Living abroad is becoming an increasingly attractive option for US Americans each year as it offers many lifestyle benefits. In addition, being a bona fide resident in a foreign country has a major tax benefit, the Foreign Earned Income Exclusion (FEIE).
This exclusion allows the taxpayer to exclude from income tax up to $104,100 (2018) of salary that they earn while living abroad. However, to be eligible for the exclusion you must qualify through one of two tests: the bona fide residency test or the physical presence test.
Many expats like the physical presence test because the requirements are clearly defined. Under this test, you must spend at least 330 full days in a 12 month period in a foreign country.
However, the bona fide residency test is the most popular way to qualify for the FEIE as it has added advantages. It gives you the option to go back to the US for more than 35 days for family issues, social or work reasons.
Tax benefits for expats in general
Some tax benefits for expats are the same, no matter if they qualify under the bona fide residence or physical presence test. These benefits include:
Foreign Earned Income Exclusion (FEIE)
As mentioned above, the foreign earned income exclusion allows a taxpayer to exclude up to $101,300 (2016) of salary they earn abroad each year from being taxable in the U.S. This amount increases due to inflation every year. Be aware that this exclusion does not apply to passive income such as dividends and capital gains. It is limited to active income such as salary.
Foreign Housing Exclusion
If you qualify for FEIE, you might also be able to deduct certain foreign housing expenses such as rent and utilities to increase your savings even more. The deductible amount depends on the cost of living of the city you are living in. Only amounts above the base amount (around $16,000) are eligible.
Affordable Care Act
Americans who live abroad and qualify for the FEIE are exempt from holding minimum essential health coverage. They are therefore not subject to penalty.
Additional benefits of being a bona fide resident
Bona fide residents of a foreign country enjoy some additional advantages:
The IRS does not provide a clear definition of what constitutes a bona fide resident of a foreign country. Therefore you can demonstrate it through many factors. Due to the lack of instruction however, it can be more subjective. This makes it harder to prove that a taxpayer qualifies for the exclusion through the bona fide residency test as opposed to the physical presence test.
Trips to the US
Even as a bona fide resident, you can return to the US during the year without worrying about spending a specific number of days. However, you should generally not spend more than 3 months in the US when claiming bona fide residency. Please also note that any work performed in the US is taxable and not subject to the foreign earned income exclusion. The FEIE is calculated on a pro rata basis.
How to qualify as bona fide resident
In short, you pass the bona fide residency test if you are living overseas for more than one year and have no immediate intentions of returning to live in the US permanently.
However, the IRS does not provide a clear-cut definition of bona fide residency. Unlike the physical presence test, which merely requires counting days outside the US (and knowing the specific rules on how to count), bona fide residency can be demonstrated through many factors. These factors include your intention to stay, length of stay, returning to the foreign country after trips, etc.
The important part of claiming your bona fide residency is having various documents to show that you are a resident. Of course, a long term visa or passport of your resident country is helpful, so are any local tax filings. In addition any documentation of local ties and your intention to stay will help prove the bona fide residency, including:
- Health insurance
- Long term lease or purchased home
- Utilities and other bills
- Gym membership
- Local bank accounts
- Resident ID card
- Family or spouse from the country.
Are you unsure which test to use or need help filing your expat tax return? Contact us for a free consultation.Schedule a free consultation now
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