No matter where you live, as a US citizen or Green Card holder, you are required to file a US tax return each year. While that may incite the fear of dual-taxation, the US has actually put into place several key exclusions, deductions and credits that help limit dual-taxation from two countries. In order to take advantage of these exclusions, you must qualify as an official US resident. The primary exclusion you want to qualify for is the Foreign Earned Income Exclusion (FEIE), which allows you to exclude up to the first $99,200 of your 2014 income ($100,800 in 2015) from US taxation. That’s a huge potential savings, which is why it is so critical that you qualify one way or the other. Let’s examine the specifics of the Physical Presence test (PPT), which is the most common way for expats to qualify.
What is the Physical Presence Test?
To qualify under the PPT, expats must earn foreign income, have a tax home in a foreign country and be present inside a foreign country for 330 full days of any 365-day period. To be clear, this is not necessarily a calendar year. It must be a continuous period, but not necessarily one within a calendar or tax year—it’s more of a ‘rolling’ calendar. The IRS considers a full day a 24-hour period, so the days you enter or depart a foreign country won’t count towards your 330 days. Time spent flying (or cruising) over international waters also doesn’t count. These are important distinctions to make, as simply spending one day too many in the US can result in a large tax burden. So it is very important to carefully track your travel days when returning to the US for business or pleasure. Plan your vacations and business trips wisely! The IRS can request passport proof of your travel to prove your 330 days.
Understanding a tax home
One of the requirements of the PPT is that while you are abroad, you establish a tax home (which isn’t the same as a domicile, that refers to how closely connected you are personally to a country). This simply means that you have established the primary location of your employment, duty or business activities. While it is easy to claim a tax home, the IRS will want to see proof of your home. Such proof could include:
- Local (foreign) bank accounts
- Office location
- Whether family relocated
- Registration with overseas embassies
Think of a tax home this way: It’s more about establishing the foreign country for your central place of employment than it is about actual residency. You may very likely have a tax home abroad due to the location of your business, but you don’t have to have a specified residence there.
However, you are not considered to have a tax home in any country if you maintain an abode in the US. The definition of an abode is definitely tricky. The IRS defines it as one’s home, residence, domicile or place of dwelling. It has a domestic meaning rather than a vocational one. In short, the location of your abode often depends on where you maintain your economic, family, physical possessions and personal ties.
Here’s an example to better explain:
You are employed as a rotational worker on an offshore oil rig and spend six weeks abroad, and then return to the US for six weeks. While your primary income is being earned overseas, your US residence will be considered your domicile and you will not qualify for the PPT or the FEIE.
Here’s another example:
You are working for a landscape design company in Atlanta, GA. Your boss decides it’s time to take the business international and sends you to Ireland for 18 months to expand the business. You rent a small house in Ireland, move your family there, open bank accounts and obtain library cards for your children. You keep your US residence and rent it out, knowing you will return at the conclusion of the contract. Even though you maintain a US residence during this time, you have created both an abode and a tax home in Ireland so you will satisfy the requirements of the PPT and be eligible for the FEIE and possibly other US tax credits.
Who Uses the Physical Presence Test?
A large number of US expats go abroad for a specified period of time and then return to the US. This is very common when US employers send employees overseas on assignments on a ‘contract’ basis. These types of expats will need to use the PPT to qualify, as they do have plans to return to the US (even if the contract is for 10 years). If you are NOT planning to return to the US (i.e. you are retiring abroad, starting a business abroad or joining the workforce of a foreign company indefinitely), you can use the Bona Fide Residence test (BFR). The BRF requires you to live in a foreign country for at least one full year and have no intentions of permanently returning to the US. ]
What if you don’t qualify yet at tax time?
There is a neat little tool you can use if tax time has arrived and you haven’t yet spent 330 of 365 days abroad yet. Assuming you WILL qualify for the PPT in the near future, you can file an extension that provides you with the time you need to qualify. This is such an important extension and many expats don’t know about it. Filing Form 2350, Application for Extension of Time to File US Income Tax Return, buys you to the time you need to satisfy the PPT (or BFR) requirements and save a bundle of money! This must be filed by when your tax return would normally be due in order to be granted.
As you can see, the PPT is an excellent way for expats to save a bundle on their US tax returns each year. If you are a ‘temporary’ resident overseas, simply track your travel time carefully and establish a tax home abroad and you will keep more of your hard earned money in your wallet—not in Uncle Sam’s!