Case Study: Expat Who Didn’t Yet Qualify for the Physical Presence Test
US expats must file tax returns each year, regardless of where they live. Thankfully the IRS created certain credits, deductions, and exclusions to avoid dual taxation. But here’s the catch: you must qualify as an official US expat to take advantage of these! We recently wrote about the differences between the physical presence test and bona fide residence tests, but what if you don’t qualify for either? Read on to find creative strategies for legally qualifying as an expat to save money on your taxes!
Not Qualified for Presence Test?
The bona fide residence test requires you to live outside of the US for at least one year. The physical presence test requires that you are physically present in a foreign country for 330 days out of any 365-day period. Sometimes, expats have not yet lived overseas long enough to qualify for either test. Fortunately, that doesn’t mean they are ineligible and will be forced into paying taxes in both the US and their country of residence.
Kevin and his family were living abroad in Hong Kong. He had been sent overseas on a three to five-year contract.
He was aware that he had a filing requirement for US taxes and had been educated on how the Foreign Earned Income Exclusion (FEIE) could help offset his tax liability. With the FEIE, Kevin could exclude the first $105,900 of his income from taxation for 2019 – for tax year 2020, that number rises to $107,600. But he was a bit confused about how the physical presence test could help him, considering he had moved overseas in Spring 2019 and hadn’t been overseas for 330 days when tax returns would be due on June 15.
They spent time in the summer in the US, which made things even more complicated. Many times, expats move abroad and stay on US payroll. In this case, he was transferred to an offshore payroll system, so there were no withholdings of Social Security. He was concerned about the tax liability if he didn’t qualify for the exclusion.
Despite the fact that he wasn’t overseas long enough to qualify as an expat, Kevin’s Greenback accountant assured him he would be eligible for the FEIE – it just required a bit of creativity!
If Kevin had chosen to use the physical presence test, he would have started counting days after his return from their summer vacation, and it would have lessened the number of qualifying days (which reduces the available FEIE). Instead, Kevin’s accountant chose to use the bona fide residence test, which allowed him to start counting qualifying days from the day he moved overseas. Naturally, when tax time arrived, Kevin hadn’t been abroad long enough to qualify with the bona fide residence test. Subsequently, his Greenback accountant filed Form 2350, which provides a special extension for those who need more time to qualify for the FEIE. They need to wait until the end of the next tax year (i.e., January 2021) to file, and can then claim qualifying days from April 2019, rather than from the end of the family’s summer trip to the US.
In the End
While he wasn’t eligible for the full FEIE in 2019, filing for an extension and using the bona fide residence test maximized his exclusion and saved him the most money possible. Because this is a contract position, the family will be in Hong Kong for the next few years. The FEIE is applicable each year going forward so he will have no issues filing in the future.
Do You Have a Similar Situation?
If you have moved overseas and may need to file Form 2350 in order to qualify for the FEIE, contact our expert accountants who can ensure you minimize your expat tax liability.
Originally published August 14, 2014; updated March 2020.