To qualify for Foreign Income Exclusion and Foreign Housing Exclusion on an expatriate tax return, an American expat must meet either Bona Fide Resident Test or Physical Presence Test.
If you moved overseas and do not have plans to return back to the USA, then a bona fide residence test is the best choice for you. However, US expatriates who plan to live overseas for 11 months or more must use the presence test.
Requirements to qualify for Physical Presence Test
How to meet the conditions for the physical presence test (PPT) generates the highest number of questions from our clients. This test is used to assist expats in qualifying for foreign earned income exclusion and foreign housing exclusion or deduction. The Physical Presence Test states that the individual must be present in the foreign country for a period of 330 full days during a 12 month period. Only full days in the foreign country will count, and any 12 month period is eligible to qualify.
Following are the most common questions along with the answers posed by clients regarding the physical presence test.
Does the 12 Month Period Used to Count My Days Have to Fall in the Same Calendar or Tax Year?
An expat is allowed to use any period of 12 months to fulfill the 330 full day obligation. It can overlap calendar or tax years. Two different 12 month periods that fall within the same year may also be used, and this will be discussed at further length below. An expat will usually use the first day after the assignment begins, and forward that 12 months for their first year.
Does the Same 12 Month Period Need to Be Used Each Year for the Physical Presence Test?
Each year, an expat is able to start the Physical Presence Test obligation fresh. This means that they are capable of using a different time period from year to year, as it is not confined to a tax year. There will be more discussion regarding this below.
Can Multiple Presence Periods be used In the Same Year, and Can the Same Days be counted Each Year?
An expat is permitted to use 2 different physical presence periods during the same year. Those periods may also overlap. The US expat will record each period on a separate Form 2555. At this time these documents must be delivered to the IRS in paper format as these types of expat tax returns are unable to be filed electronically.
How Would An Expat Complete a Tax Return After Taking a Break in the States Before Returning to the Foreign Country for Another Work Assignment?
Each of the physical presence periods will be claimed on a separate tax form as discussed above. Below is more information on the need to wait until the qualifications have been met for both periods before being permitted to file.
Will an Individual Automatically Qualify for the Tax Exclusions for the Upcoming Year if the Conditions of the Physical Presence Test are Met?
An expat will need to meet the Physical Presence Test requirements each year to qualify for the foreign earned income exclusion. In some instances an expat who has become a tax resident in the foreign nation will qualify for exclusions the first year using the Physical Presence Test. After holding the tax resident status for a full calendar year, they may use the bona fide residence test (BFR).
In order to ensure that they will meet the BFR requirement an expat may have to meet the 330 day count requirement of the Physical Presence Test for two years before they will be considered a candidate for Bona Fide Residence test. This could occur with an expat who became a tax resident in the early part of a calendar year. If they were to be granted that status in January for example, it would take a full 23 months before they would meet the conditions for the BFR test.
Does the Tax Year Change When an Expat Uses the Physical Presence Test?
The tax year will not change, instead the American expat will report their income earned during the tax year and only claim the exclusions for the days that fall within it. The 12 month period may extend beyond the tax year, but those days will not be counted on the return.
What is a Full Foreign Day?
This refers to period that starts at midnight and ends on the subsequent midnight. Partial days will not count towards the 330 day requirement, this includes the travel days to and from the United States.
How are the Dates for Leaving and Entering the United States Counted?
Travel days to and from the United States are not counted as being a full foreign day. Additional days could be lost if the expat needs to travel to another foreign location. The following examples will illustrate this point:
- An expat leaves Dubai at 2 am and arrives at their US destination later that same day. That day is not considered a full foreign day and will not be able to be used to meet the 330 day requirement.
- The expat flies out of the Atlanta airport at 11 pm on day 1. By 2 am they are out of US airspace and flying over Greenland and arrive in Europe on day 2. The rest of day 2 and day 3 are spent in the European country. Days 1 and 2 are travel days and not considered for the 330 day requirement. Day 3 however is.
- An expat leaves from Houston at 4 pm, entering Canadian airspace by late that same day. They arrive in Europe on the morning of day 2, staying until day 3. Day 1 does not count as a full foreign day, but day 2 and 3 yes.
Does a Full Foreign Day Only Count if I am Working and Does Each Day have to be Spent at the Foreign Location?
Any day spent in its entirety outside of US borders will count as a full foreign day regardless if the individual is working at their job location.
Do the 330 Days Have to Be Consecutive, Run One after the Other?
No, so long as they are in the same 12 month period. Expats may enter and leave the United States multiple times in that period breaking up the 330 days.
Do Days Spent in US Territories or Possessions Count Towards Full Foreign Days?
Under these circumstances, any US territory or possession will not count as time spent outside of the country. There may however still be exclusions or credits available. There could be an exclusion for individuals in Puerto Rico, or a credit for those in the US Virgin Islands or neither in Johnston Atoll. For further information on these exclusions and credits click here, www.irs.gov/businesses/small/international/article/0,,id=97321,00.html and read Publication 570.
Will Days Spent in International Waters Count?
The requirement is to have 330 full days in a foreign country, not to spend 35 outside of US borders. Therefore, time spent in International waters, such as aboard a cruise ship, will not work towards that requirement. It has been our experience that even a five day cruise inside the Gulf of Mexico or to the Caribbean may only result in one full day in a foreign country.
Can Exceptions be Made in an Emergency Situation to the 330 Full Day Policy? IE: An Injury or Death in the Family or the Sudden Outbreak of War?
No exceptions will be made to the 330 day requirement. Even if a reservist is called back to the United States to fulfill their reserves obligation, the IRS will not make an exception. For example, if an expat is traveling in Iraq and injured when an IED hits their truck, the treating medic may tell them that going home to receive proper medical care will not affect the 330 day rule. Yet they are only saying this to stabilize the patient for transport knowing full well that even seeking treatment for that injury back in the US will affect the Physical Presence Test.
I Only Reached 329 Full Foreign Days, Can I Qualify for a Partial Physical Presence Test and Benefit?
No partial benefits will be given, with no exception to this rule. Do note as mentioned above however, that the 12 month period does not need to be in the same tax year.
What is the Safest Way to Plan For Travel in and out of the US for the First Year?
An expat who is traveling back to the states should always plan a few extra days in case of an emergency. Our experience shows that individuals need a minimum of five days to attend to family matters such as funerals.
They should also always allow for at least one extra travel day. If for any reason there is a flight delay that does not get the expat back to the foreign country on time, the 330 days might not be met, disqualifying them from the exclusions. There have been cases with our clients where security alerts, mechanical issues, inclement weather and overbooking caused them to miss the full foreign day. Again it is important to remember that no exceptions will be made under any circumstance.
How Should Travel to the US Be Planned After the First Year?
The best way for an expat to plan their second and subsequent years is to always have 330 full foreign days in the preceding 12 months. This ensures that they will always qualify for any eligible exclusions through the last day spent outside of the US.
Some individuals will plan their US travel for the same period each year in line with an existing service contract. In doing so, they run the risk of not meeting the full 12 months for the following contracts disallowing them from the full exclusions for their last year abroad.
My W-2 Reflects My Income For the Tax Year, Should I Tell My Employer What Period I am Using to Count My Days for Physical Presence Test?
A W-2 will always show income paid during the calendar year only. Even if an individual works in December but is paid in January, that income will count for the following year. Despite the period being used for the physical presence test, income will always be reported for the calendar year.
There is no reason to alert an employer to the Physical Presence Test period being used. There is nothing on the W-2 that will indicate this nor will anything be reported to the IRS if the individual plans on qualifying for the foreign earned income exclusions. This is also true for those who have submitted a Form 673 to the payroll department.
What Should I Do if I Have Not Yet Met the 330 Day Requirement By the Time I Need to File My expat Tax Return?
An expat should wait to file the return until they can pass the physical presence test so that they may qualify for the exclusions. They can file an for a time extension until the 330 full day requirement is met. If an expat were to submit a return before being able to qualify they would likely receive a tax bill as if they had been working inside of the United States during that period. The IRS has in place a well developed extension process allowing expats to qualify for those exclusions before filing a tax return. There is more information on our extensions page in the discussion of Form 2350.
Is it Better to File the Return Before Qualifying and Then Ask For Amendments Later?
Within a certain time frame, an individual can file an amended return under these circumstances. In our experience though, it is easier to ask for the extension in filing that the IRS offers. This will avoid any delay in receiving a refund and make better use of the IRS’s and the expats resources. Amended returns are also more susceptible to further scrutiny- there is a higher percentage of amended returns chosen for examination then original returns.
How are Travel Dates Proven During an IRS Audit?
The documents used will be at the discretion of the auditor as the IRS does not list any acceptable or unacceptable documentation needed for this purpose. The documents that are used will be subject to the auditor’s personal judgment based on the circumstances. In our experience IRS agents have asked for copies of the employment contract along with copies of the plane tickets to and from the United States. The employer’s travel department might be asked to supply additional information to support the tax return and in some cases border security may be asked for documentation providing proof of travel across US borders.
- US expatriate must be a US citizen or resident alien.
- US expatriates must live outside of the United States for 330 days during 12 consecutive months.
- US expatriate must legally reside in a foreign country (Cuba, North Korea are not included in this list).
How to calculate 330 days on expatriate tax returns?
· Any day of presence in the USA is excluded per the IRS.
· Any day while traveling to/from the USA is not included either.
- John Smith, an expatriate from the US, decided to move to Germany on January 1, 2012 for a new job. His annual salary is around 90,000 euro. He made some trips to other European countries but didn’t have a chance to go back to the USA until February 1, 2013. In this scenario John Smith meets a presence test because he was outside of the USA for 330 days within 12 consecutive months. As a result of it, this US expatriate will claim the Foreign Income Exclusion ($95,100 in 2012) and Foreign Housing Exclusion on expatriate tax returns.
- Second scenario. In June 2012 John has to go back for training in Washington, DC. He stayed in the USA for 10 days and returned back to Germany. Since John was on the US soil, these days in the USA are excluded from the 330-day calculation. However, this US expatriate still meets the requirements of the Physical Presence Test because he was outside of the USA for 330 days during 365 days.
- Third scenario. John had to go back to the USA on October 20, 2012. He spent 2 months in Washington, DC working on a project. John returned to Germany on January 1, 2013. In this scenario John cannot claim the foreign income exclusion and foreign housing exclusion on expatriate tax returns because he does not meet the physical presence test.
If you are not sure whether you meet the physical presence test or you can claim the foreign income exclusion or foreign housing exclusion on your expatriate tax returns, please consult a CPA that provides expat tax services.