IRS Physical Presence Tests and Bona Fide Residence Tests Explained
US citizens who live and work outside the United States may be able to exclude some or all of their foreign-earned and self-employment from federal income tax.
They can do this through the Foreign Earned Income Exclusion (FEIE).
To qualify for the FEIE, a person needs to either work or reside outside the US and complete the Bona Fide Residence or Physical Presence Test to prove eligibility to the IRS.
The Bona Fide Residency test relates to economic and social ties.
The Physical Presence Test has to do with the number of days that are spent outside of the United States.
It is important to establish bona fide residence to save tax abroad.
A confirmed substantial presence test can also have tax benefits.
What are the basics of the Physical Presence Tests and Bona Fide Residence Tests?
As a tax advisor that owns real estate property investments in and outside of the US, I know that the Bona Fide Residence Test and Physical Presence Test can be difficult to navigate.
The Bona Fide Residence Test can be used if you think you are a bona fide resident of a foreign country (or countries) for an uninterrupted period of time that includes an entire tax year.
To meet the requirements for the Physical Presence Test, you must be physically present in a foreign country (or countries) for at least 330 full days during a 12-month period.
The days do not have to be consecutive.
Determining if you are a bona fide resident of a foreign country is determined by the facts of your situation and may include factors such as your intention of purpose for being in the foreign country, your activities in the foreign country, and whether you have paid taxes to the foreign country.
A bona fide resident is an individual that is either a US citizen or a US resident alien who is a citizen or national of a country with which the United States has a tax treaty in place.
You do not automatically gain bona fide residence status by living in a foreign country for a year.
You pass the Physical Presence Test (this applies to both US citizens and resident aliens from the US) if you are physically present for 330 qualifying days during a 12-consecutive-month period.
You can count the days you spent abroad for any reason, including employment or vacation time.
You will not meet the Physical Presence Test requirements if you are there due to an illness, an employer’s orders or family problems causing you to be in a foreign country for less than the required amount of time.
Are you paying too much tax as a bona fide resident?
According to the IRS, US ex-pats can use the Bona Fide Residence Test to be eligible for tax exclusions and tax benefits including the FEIE, the Foreign Housing Exclusion and/or the Foreign Housing Deduction.
The Bona Fide Residence Test enables you to prove to the IRS that you are a true resident of a foreign country.
Moving or living in a foreign country is not enough to gain tax benefits.
You meet the bona fide residence test if you are a bona fide resident of a foreign country for an uninterrupted period including an entire tax year.
If you are a calendar year taxpayer, an entire tax year is from 01 January to 31 December.
During your period of bona fide residence in a foreign country, you may leave that foreign country for brief or temporary trips back to the United States or other destinations, so long as you intend to return to your foreign residence.
It can also include a new foreign bona fide residence without unreasonable delay.
If you qualify, you will be classified as a bona fide resident starting from the date you began the residency and ending with the date you leave your foreign residence.
This means you could qualify as a bona fide resident for parts of one or two other tax years in addition to the full tax year of bona fide residency.
If you go to a foreign country to work for an indefinite or extended period and set up permanent accommodation there for yourself and your family, you will have effectively established a bona fide residence in a foreign country.
This is the case even if you intend to return eventually to the United States.
I recommend that you get professional tax advice to ensure you are not paying more tax than you need to as a bona fide resident.
Does being a bona fide resident have tax benefits?
The United States is one of only a few countries that taxes its citizens no matter where they live in the world.
If you are an American living abroad, you must file a US federal tax return and pay US taxes on your worldwide income regardless of where you reside at the time.
If you lived in a foreign country for at least a full tax year, earned foreign income and had no plans to return to the US, you would establish bona fide residence and thus allowing you to claim FEIE.
US ex-pats who pass the Bona Fide Residence Test are able to return to the United States for holidays.
The IRS determines Bona Fide Residency on a case-by-case basis.
What you should do next
I know from first-hand experience that getting the right tax advice is essential so that you can use the tax-saved money on more important aspects of your life.
The danger is that you read this article and then take no action.
Both tests have a time requirement for you to qualify, whether you’re looking at the bona fide resident or physical presence tests.
It is critical to take action to ensure that you save money on taxes.
I suggest that you book in time to speak to one of my team of US tax advisors and start saving more money for yourself today.