Withholding US Income Tax for an Employee Working Abroad

When a US company keeps a US citizen on its payroll while they work abroad, US federal income-tax withholding does not stop by default. The wages remain subject to withholding unless the employee files a specific form to claim the foreign earned income exclusion, and even then the relief covers income-tax withholding only, not Social Security or unemployment tax. There is also a widely repeated 401(k) misconception that costs employees retirement savings they are actually entitled to make. This guide sets out the default withholding rule, Form 673, the 2026 exclusion and housing figures, and how the exclusion does and does not interact with payroll and retirement contributions.

Withholding continues by default

A US employer generally withholds US federal income tax on a US citizen's wages even when the work is performed abroad. The IRS treats wages paid by a US person to a US citizen for services outside the United States as subject to federal income-tax withholding, with two main exceptions: where the employer is required by a foreign country's law to withhold that country's income tax, or where the employee furnishes Form 673 to claim the foreign earned income exclusion. In a Gulf market with no personal income tax, the first exception does not apply, so withholding continues unless the employee files Form 673. Moving a US citizen abroad therefore does not, by itself, switch off US income-tax withholding.

Form 673 is the employee's switch, not the employer's

Form 673 is the statement an employee gives the employer to stop federal income-tax withholding on wages the foreign earned income exclusion will cover. Its full title is the Statement for Claiming Exemption From Withholding on Foreign Earned Income Eligible for the Exclusion(s) Provided by Section 911, and the form is given by the employee to the employer, not filed with the IRS. The employer may then stop withholding on the covered amount, but it remains liable to withhold if it has reason to believe the employee will not qualify for the exclusion. Form 673 is available to US citizens, not resident aliens, and it is the mechanism that aligns withholding with an exclusion the employee expects to claim.

The foreign earned income exclusion and housing amounts for 2026

The foreign earned income exclusion lets a qualifying US citizen exclude up to USD 132,900 of foreign wages from federal income tax in 2026. Qualification depends on meeting either the bona fide residence test or the physical presence test, and the exclusion is claimed on Form 2555. A separate foreign housing exclusion can cover qualifying housing costs above a base amount, up to a general limit, with higher limits in listed high-cost cities. The 2026 figures are set out below.

2026 amount	Figure
Foreign earned income exclusion	USD 132,900 (up from 130,000 in 2025)
Foreign housing, base amount	USD 21,264
Foreign housing, general expense limit	USD 39,870 (higher in listed high-cost cities)

The foreign tax credit on Form 1116 is the alternative to the exclusion, but in a Gulf state with no personal income tax there is little or no foreign tax to credit, so the exclusion is usually the relevant relief.

Form 673 stops income-tax withholding only

Form 673 and the exclusion affect federal income-tax withholding only, not Social Security, Medicare, or federal unemployment tax. Social Security and Medicare run on the separate American-employer and totalization rules, and because the United States has no totalization agreement with any Gulf state, those taxes can continue regardless of Form 673, as the guide to US employers and Social Security for staff in the Gulf explains. Federal unemployment tax also continues for a US citizen working abroad for an American employer, alongside the state tax questions a relocation raises. Filing Form 673 therefore reduces one withholding stream, not the whole US payroll-tax footprint. Keeping a US citizen on the US payroll while they work abroad means administering income-tax withholding, Social Security, Medicare, federal unemployment, and state tax in parallel, on top of the host country's own payroll and the local visa sponsorship the worker needs to be there at all. That multi-jurisdiction stack is what an employer of record removes by becoming the legal employer in the host country.

The 401(k) point most companies get wrong

Foreign earned income excluded under the exclusion still counts as compensation for a 401(k), so an employee can defer into the plan even though the wages are excluded from income tax. Plan compensation for qualified-plan purposes is determined without regard to the section 911 exclusion under Treasury regulations, so an employee whose wages are fully excluded is not shut out of 401(k) elective deferrals, a point often stated the wrong way round. The individual retirement account rules are different and more restrictive, because excluded foreign earned income is generally not treated as compensation for IRA purposes, so whether an employee who excludes their wages can still contribute to an IRA depends on the size of the exclusion and the income phase-outs. Because the IRA and 401(k) rules diverge on exactly this point, the position should be confirmed with a tax adviser.

What a US company should set up

A US company employing a US citizen abroad sets up the withholding position once, at the start of the assignment. Where the employee expects to qualify for the exclusion, they file Form 673 with the employer so income-tax withholding is adjusted, while the employer keeps running Social Security, Medicare, and federal unemployment tax and coordinates the state withholding position. Where the worker is instead employed by a local entity or an employer of record abroad, US income-tax withholding falls away for those wages because the US company is no longer the employer, leaving the US-side questions only for staff kept on the US payroll. For employing staff in the Gulf without running US payroll across the border, see the Employer of Record service.

About Aspirock

Aspirock is an Employer of Record and payroll provider operating across 70+ countries, with six global offices and over 22 years of combined experience supporting more than 5,000 workers. Every client works with a named account team that owns the deployment end to end, so contracts, payroll, visas, and compliance filings in each market are handled by people accountable for the outcome. For employer-of-record and international payroll support, see the Employer of Record service page.

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