Let’s face it, Americans don’t have the best relationship with taxes and the IRS. According to a CBS News/YouGov survey, over 60% of Americans believe they’re paying more than their fair share on their US tax return.
Taxes are a particularly annoying issue as Americans still have to declare their income to the IRS wherever they live, whether they’re in Italy or living on Mars. It seems like no matter how far you want to run away, Uncle Sam will always be there to knock on your door.
The good news? American citizens and resident aliens can benefit from IRS tax savings while living abroad to avoid double taxation if they pass the Bona Fide Residence Test. In this article, we answer common questions from our clients about the Bona Fide Residence Test and how U.S. citizen expats can qualify.
What is the Bona Fide Residence Test?
The Bona Fide Residence Test from the IRS proves you’ve established a residency in another country. You must pass the Bona Fide Residence Test to benefit from the IRS’ tax savings exclusions, including the Foreign Earned Income Exclusion (FEIE) and Foreign Housing Exclusion (FHE).
According to the IRS, “you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. If you are a calendar year taxpayer, the entire tax year is from January 1st through December 31st.”
Bona Fide Residence Test vs. Physical Presence Test: What’s the Difference?
It’s essential not to get the Bona Fide Residence Test confused with the Physical Presence Test. While both tests help you qualify for the IRS tax exemption programs and avoid double taxation, they are not the same.
The Bona Fide Residence Test has to do with the social and economic ties that you have with your new home country. It means you must have already established permanent residency in a country without plans to return to the US.
On the other hand, the Physical Presence Test only has to do with the number of days you spend outside the US. To pass the test, you just need to spend more than 330 full days overseas across a 365-day period, which doesn’t necessarily need to align with the tax year. You can view this resource from the IRS to learn more about the test.
How Do I Qualify For Bona Fide Residence?
Nothing can 100% confirm that you’ll pass the Bona Fide Residence Test, since the IRS will review whether you qualify as a bona fide resident on a case-by-case basis. However, here are the main requirements to take advantage of the Bona Fide Residence test:
- – You have established residence in a foreign country of your choice.
- – You actively earn foreign income in your new country of residence. Unearned income such as dividends or pensions doesn’t count.
- – You don’t plan to return to the US anytime soon. For example, if you have a student visa, you won’t be able to qualify for bona fide residence.
- – You have proof of a foreign address or a permanent home. Documents such as utility bills and rental contracts will help your case.
- – You lived in your new home country for a full tax year, which is the same as the calendar year.
Other things that aren’t necessarily requirements but will help you qualify as a bona fide resident include documents such as proof of paying foreign income tax or an employment contract. If you have family members in your new home country, it will also help to prove that you’ve permanently made your new life abroad.
Can I Still Travel to the US as a Bona Fide Resident?
As a bona fide resident, you can return to the US for vacation without worrying too much about disqualifying yourself for the test. However, make sure to monitor the length of your stay. You must avoid spending too much time in the US throughout the tax year or doing anything else that would demonstrate intention to move back to the US, such as buying a personal residence, to avoid jeopardizing your bona fide resident status.
Examples of Bona Fide Residence
To help better understand the Bona Fide Residence Test, we’ve included two examples of when an expat might (or might not) qualify as a bona fide resident abroad:
You landed a job at a company based in the UK and moved to London in August 2020. The opportunity was supposed to be a temporary position and last three months, but you negotiate a permanent position and decide to purchase a home in the UK in December 2020.
In April of 2021, you went back to Chicago, Illinois (where you used to live before moving to the UK) for one week to visit friends and family. You returned to London right after that week and remained in the country for the rest of the year.
In this case, you spent an entire tax year (January 2021 – December 2021) in the UK. As a result, you may qualify for bona fide residence in the eyes of the IRS.
Your US-based tech company transferred you to Switzerland in August of 2020. You rent a home in the country and enjoy your new life in Switzerland until your company decides to move you back to the US in October 2021.
Technically, you did spend more than a year in Switzerland. However, you didn’t spend an entire tax year across a 12-month period in the country, which means you won’t be able to qualify for bona fide residence. What can we say? Life isn’t fair sometimes.
Need Help With Your Bona Fide Residence? Contact Bright!Tax Today
The Bona Fide Residence Test can be a difficult topic to navigate for American expats. If you still have questions about the test and whether you qualify, our tax team at Bright!Tax is here to help and offer guidance. Contact us today and one of our CPAs will reach back to you with answers on your US expat tax situation.