For Americans living abroad, the IRS provides tax relief through exclusions and deductions, such as the Foreign Earned Income Exclusion (FEIE). One of the key requirements to claim these benefits is passing the Bona Fide Residence Test, which is one of the two tests to qualify for the FEIE (the other being the Physical Presence Test). Understanding how to pass this test can significantly reduce a US citizen’s taxable income.
What is the Bona Fide Residence Test?
The Bona Fide Residence Test is a requirement set by the IRS for US citizens who want to claim the Foreign Earned Income Exclusion (FEIE). The test essentially evaluates whether you have established a residence in a foreign country with the intention of living there for an extended period. To meet this test, the IRS requires you to be a “bona fide resident” of a foreign country or countries for an uninterrupted period that includes an entire tax year (from January 1 to December 31).
The Bona Fide Residence Test is not based solely on the number of days spent in a foreign country, unlike the Physical Presence Test. Instead, it is based on your intent and actions that demonstrate you have made the foreign country your home.
To claim the Foreign Earned Income Exclusion using the Bona Fide Residence Test, you must file IRS Form 2555. This form is submitted along with your US federal tax return (Form 1040) and allows you to exclude a certain amount of foreign-earned income (up to $120,000 for tax year 2023) from US taxation.
How to pass the Bona Fide Residence Test?
There is no specific list of items that the IRS uses to determine if you pass the Bona Fide Residence Test, but the following factors will play a role in assessing your situation:
- Intent: The most significant factor is your intent to live in the foreign country for an extended period. The IRS will look for evidence of your long-term plans, such as having a permanent home, a job, or family connections in the foreign country.
- Length of Stay: You must reside in a foreign country for a period that covers an entire tax year, which runs from January 1 to December 31. This means you need to be living in the foreign country for 365 days during a 12-month period, and it must be uninterrupted. This period doesn’t have to be consecutive, but it must span the entire year.
- Nature of Employment: If you’re employed abroad, having a job with a long-term contract or working for a local employer can support your claim of bona fide residency. Short-term assignments or jobs that are expected to end quickly may make it harder to prove bona fide residency.
- Establish a permanent home: Show that you have an established home in the foreign country, where you plan to stay for a prolonged period. This doesn’t necessarily mean owning property; renting or having a long-term lease can also count as having a home.
- Family and Social Ties: Establishing strong ties in the foreign country—such as family members living there, children attending school, or being involved in local social activities—can also support your case.
Scenarios where a US Citizen passes the Bona Fide Residence Test
While the test requires the taxpayer to live in a foreign country for an uninterrupted period, there are specific situations where a US citizen can still pass the Bona Fide Residence Test despite unique circumstances:
Living Abroad for Employment
A US citizen who works for an international company in a foreign country for several years may pass the Bona Fide Residence Test. For example, if a US citizen is assigned to a managerial position at a foreign subsidiary and plans to stay for an extended period, they can qualify as a bona fide resident if they meet the other requirements.
Retirement Abroad
If a retired US citizen moves to a foreign country for retirement and establishes residency for more than a year, they could pass the Bona Fide Residence Test. Factors such as maintaining a long-term rental home, enrolling in local healthcare, and forming ties with the local community can support their claim.
Dual Residency with a Foreign Spouse
A US citizen married to a foreign national and living together in a foreign country for an extended period could qualify for the test. As long as the individual is a bona fide resident of that country, and they do not have the intent to return to the US within the year, they can pass the test, regardless of their marital status.
Foreign Students or Researchers
US citizens studying abroad or conducting research can pass the Bona Fide Residence Test, provided they live in the foreign country for an uninterrupted period of one year or longer. Temporary visits to the US during holidays or breaks do not automatically disqualify them from meeting the test’s requirements.
Situations where you may fail the Bona Fide Residence Test
Some situations may lead to failing the Bona Fide Residence Test, including:
- Intending to Return to the US: If the individual has a clear and set intention to return to the US within a short period (like returning after a year or two), they are unlikely to pass the test, even if they reside in the foreign country for more than a year.
- Maintaining Strong US Ties: If the taxpayer maintains significant ties to the US, such as owning a home in the US, maintaining US bank accounts, or regularly visiting the US without a clear intention to reside abroad, they might fail the Bona Fide Residence Test.
- Temporary Assignments or Business Trips: Employees on temporary business assignments abroad (e.g., less than a year) may not meet the residency requirement of the Bona Fide Residence Test, since their stay is considered temporary.
The Bona Fide Residence Test offers significant tax benefits for US expats, allowing them to exclude foreign-earned income from US taxes. By understanding the test’s requirements, US citizens living abroad can ensure they meet the criteria for this exclusion and reduce their overall tax burden.
If you’re a US expat and need guidance on passing the Bona Fide Residence Test, feel free to reach out to Universal Tax Professionals. We specialize in a wide range of US expat tax services.
