Today guest blogger Chris Rusch, tax attorney specializing in international taxation and foreign corporate formations is back to talk about the Bona Fide Residency Test. The Bona Fide Residency Test is one of the ways you can qualify for the U.S. Foreign Earned Income Exclusion (FEIE). Chris explained FEIE in a previous post - part 1 of this article.
Bona Fide Residency Test
The bona fide residency test is one of two ways of qualifying for the U.S. Foreign Earned Income Exclusion and one of the most misunderstood and misused sections of the tax code by those working and living abroad...especially by contractors in military zones.
You are a bona fide resident if you move to a foreign country and make it your home. You do this by filing and paying taxes in that country, moving there and planning to stay indefinitely, etc.
The perfect example of a resident is someone who moves to a foreign country, does not intend to return to the U.S., files and pays taxes in that country, is on a long term visa that allows them to work in that country, they sell their U.S. home an buy one in the foreign country, and they relocate with their family.
The problem with the residency test is that very few cases are perfect. For example, a husband might move to France to work indefinitely, leaving his family in California, may return to the US for 40 days per year to visit, and intends to return as soon as financially possible. He might have a high probability of being allowed the Exclusion, assuming he is out of the U.S. for at least one year, but it will depend on the many facts and circumstances of his situation.
Also, being out of the U.S. for one calendar year does not make you a resident of a foreign country. For example, if you go to a foreign country to work on a particular construction job for a specified period of time, say 14 months, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for one tax year or longer. The length of your stay and the nature of your job are only some of the factors to be considered in determining whether you meet the bona fide residence test.
If the residency test is so complex, why should you use it? Most importantly, it allows you to return to the U.S. for a few months each year, rather than only 35 days. Second, once you qualify as a resident of a foreign country, you will remain a resident of that country until you give up that residency. With the 330 day test, you must be out of the country for 330 of each 365 day period. With the residency test, you can qualify for all or part of a year. Here is an example from the IRS website:
You were a bona fide resident of England from March 1, 2006, through September 14, 2008. On September 15, 2008, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2007, you also qualify as a bona fide resident from March 1, 2006, through the end of 2006 and from January 1, 2008, through September 14, 2008.
Conclusion
I hope this article sheds some light on the misunderstood Foreign Earned Income Exclusion. It is a great benefit to those living and working abroad and can significantly reduce your U.S. tax obligations.
However, if you are audited and you have not filed your returns, you will lose this deduction and pay U.S. tax on all of your income. In other words, use it or lose it!
YOUR EXPAT SUCCESS TIP: If you are an American abroad and are not sure of whether you qualify for the Foreign Earned Income Exclusion, contact a qualified tax professional who can help you sort out how best to handle your taxes and maximize your income while you are living and working overseas.
YOUR THOUGHTS? What are your experience with FEIE? Are you aware of it? Are you using it to maximize your income while abroad? Share your experience with fellow expats here.
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Excellent information in a very concise and succinct article. Thank you.
Posted by: Lynn | April 2012 at 01:11