How to Reduce Your Tax Liability with the Physical Presence Test When Moving Back to the United States
IJ Zemelman Mar-25-2015
The Foreign Earned Income Exclusion (FEIE) helps US Expats to prevent paying taxes to two separate countries. In order to qualify for the FEIE, you must meet certain conditions. If these conditions are met for the previous tax year, you may still take advantage of the FEIE once you move back to the United States.
The FEIE is an exclusion offered by the IRS to US Expats who are able to pass the ‘tax home test’ and who meet the conditions of either the Bona Fide Residence Test or the Physical Presence Test. By taking advantage of the FEIE, US Expats are able to deduct up to $99,200 (in 2014) from their taxable income on their US expat tax return. If you meet the conditions for the FEIE for the tax year in which you earned foreign income, you may even claim this exclusion if you have moved back to the United States.
In order to pass the ‘tax home test,’ you must be able to prove that you conduct a significant portion of your business in your host country.
To meet the qualifications of the ‘tax home test,’ you must be able to prove that you maintain employment or conduct business primarily in the foreign country in which you reside. You may rely on items such as your bank accounts, the residence of your family, the location of your office, and your communication with embassies to meet this burden of proof and qualify for the FEIE.
In addition to your ability to pass the ‘tax home test,’ you must meet the conditions of either the Bona Fide Residence Test or the Physical Presence Test.
In order to deduct your foreign earned income from your US expat tax return using the FEIE, you must qualify for either the Bona Fide Residence Test or the Physical Presence Test.
To qualify for the Bona Fide Residence Test, you must spend at least an entire year in a foreign country and have no plans of returning to the United States. If you have moved back to the United States and are still planning on claiming the FEIE, you would not be able to use the Bona Fide Residence Test.
The Physical Presence Test only requires you to have spent at least 330 days out of a period of 12 months in a foreign country. Each day of your 330 days has to have been a full day, so days in which you arrived in or left a foreign country do not count. The only exception would be if you were in foreign airspace at midnight. Your qualifying 330 days do not have to be consecutive. If you had moved back to the United States and are planning to claim the FEIE, you would still qualify if you meet the conditions of the Physical Presence Test.
If you move back to the United States during the tax year, you will calculate the time you spent in that tax year in a foreign country to prorate the FEIE amount available to you.
Assume you had been living in France for two years. Since you spent more than 330 days in your host country, you will already have qualified for the Physical Presence Test. If you moved back to the United States on August 14, 2014, you would have spent 225 days in a foreign country. In other words, your qualifying period for the Physical Presence Test for 2014 would be from January 1 to August 13.
To figure out how much you are able to deduct when claiming the FEIE, you would first divide 225 by 365 for a total of 0.62. You would then multiply $97,600 by 0.62 for a total of $60,512. The total you would be able to claim for the FEIE in 2014 would be $60,512.
You may increase your prorated FEIE by taking into consideration the slide days provision
If you earned more than $60,512 in foreign income in 2014 and you want to increase your FEIE deduction amount, you may take advantage of the slide days provision. Since only 330 days in a foreign country are required to meet the conditions of the Physical Presence Test, you are allowed to be in the United States for 35 days and still qualify for the test. Using the slide days provision, you would add that 35 days onto your qualifying period in your host country.
Still using the example above, your return date of August 14 would be extended to September 17, giving you a qualifying period of 260 days. When you divide 260 by 365, the total is 0.71. When you multiply $97,600 by 0.71, you come up with a total of $69,296; so you have now added another $8784 on the amount you’re able to deduct by claiming the FEIE for your foreign earned income in 2014.
I.J. Zemelman, EA is the founder of Taxes for Expats