Americans living abroad are always looking for ways to reduce their US income tax liability. Qualifying for some of the major exclusions and deductions that the IRS offers to expats is the very best way to offset your US taxes each year. Notice how we said ‘qualifying’? That’s because these exclusions are not automatic just because your current residence is overseas. The IRS wants to be sure you’re not just on an extended vacation abroad and attempting to avoid your US tax responsibilities. Long-term expats often look to the Bona Fide Residence test (BFR). Let’s look at the test and some of the ways it can help you if you are eligible to use its status to qualify.
Specifics of the test
In essence, the BFR will be satisfied if you are living overseas for more than one year and have no immediate intentions of returning to the US permanently. This doesn’t mean that you can’t return to the US for visits or that your intentions can’t be changed in the future. It simply means that your life now and in the foreseeable future is outside the US.
Who exactly is a Bona Fide Resident?
Unfortunately, the IRS definition isn’t as clear-cut as you would like. They look at a number of factors to determine your status, including:
Your domicile: Domicile isn’t exactly the same as your residence. Domicile refers to the place where you have established your life—by opening certain foreign accounts, renting/owning a home, integrating with the culture (such as joining a church or other activity involvement, etc).
Your intentions: As mentioned above, this test is about proving your intentions. If you are planning to stay abroad, there will be evidence—such as those things you have done to establish your domicile. If you are an expat on a contract with a US employer, using the BFR can be tricky. If you maintain your permanent residence in the US, leave your family behind in the US or fail to establish a true foreign residence, it’ll be a tough sell to the IRS that you are a foreign resident. Military and other short-term overseas contractors often find themselves in this situation, as they move from country to country without establishing a true home, leaving their family at their home base in the US.
It can also be difficult (or impossible) to qualify with the BFR if you claim ‘non-resident status’ in that foreign country. Some countries offer tax breaks to non-residents but you must claim your status to take advantage of them. If you are declaring that you aren’t a permanent resident of a foreign country, than you are essentially admitting you are still a resident of the US.
What if you work part-time in the US?
This is another sticky question without a concrete answer. But in general, if you work 50% of the time in the US and 50% of the time abroad, you will likely not qualify as a bona fide resident of another country. However, if you work for say, 90 days in the US on a specific assignment and your family remains abroad (as well as your domicile), than you can still qualify as a bona fide resident. Again, there are no hard and fast rules here—it truly is up to the discretion of the IRS employee evaluating your return and how they perceive the facts on your return. Just remember that you need to maintain a foreign domicile in order to retain bona fide residence status.
What if you can’t qualify for the BFR?
Many US expats don’t qualify for the BFR, so thankfully there is another popular presence test: the Physical Presence test. This test requires you to be inside a foreign country for 330 of any 365-day period. If you are overseas for a shorter period of time or it’s clear your contract overseas will end at some point (whereby indicating your return to the US) then this is the residency test for you. A full explanation of the Physical Presence test is part of this US Expat Taxes 101 series and you can read more here.
How does the BFR help you?
Here are a few ways the BFR can help you save money on your US income taxes:
Foreign Earned Income Exclusion: You can deduct up to the first $99,200 of your foreign earned income from US tax liability. That is the amount for the 2014 tax year but in 2015 it jumps to $100,800, as it varies with inflation.
Foreign Housing Exclusion: You can deduct certain housing expenses (such as rent, utilities and furniture rental), up to a specified maximum amount. Certain high-cost cities qualify for a higher limit based on their increased cost of living. There is a base amount of expenses that are ineligible for exclusion, but any amounts over the base can be used.
Affordable Care Act: In 2014, the ACA (Obamacare) went into effect. For the time being, all US citizens are required to hold the minimum essential healthcare coverage as defined by the plan—or be subject to a tax on your US Federal Tax Return. Those who qualify for the Foreign Earned Income Exclusion via one of the two available tests is currently exempt from the provisions—meaning, if you are a bona fide resident or qualify by the Physical Presence test, you won’t be required to hold a qualifying US healthcare plan. The government has noted that this is how expats will be handled until at least December 2015, when the specifics of the policy will be re-evaluated.
More information is available!
Clearly, the BFR can be a very useful tool for expats to help offset (and hopefully eliminate) US tax liability. If you have any questions about the BFR or any of the exclusions you may be eligible for, don’t hesitate to contact our expert CPAs and IRS Enrolled Agents who can examine your situation and advise you on the best way to save on your US tax return.