and possibly penalties. You’ll still have rights to Tax Court (90 days if in the U.S., 150 if abroad), but ignoring notices almost always worsens your position.

Q4: How does the IRS count days for the Physical Presence Test?
They only count full days in foreign countries. Travel days to or from the U.S. generally don’t count. Days spent in international waters or airspace don’t count as “foreign country” days either. Missing this detail is one of the most common audit failures.

Q5: What if my employer is a U.S. company, but I worked entirely overseas?
If you worked outside the U.S. for a U.S. private employer, your wages still qualify as foreign earned income (assuming you meet presence/residence tests). However, if your wages were paid by the U.S. government or a related agency, they are not excludable, no matter where you worked.

Q6: Will the IRS ask for my foreign tax returns?
They often do, especially if you claim bona fide residence. While paying foreign taxes isn’t required to qualify for FEIE, having those records strengthens your case that you truly lived abroad with a foreign tax home.

Q7: Do I need to submit every single receipt for housing expenses?
Usually, you’ll be asked to provide a summary worksheet of your housing expenses with representative receipts (lease, rent payments, utilities). If the auditor senses inconsistencies, they may request more detailed documentation.

Q8: How do I prove my intent to reside abroad (for bona fide residence test)?
Evidence includes long-term leases, family relocation, local tax registration, school enrollment for children, and integration into the local community. If your trips to the U.S. are lengthy or frequent, you’ll need especially strong proof of foreign ties.

Q9: Can I lose FEIE if I spend too much time in the U.S. visiting family?
Yes. If you’re using bona fide residence, extended or repeated U.S. visits may show your “real home” is still the U.S. If you’re using physical presence, those days in the U.S. simply don’t count toward the 330-day requirement, which may disqualify you if your margin is too tight.

Q10: What penalties could apply if I lose the audit?
The most common is the 20% accuracy-related penalty on the underpaid tax, plus interest. In rare cases, negligence or substantial understatement penalties can apply. Criminal penalties are virtually unheard of in FEIE audits unless there’s fraud or intentional concealment.

Q11: Can I switch from Bona Fide Residence to Physical Presence during an audit?
Yes, if your facts support it. Many taxpayers claim bona fide residence initially but pivot to physical presence during an audit when U.S. travel patterns undermine their case. Both tests are valid, and you only need one.

Q12: What’s the difference between a “no change” audit and a “partial allowance”?

• No change: IRS accepts your return as filed, nothing owed.
• Partial allowance: IRS disallows some portion of the FEIE or housing but not all. For example, they may remove 20 days that were U.S. or international waters, but allow the rest.

Q13: Do I need a CPA to represent me in an FEIE audit?
Not always. If your return is straightforward and you have good records, you can often handle a correspondence audit yourself. But if facts are messy, deadlines tight, or computations complex (especially involving both FEIE and foreign tax credits), hiring an experienced CPA or EA can make the difference between success and an expensive adjustment.

Q14: Can I appeal if I disagree with the audit result?
Yes. After the exam report, you can appeal within the IRS by filing a protest. If you get a Notice of Deficiency, you can petition U.S. Tax Court. Many cases are settled in Appeals or before trial in Tax Court.

Q15: Will being audited for FEIE affect future years?
Potentially. If the audit uncovers an error pattern (e.g., you miscount days each year), the IRS may look at other years. Conversely, if you prevail and establish clear facts, future returns with the same pattern may be less likely to be challenged.

Q16: What if I moved mid-year? Can I claim FEIE for part of the year?
Yes. The FEIE can be prorated. You’ll need to prove when you moved and provide evidence (lease, employer records, moving documents). Auditors will check that you didn’t over-claim days or exclude income earned while still U.S.-based.

Q17: How long does an FEIE audit usually take?
Most correspondence audits run 3–9 months. Complex cases (e.g., multiple countries, employer letters needed, appeals) can take a year or more. Patience is required, but a clean, well-documented response often speeds closure.