In order to qualify for certain deductions, expats must pass the Bona Fide Residence Test to determine whether they have truly set up residence in their overseas home. Your preparer will use this test to determine whether you are eligible for the Foreign Earned Income Exclusion. Living overseas does not necessarily mean that you qualify for expatriate status with the IRS. The requirements for every deduction and exclusion should be carefully reviewed, and expats should never simply assume that they qualify.
Bona Fide Resident Qualifications:
In order to claim the deductions and exclusions available to expatriates, you must meet each of these four requirements.
- You must be a US citizen (or resident alien living in a country that has a tax treaty with the US).
- You must have set up residence in a foreign country.
- You must live within that country for the whole year.
- You must not have any plans of moving away from your country of residence and returning to the US.
The requirements of the Bona Fide Resident Test are basically straightforward, except for the last point mentioned. Whether an expat has plans to return to the US can be difficult to determine. The following examples are intended to clarify this point.
- An expatriate travels to Germany because of a two year work assignment. During the entire two years, he does not return home to the US. Even though he lives and works overseas for two years, he does not qualify for any exclusions or credits. He does not pass the Bona Fide Resident Test because he has predetermined to move back to the US.
- An expatriate buys a house in Ireland. Every year, he spends at least six months there with his family. He will never qualify as a Bona Fide Resident, however, because he still maintains residence in the US.
- An expatriate accepts a long term job in China. After the completion of his first year there, he would then qualify for credits and exclusions available to Bona Fide Residents. Although he may someday move back to the US, to qualify, he must have no immediate plans of doing so.
- An expatriate moves to India for work and he takes his family with him. After a few months, his company sends him back to the US for four weeks of job training. After a year, he will qualify as a Bona Fide Resident. He has truly set up residence in India and has no plans of moving back to the US. As a Bona Fide resident he will qualify for the Foreign Tax Credit, Foreign Housing Credit and the Foreign Earned Income Exclusion.
Whether or not you qualify as a Bona Fide Resident will dramatically affect your taxes as a US expat. The credits and exclusions that coincide with this label can save you thousands of dollars. It's important, especially as an expat, to have an expert prepare your taxes as the Bona Fide Resident Test is not simply cut and dry. The IRS handles each of these cases as they come. If you've moved overseas and are not entirely sure when or if you will return to the US, you will most likely qualify as a Bona Fide Resident after your first full year abroad. To be sure, though, and to be sure that the relevant form (2555) has been completed correctly, it is wise to seek the assistance of an international tax expert.