The Bona Fide Residence Test for US Expats

As an American, you’re subject to US income taxation, even if you live abroad. Therefore, you’re required to file a US tax return and report your worldwide income to the IRS. However, you may be allowed to exclude part of your income, if you’re a bona fide resident of a foreign country. As such, you would qualify for the Foreign Earned Income Exclusion. By claiming the Foreign Earned Income Exclusion, you’re allowed to exclude up to $120,000 of your foreign earned income. This amount is adjusted for inflation annually.

What is the Bona Fide Residence Test?

The Bona Fide Residence Test is a test used by the IRS to determine whether you qualify for certain tax benefits. As a bona fide resident of a foreign country, you may be eligible for the Foreign Earned Income Exclusion. In addition, you may be eligible for the foreign housing exclusion or deduction.

The Bona Fide Residence Test is a subjective test, meaning there is no set formula or checklist to determine whether you’re eligible. Whether you meet the requirements is determined based on your specific circumstances and intentions. The determination is made based on the information you report to the IRS on Form 2555. Form 2555 is filed as part of your US tax return. If you live, work and pay tax in a foreign country for a longer period of time (more than 1 calendar year), you would generally be considered a bona fide resident of that foreign country.

Can I Travel to the US and Still Meet the Bona Fide Residence Test?

Yes, it is possible to meet the Bona Fide Residence Test even though you travel to the US. The key factor is that you are a bona fide resident of a foreign country. You must have closer ties to the foreign country. If you work and live in the foreign country and pay tax in the foreign country, you’re generally considered a bona fide resident of the foreign country. Even if you intend to eventually return to the US. Short visits to the US while you’re a resident of a foreign country do not automatically disqualify you. As long as the frequency of those short visits do not establish a closer connection to the US.

The Physical Presence Test: If You’re Not Yet a Bona Fide Resident

To qualify for the Foreign Earned Income Exclusion, you must either be a bona fide resident or meet the Physical Presence Test. Whereas the first is a subjective test, the Physical Presence Test is objective. To meet the Physical Presence Test, you must demonstrate that you have been physically present in a foreign country for a specific time period. The determination is made on Form 2555. If you’re physically present in a foreign country for at least 330 full days during a 12-month period, you meet the test. The 12-month period can start at any time during the tax year. It does not necessarily have to be a calendar year.

A main difference between the two tests: In order to meet the Bona Fide Residence test, you must have been a bona fide resident for at least a full tax year. For the Physical Presence Test, any 12-month period can be used. When moving to a foreign country, you would generally meet the Physical Presence Test before the Bona Fide Residence Test.

Should I Claim the Foreign Earned Income Exclusion or Foreign Tax Credit?

Generally, the Foreign Earned Income Exclusion is more advantageous if you live in a country where the tax rates are lower than those in the US. However, the Foreign Earned Income Exclusion allows you to exclude ‘earned income’ only. Earned income includes wages and self-employment income. It does not include pensions and passive income such as dividends, interest, etc.

The basic idea behind the Foreign Tax Credit is to allow US taxpayers to reduce their US tax liability by the amount of income tax paid to the country where they live. This may be advantageous if the foreign tax rates are higher than those in the US. Also, you can claim a credit for foreign taxes paid on passive income and other unearned income.

Deciding whether to claim the Foreign Earned Income Exclusion or Foreign Tax Credit depends on your individual circumstances and the specifics of your income and tax situation. We’ll provide personalized advice based on your individual circumstances and help you optimize your tax benefits.

Questions?

Are you uncertain whether you meet the bona fide residence test? Don’t hesitate to contact us to ensure that you meet the requirement correctly. We’ll help you to maximize your tax benefits and minimize the risk of errors or discrepancies in your tax filing. We’ll also offer advice on tax planning strategies and ensure compliance with all relevant tax laws.