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The Importance of the Physical Presence Test to Americans Working Abroad

The Importance of the Physical Presence Test to Americans Working Abroad
Ines Zemelman, EA
15 October 2015

The Physical Presence Test can help reduce your tax liability.

As a US Expat living and working overseas, you are required to file a US income tax return.  One of the primary concerns to US Expats is whether or not they will be taxed twice on the same income.  This is known as dual-taxation, and the IRS makes a variety of concessions designed to minimize or eliminate dual-taxation.  In order to qualify for the credits, deductions, and exclusions offered by the IRS, you must first pass the Physical Presence Test.

The most significant exclusion available is the FEIE.

The absolute best exclusion for most US Expats is the FEIE (Foreign Earned Income Exclusion) which allows you to take up to $100,800 ($201,600 for married couples filing a joint return) of your foreign income and exclude it from taxation on your US expat tax return.

What is the Physical Presence Test and what does it mean to pass it?

The Physical Presence Test is a set of criteria that a US Expat must meet before qualifying for the FEIE.  To pass this test, you must have have both of the following:

●Have  earned income from wages, salaries, professional fees, and other compensation received for personal services performed in a foreign country

●Have a tax home in a country outside of the US and its territories.  Additionally, you must have resided in a foreign country or countries’ for a full 330 days out of a period of 365 days.  Keep in mind that this 365 day period doesn’t need to be a calendar year.  It starts on your first day living in a new country.

It’s important to note that travel days to and from your country of residence do not count as days in the country since you weren’t there for the entire day.  In order for the IRS to concede to the fact that you spent a full day in your host country, you must be there for a full 24 hours.  It’s imperative that you keep detailed records of your time in your host country and your time in the United States.  You are only allowed 35 days of presence in the United States in order to meet the conditions of the Physical Presence Test.

What does it mean to have a tax home?

As indicated earlier, in order to qualify for the exclusions and deductions available to you as a US Expat, you must have an established tax home.  In order to establish a tax home, you must be able to identify your place of employment or the location at which you conduct your business activities.  It’s not difficult to prove a tax home.  Generally, the IRS will only want to see items like your foreign bank accounts, the address of your home and office, and any registration with overseas embassies.

You are not asked to provide proof of your address when verifying your tax home to the IRS.  You simply need the details of the place you conduct business.  While you won’t be required to prove that you do have a home in your host country, you will be required to prove that you don’t have a primary abode in the United States.  The IRS defines ‘abode’ as being a taxpayer’s domicile home, residence or place of dwelling.  The location of your official abode will be identified by the economic and family ties that you have as well as the location of your personal possessions.

For whom is the Physical Presence Test designed?

Thousands of US Expats spend periods of time overseas before returning to the United States.  It’s a common practice to send employees on international business trips.  Sometimes these trips are short, but there are other times when there is a long-term relocation on a contract basis.  The Physical Presence Test is for US Expats who are spending a substantial amount of time overseas but plan to return to the United States in the foreseeable future.  If you have no plans on returning to the United States any time soon, the Bona Fide Residence Test will be your best option.

What happens if you don’t meet the conditions of the Physical Presence Test when tax time rolls around?

If you haven’t been living in your host country for at least 330 days out of the year by the time you’re required to file a US expat tax return, you may request a filing extension from the IRS if you will qualify by the end of the year.  To request an extension from the IRS, you must fill out Form 2350 and file it with the IRS at or before the time you need to file your US expat tax return.

Ines Zemelman, EA
founder of Taxes for Expats