The Bona Fide Residence Test for Claiming the Foreign Earned Income Exclusion
For U.S. citizens living abroad, the foreign earned income exclusion (FEIE) is one of the most common ways to avoid the double taxation of income. The FEIE allows expats to exclude their foreign earned income up to a certain maximum amount each year.
This expat tax basic is familiar to most overseas filers and is usually claimed with little complication in the case of individuals who don’t spend much time in the US during the tax year, if at all.
For those who are physically present in the U.S. for more than 35 days, however, there is a second path to claiming the foreign earned income exclusion – namely the bona fide residence test.
In this blog, we take a deep into the nuances of the bona fide residence test and offer some practical examples as well.
The Basics of the Bona Fide Residence Test
The bona fide residence test is met if an individual is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year.
Unlike the 330-day physical presence test, the bona fide residence allows individuals to take longer temporary trips back to the U.S. as long as an intention is shown to return to the foreign country of residence.
Once an expat establishes bona fide residence in a foreign country for an uninterrupted period that includes an entire tax year, he or she qualifies as a bona fide resident starting with the date that the residency began. This means you can qualify for the FEIE as a bona fide resident for the partial year previous to the full tax year of bona fide residence.
Example:
Tom was a bona fide resident of the United Kingdom from March 1, 2017, through December 31, 2019. On January 1, 2020, he returned to the United States. Since he was a bona fide resident of a foreign country for all of 2018, he also qualifies as a bona fide resident from March 1, 2017 through the end of 2019. The exclusion amount for the 2017 tax year is prorated according to the portion of the year during which Tom qualified for the FEIE using the bona fide residence test.
Passing the Bona Fide Residence Test
The bona fide residence test is mostly a facts-and-circumstances test that weighs factors such as a person’s intention or purpose for being in the foreign country, as well as economic and social activities in the foreign country, among other factors.
Two factors in particular, however, are generally considered dispositive – you won’t satisfy the bona fide residence test if you make a statement to the authorities of the foreign country that you are not a resident of that country and the authorities hold that you are not subject to their income tax laws as a resident.
Taxpayers have the chance to state their case for the bona fide residence test on the Form 2555, which must be filed to claim the foreign earned income exclusion.
Filing Extension to Pass the Bona Fide Residence Test
While filing deadlines can normally be extended for 6 months, a further extension will be granted if the filer needs additional time to meet the the bona fide residence test (or the physical presence test) to qualify for the foreign earned income exclusion. To obtain such an extension, a taxpayer must file the Form 2350 by the due date for filing the tax return.
If you are granted the extension, it generally will last until 30 days beyond the date on which you can reasonably expect to qualify for an exclusion under the the bona fide residence test (or physical presence test).
Example:
Rob moved to Australia and established bona fide residence there on August 1, 2019. He then passed the bona fide residence test for the full 2020 tax year. He satisfied all the other FEIE requirements during this period as well. As a result, he qualifies for the FEIE for all of 2020 as well as a prorated portion of 2019. Rob does not qualify for the FEIE on his 2019 tax return until he’s established bona fide residence for all of 2020, meaning that he can’t file his 2019 tax return until 2021. The IRS allows for a special extension in such circumstances (applied for on the Form 2350). If Rob timely files this extension, the filing deadline for his 2019 income tax return will be January 30, 2021.
The Takeaway for US Expats
If you are a U.S. expat, we cannot understate the importance of accurately filing your U.S. tax return, including basics claims such as the foreign earned income exclusion.
We’ve helped many clients file their U.S. tax returns in a timely and accurate manner, and have assisted many others with coming into compliance with the IRS. We are available to help discuss your options and guide you through each step of the filing process. Contact us today!
