It’s my annual “Taxes from A to Z” series! Next up:
If you are a U.S. citizen or a U.S. resident alien, you’re taxed on your worldwide income (just ask London Mayor Boris Johnson). However, you may be able to exclude some or all of your foreign wages under the foreign earned income exclusion. It’s a hefty amount: for 2014, the exclusion is $99,200 and for 2015, the exclusion is $100,800.
To claim the foreign earned income exclusion, you must have foreign earned income (generally, wages) and your tax home must be in foreign country. Generally, you must also pass the bona fide residence test (there’s an alternative, the physical presence test, but that’s beyond the scope of this post).
You pass the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. For most taxpayers, a tax year equals a calendar year (January 1 – December 31). You can leave the foreign country for temporary trips back to the United States or elsewhere for vacation or business but you must have a clear intention of returning to your residence without unreasonable delay.
In extreme circumstances, you can get a waiver if you don’t stay for the entire year. Generally, to qualify for a waiver, you have to prove that you would have stayed for the entire country except for “war, civil unrest, or similar adverse conditions” that caused you to flee. Leaving for less extreme personal or business reasons will not result in a waiver.
To further qualify, you must demonstrate that you have established residence in a foreign country. For tax purposes, residence may be different from your domicile. Your domicile is generally the place to which you always return or intend to return. A good rule of thumb (though certainly not determinative) is that your residence is where you live but your domicile is where you intend to die. You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for a year.
There is no bright line test for bona fide residency. Whether you meet the test is determined on a case-by-case basis, taking into account your intention to remain or the purpose of your trip and the nature and length of your stay abroad. You’ll plead your case to Internal Revenue Service (IRS) on a form 2555, Foreign Earned Income at Part II.
Of course, you have to be consistent. You can’t tell IRS that you’re a bona fide resident in one breath and then argue to the authorities of a foreign country that you are not a resident of that country for tax purposes in another. If you do, you will not pass the bona fide residence test.
The bona fide residence test applies to U.S. citizens abroad or any U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect. The language in any income tax treaty matters: all provisions of the treaty, including specific provisions relating to residence or privileges and immunities, are applicable when determining residency.
The laws governing residency and the foreign earned income exclusion can be tricky. Additionally, other tax provisions – like the foreign housing exclusion or the foreign housing deduction – might apply. Check with your tax professional for further guidance.
