Using the Physical Presence Test Towards Your Expat Tax Returns
Many Americans living abroad believe that to qualify for the tax benefits such as the foreign tax credit, you simply have to reside abroad. There are a number of qualifying factors that will need to be met in order to leverage many available expat tax allowances. To qualify for the credits on your earned foreign income and allow the maximum tax savings on your expat tax returns, you will have to pass one of two tests: either the bona fide residence test or the physical presence test. This article discusses the physical presence test and how meeting its qualifications will grant you access to expat tax benefits such the foreign tax credit, foreign earned income exclusion, and foreign housing credit, among others.
How to Qualify When Filing Your Expat Tax Returns
To qualify for the expat tax allowances using the physical presence test, a taxpayer must meet three requirements:
- The taxpayer must have earned foreign income. This includes salaries, wages, bonuses, and even self-employment income. This does not include dividends, interest, pension distributions and/or capital gains. Of course these lists are not comprehensive, but they comprise the most common forms of income.
- The taxpayer must have a “tax home” in a foreign country. This is perhaps the most misunderstood aspect of qualifying for expat tax benefits. A tax home is where a person is permanently or indefinitely is engaged in work, regardless of where their personal residence is. To establish a tax home, a person must have a work engagement expected to last at least a year. Furthermore, if you have retained a personal residence (aka “abode”) in the United States, you cannot be considered to have a “tax home” in a foreign country. The IRS explains this requirement more on its website.
- Lastly, to qualify for the expat tax exclusions and credits using the physical presence test, a taxpayer must be physically present in a foreign country for at least 330 days out of a 365-day period.
What is a 365-Day Period?
The 365 days (“qualifying period”) does not have to be on a calendar-year basis. The period can be adjusted to span two years as needed to show the qualification. For example, if a taxpayer has a work assignment lasting between August 2011 and October 2012, they could meet the physical presence test in both the 2011 and 2012 years, as long as they did not return to the states for more than 35 days during that period. However, it should be noted that expat tax allowances, such as the foreign earned income exclusion amount, is prorated based on the number of days within the qualifying period that fall within the calendar year. In the example above, let’s assume that the taxpayer’s qualifying 365 period for his 2011 taxes will be 8/1/2011 – 7/31/2012 (153 days). Let’s also assume no return travel to the US. In this example, the amount of income excludable under foreign earned income exclusion would be calculated as follows:
What If I Return to the US for Work?
As far as the IRS is concerned, your reasoning for returning to US is irrelevant. You can be in the US for work, sickness, vacation, or any other reason and it will still “count against you” in the 330 day requirement. However, this stipulation also goes both ways. You can use anytime you spend in a foreign country, whether for vacation or work, as part of your 330 day qualification period. Many American expats structure their vacation time with their family in a foreign country as opposed to coming back to the States, just to ensure continued qualification for the foreign earned income exclusion.
What About Travel Time?
This is where things can get a little sticky. Per the IRS rules, you must spend 330 full days in a foreign country to qualify. Partial days and travel spent over international water do not count toward the 330 day requirement. A full day will begin and end at midnight. In the event of an audit, the IRS will verify travel days by referencing passports. If further information is needed, or the qualification period is barely being met, the IRS may also request airline reservation records.
For more information about the physical presence test, please see the IRS website.
Need Help with Your Expat Tax Returns?
If you have questions about the physical presence test, your qualifications regarding the foreign earned income exclusions and foreign tax credit, or would like our help filing your US expat tax returns, please contact us.