Bona Fide Residence Test vs. Physical Presence Test

For U.S. expatriates, understanding the Foreign Earned Income Exclusion (FEIE) is crucial for tax planning and compliance. The FEIE allows qualifying U.S. citizens and resident aliens to exclude a certain amount of their foreign earnings from U.S. taxation. To claim this exclusion, expats must pass either the Bona Fide Residence Test or the Physical Presence Test. The information below will help explain the differences between these two tests and the basic criteria for each.

However, it's important to note that an experienced expat tax expert is your best bet to avoid mistakes and unnecessary fines and other penalties.

Bona Fide Residence Test

The Bona Fide Residence Test is designed for individuals who establish a long-term residence in a foreign country. To qualify, an expatriate must:

• Be a U.S. Citizen or Resident Alien: Only U.S. citizens and resident aliens are eligible to use this test.
• Be a Bona Fide Resident of a Foreign Country for an Entire Tax Year: The individual must reside in a foreign country for an uninterrupted period that includes an entire tax year (January 1 to December 31).
• Establish a Permanent Home Abroad: The expatriate must have a settled intention of staying in the foreign country indefinitely. Temporary trips to the U.S. or other countries for vacation or business do not necessarily affect the residency status, as long as the primary residence remains abroad.
• Provide Evidence of Residency: Factors such as the nature and purpose of the stay, type of residence, and participation in local activities can be used to establish bona fide residency. Owning property, having a family abroad, and integrating into the local community are indicators of bona fide residence.

Advantages of the Bona Fide Residence Test

• Flexibility: Allows for more flexibility in travel and temporary returns to the U.S.
• Stability: Ideal for expats with long-term assignments or those planning to reside abroad indefinitely.

Disadvantages of the Bona Fide Residence Test

• Subjective Nature: Determining bona fide residency can be subjective and may require substantial documentation.
• Time Requirement: Requires residency for an entire tax year, which might not suit short-term assignments.

Physical Presence Test

The Physical Presence Test is more straightforward and is based on the number of days an expatriate is physically present in a foreign country. To qualify, an expatriate must:

• Be a U.S. Citizen or Resident Alien: As with the Bona Fide Residence Test, only U.S. citizens and resident aliens are eligible.
• Be Physically Present in a Foreign Country for 330 Full Days During a 12-Month Period: The 330 days do not need to be consecutive but must fall within a continuous 12-month period. The days spent in foreign countries can be combined, and brief trips to the U.S. are allowed, as long as the 330-day threshold is met.
• Count Full Days: A full day is a 24-hour period beginning at midnight. Travel days into or out of a foreign country do not count as full days abroad.

Advantages of the Physical Presence Test

• Objective Criteria: The test is based on clear, quantifiable days, making it easier to determine eligibility.
• Flexibility in Timing: The 12-month period can begin on any day, allowing for flexibility in planning.

Disadvantages of the Physical Presence Test

• Strict Time Requirement: Requires careful tracking of days and limits time that can be spent in the U.S.
• Less Suitable for Frequent Travelers: Frequent business travelers or those with family obligations in the U.S. might find it challenging to meet the 330-day requirement.

Choosing Between the Bona Fide Test and the Physical Presence Test

Deciding which test to use depends on an expatriate's specific circumstances and lifestyle. Those with long-term assignments or permanent moves abroad may find the Bona Fide Residence Test more suitable due to its flexibility and recognition of their permanent residence status. On the other hand, expatriates on short-term assignments or those with more transient lifestyles might prefer the Physical Presence Test for its clear and objective criteria.

Importantly, IRS.gov notes the following as exceptions:

There are two exceptions to meeting the minimum time requirements under the bona fide residence and the physical presence tests: (1) the waiver of time requirements allows a taxpayer the foreign-based tax benefits when they are forced to leave certain countries early due to war or unrest, and (2) U.S. travel restrictions for certain countries preclude a taxpayer from accruing qualifying time in a restricted country.

Read more on IRS.gov about the Exceptions to the Bona Fide Residence and the Physical Presence Tests

Key Considerations

• Documentation: Maintain thorough records of travel dates, residency status, and other relevant information to support the chosen test.
• Tax Planning: Consult with a tax advisor to determine the most advantageous test based on individual circumstances and to ensure compliance with all requirements.
• IRS Scrutiny: Be prepared for potential IRS scrutiny and provide adequate documentation to substantiate the claim for the FEIE.

Understanding the differences between the Bona Fide Residence Test and the Physical Presence Test is essential for U.S. expatriates seeking to maximize their tax benefits under the Foreign Earned Income Exclusion. By carefully evaluating their residency status and travel patterns, expats can make informed decisions that align with their financial and lifestyle goals.

Every person or couple has a unique situation and neither this article or any other like it out on the web will provide you with all of the information for every possible situation. You'll see that there are links to the appropriate IRS pages at the bottom. As noted earlier, an experienced expat tax professional is your best bet to avoid unnecessary mistakes, fines and other penalties.

Learn More About the Bona Fide Residence Test, Physical Presence Test, and the Foreign Earned Income Exclusion and more

• The IRS provides tax information on its website for International Tax Payers who are "foreign persons with income in the U.S. or U.S. citizens and resident aliens with income outside the U.S."

Sources:

• IRS.gov: Bona Fide Residence Test
• IRS.gov: Physical Presence Test
• IRS.gov: Foreign earned income exclusion
• IRS.gov: Exceptions to the Bona Fide Residence and the Physical Presence Tests