Qualify for US Expat Tax Breaks Using the Bona Fide Residence Test

Tax Compliance

The Bona Fide Residence Test is one of two tests that Americans living abroad can meet to qualify for the special allowances on their foreign income when filing expat tax returns. Some of the main expat tax benefits include the foreign tax credit, the Foreign Earned Income Exclusion (FEIE), and the Foreign Housing Credit.

The Bona Fide Residence Test requires that a US taxpayer establish permanent residence in a foreign country.  The other test, the Physical Presence Test, requires that a taxpayer only be abroad for 330 days out of a 365-day period.  This article will discuss how to meet the expat tax return qualifications under the Bona Fide Residence test and why civilian military contractors are unlikely to pass the test.

Bona Fide Residence Test Qualifications

To qualify for expat tax credits using the Bona Fide Residence Test, a taxpayer must meet three requirements:

  1. The taxpayer must have foreign income.  Earned foreign income includes salaries, wages, bonuses, and even self-employment income.  However, it does not include dividends, interest, pension distributions and/or capital gains; this type of income is referred to as “passive” in the tax world.
  2. The taxpayer must have a “tax home” in a foreign country.  A tax home is where a person is permanently or indefinitely engaged in work, regardless of where their personal residence is.  To establish a tax home, a person must have a work engagement expected to last at least a year.  Furthermore, if you have retained a personal residence (aka “abode”) in the United States, you cannot be considered to have a “tax home” in a foreign country.   This is the biggest test for military contractors to overcome.
  3. Third, the taxpayer must have been a bona fide resident of a foreign country for an entire tax (most often calendar) year.  You do not obtain status as a bona fide resident by simply living in a foreign country for a year.  You must have demonstrated an intention to stay in the foreign country for at least a year.

Who is a Bona Fide Resident?

So who is a bona fide resident exactly?  Unfortunately, the IRS’ definition of a “bona fide resident” is relatively vague.   They do make note of several key factors, though:

  • A taxpayer’s bona fide residence is not necessarily the same thing as his/her domicile.  A domicile is a taxpayer’s place where they intend to permanently return.  Therefore, if you move abroad for an assignment (longer than a year), you can establish bona fide residence even if you intend to return to the US someday.
  • Your status as a bona fide resident is reflected in your intentions.  If you retain your house and car in the US, make short but frequent return trips, and leave your immediate family in the US, it will be difficult to prove to the IRS that you are residing abroad for an extended or indefinite period of time.  If you do not have the documentation as proof, you should be able to show the IRS in your actions that you are intending to reside abroad for at least a year.  You can do this by establishing residence in a foreign country, integrating with the foreign culture (i.e. setting up a bank account, having professional relationships, etc), and other type actions.
  • You will not be considered a bona fide resident of a foreign country if you make an official claim to your resident country that you are a nonresident.  Some foreign countries have expat tax benefits for temporary residents.  The idea of the FEIE and foreign tax credit is to reduce the potential for double taxation.  Therefore, if you have taken steps to reduce your foreign expat tax burden by telling the foreign country that you are a nonresident, you cannot make a contradictory statement to the IRS to reduce your US tax burden.  This question is directly asked of the taxpayer on Part II, Question 13A of Form 2555:

I’m a Contractor. Why Don’t I Qualify as a Bona Fide Resident?

The IRS has recently begun several initiatives to audit expat tax returns of civilian military contractors to examine their qualifications for FEIE and foreign tax credits claimed on their returns. The majority of these audits have resulted in the rejection of the FEIE. This is because military contractors are having a difficult time proving that they have established a foreign “tax home.”

If you retain all of your assets and ties in the US, and work in various camps in foreign countries as needed by your employer, you’re not really establishing a foreign residence and therefore cannot qualify as a bona fide resident of a foreign country. As a result, military contractors will likely be better served to use the physical presence test to qualify for the FEIE and foreign tax credit. For more information about the physical presence test, please see the IRS website.

Need Help with the Bona Fide Residence Test?

We offer some examples of expats who qualify under the Bona Fide Residence Test here. If you have any questions about the Bona Fide Residence Test or the Physical Presence Test, or if you would like help with your expat tax returns, please contact us.