The Foreign Earned Income Exclusion (FEIE) is a significant tax benefit for U.S. expats, allowing them to exclude a portion of their foreign-earned income from U.S. taxation, which is a crucial aspect of expat taxes. To qualify, expats must pass either the Physical Presence Test or the Bona Fide Residence Test. This article focuses on the Bona Fide Residence Test, providing updated information for 2024 and detailing everything you need to know to claim it.

WHAT IS THE BONA FIDE RESIDENCE TEST?

The Bona Fide Residence Test is a of two methods for American expats to qualify for the FEIE. To qualify, expats must pass either the Physical Presence Test or the Bona Fide Residency Test, which focuses on economic and social ties to a foreign country, uninterrupted residency, and subjective qualifications. This test is more subjective and often harder to pass, as the IRS scrutinizes your intentions and ties to the foreign country.

HOW DO YOU QUALIFY FOR THE BONA FIDE RESIDENCE TEST?

To qualify for the Bona Fide Residence Test in 2024, you must meet several criteria:

1. U.S. Citizen or Resident Alien: You must be a U.S. citizen or a resident alien.
2. Uninterrupted Period: Establish residency in a foreign country for an uninterrupted period that includes an entire tax year. This means that you must live in the foreign country for a continuous period that covers the entire calendar year.
3. No Intentions to Return: Demonstrate that you have no immediate plans to return to the U.S. and that you have strong ties to the foreign country.
4. Strong Ties: Establish strong connections to your foreign residence, such as employment, property ownership, family presence, and social ties.

Meeting these criteria helps determine if you qualify as a bona fide resident abroad for IRS purposes.

WHAT ARE THE COMMON PITFALLS?

Here are some common pitfalls to avoid:

• Maintaining a U.S. Residence: Keeping a home in the U.S. can undermine your claim of bona fide residence. The IRS considers your intentions and the nature of your stay abroad.
• Proving Strong Ties: Demonstrate strong ties to your foreign country, such as having a permanent home, a job, utility bills in your name, and social connections.
• Understanding Domicile vs. Residence: Having a domicile (permanent home) abroad is not the same as meeting the residency requirement. The IRS looks at your overall situation, including your intentions and the permanence of your stay.

HOW DOES THE IRS DETERMINE BONA FIDE RESIDENCY?

The IRS determines bona fide residency on a case-by-case basis, considering several factors:

• Intentions: Demonstrating that you intend to remain in the foreign country indefinitely is crucial.
• Purpose of Stay: The reason for your stay abroad, such as employment or family, is also important.
• Nature and Length of Stay: The duration and nature of your residency in the foreign country are critical elements.
• Supporting Documentation: Providing documents such as lease agreements, employment contracts, and utility bills can help establish your bona fide residence.

CAN YOU SPEND TIME IN THE U.S. AND STILL QUALIFY?

Yes, you can spend time in the U.S. and still qualify for the Bona Fide Residence Test, but there are limitations:

• Substantial Presence Test: You must not qualify as a U.S. person under the Substantial Presence Test, which considers the number of days you spend in the U.S. during the tax year.
• Temporary Trips: You can take short trips to the U.S. or other countries, but you must show a clear intention to return to your foreign residence after these trips.

WHAT HAPPENS IF YOU FAIL THE BONA FIDE RESIDENCE TEST?

Failing the Bona Fide Residence Test means you cannot claim the FEIE under this test. However, you might still qualify under the Physical Presence Test if you meet its requirements. It’s essential to understand the differences and requirements of both tests to determine the best option for your situation.

EXAMPLES OF THE BONA FIDE RESIDENCE TEST IN ACTION

1. Example 1: Jane, a U.S. citizen, moves to France for a job assignment that lasts indefinitely. She rents an apartment in Paris, opens a bank account, and marries a French architect, demonstrating strong ties to France. Jane is not maintaining a residence in the U.S. and does not return frequently. She meets the Bona Fide Residence Test requirements.
2. Example 2: John, another U.S. citizen, buys a house in Spain and moves there for work. However, he frequently travels back to the U.S. and maintains a home there. Despite his presence in Spain, the IRS determines that John does not meet the Bona Fide Residence Test due to his frequent U.S. visits and maintained U.S. residence.

FILING REQUIREMENTS AND TAX FORMS

To claim the FEIE using the Bona Fide Residence Test, you must file Form 2555 along with Form 1040. On Form 2555, you must accurately report your bona fide residence information. Ensuring all details are correctly documented is crucial for claiming the exclusion.

THE IMPACT OF TAX TREATIES ON THE BONA FIDE RESIDENCE TEST

Tax treaties between the U.S. and other countries can influence your ability to qualify for the Bona Fide Residence Test. These treaties can affect your tax obligations and residency status. For example, an income tax treaty might provide tax exemptions or reduce the amount of foreign income tax you owe, which can impact your bona fide resident status.

THE ROLE OF FOREIGN HOUSING EXCLUSION AND DEDUCTION

In addition to the FEIE, expats can benefit from the Foreign Housing Exclusion or Deduction, which includes the foreign housing deduction. These provisions allow you to exclude or deduct certain foreign housing expenses, such as rent and utilities, from your taxable income. To qualify, you must meet the requirements of the Bona Fide Residence Test or the Physical Presence Test and have housing expenses that exceed a specified base amount.

HOW TO ESTABLISH AND MAINTAIN BONA FIDE RESIDENCE

Establishing and maintaining bona fide residence requires careful planning and documentation:

• Establish a Permanent Home: Rent or purchase a home in the foreign country and use it as your primary residence.
• Integrate into the Community: Join local organizations, open bank accounts, and participate in social activities.
• Minimize Ties to the U.S.: Limit trips to the U.S. and avoid maintaining a residence there.
• Maintain Clear Intentions: Clearly indicate your intention to remain in the foreign country indefinitely.

THE BONA FIDE RESIDENCE TEST VS. THE PHYSICAL PRESENCE TEST

While the Bona Fide Residence Test offers more flexibility in terms of time spent in the U.S., it is often harder to pass due to the subjective nature of the requirements. The Physical Presence Test is more straightforward but limits the time you can spend in the U.S. Understanding the differences between these tests is crucial for choosing the best option for your situation.

EXCEPTIONS TO THE BONA FIDE RESIDENCE TEST

In certain situations, the IRS may waive the requirements of the Bona Fide Residence Test:

• War, Civil Unrest, or Similar Adverse Conditions: If you must leave the foreign country due to these conditions, the IRS may waive the uninterrupted period requirement. You must prove that you could have met the requirements if not for the adverse conditions.
• Violation of U.S. Law: If you are present in a foreign country in violation of U.S. law, you cannot qualify as a bona fide resident. Currently, travel restrictions apply to Cuba.

TAX IMPLICATIONS FOR BONA FIDE RESIDENTS OF PUERTO RICO

Special rules apply to bona fide residents of Puerto Rico. To qualify as a bona fide resident of Puerto Rico, you must meet the presence test, not have a tax home outside of Puerto Rico, and not have a closer connection to the U.S. or another foreign country. Bona fide residents of Puerto Rico may be exempt from filing a U.S. tax return if their income is sourced entirely within Puerto Rico.

Qualifying for the Foreign Earned Income Exclusion through the Bona Fide Residence Test can be challenging but rewarding. This test requires a strong commitment to establishing and maintaining residency in a foreign country. If you have any questions or concerns about meeting the requirements, we offer free tax consultations. Our team of expat tax experts is here to assist you with your tax needs and ensure you remain compliant with U.S. tax laws. Contact us to discuss your situation and get the professional help you need.

Have a question? Contact Olivier Wagner, 1040 Abroad.