If you are an expat (or are considering working overseas in the future!) we are confident that you have you heard of the Foreign Earned Income Exclusion (FEIE). This exclusion is provided by the IRS and allows you to earn just over $100,000 and not pay a single cent in federal income tax on that income. You may have heard that you need to meet one of two tests of the exclusion, the bona fide resident or physical presence test. Once one of these tests has been met, you might think that filing your federal income tax return and claiming the exclusion is easy. If only it were. Before you can consider claiming the Foreign Earned Income Exclusion, you must also meet a significant test that is often overlooked: the tax home test. This test will be crucial because you’ll need to know if you have a tax home in a foreign country, or if it is in the US.
What Is the Tax Home Test?
The tax home test states that you don’t qualify for the Foreign Earned Income Exclusion if you have a tax home or abode within the United States. The IRS instructs that the tax home is usually the general area where you work. Wherever you permanently or indefinitely work, that’s your tax home. Also, the IRS notes that you cannot have an abode in the US. The term abode has an ambiguous definition, which we will examine next, but the central idea is that people with closer connections to the US do not qualify for the exclusion. Even if you have been outside of the country and would otherwise qualify for the exclusion, you will not if your tax home or abode is in the United States.
What’s an Abode?
The IRS has defined abode as one’s home, habitation, residence, or place of dwelling. While this may seem straightforward, it isn’t, because the IRS also considers social and economic connections to determine the location of one’s abode. Someone could own a home in the US with a spouse or other family member living there, and they can still qualify for the tax home test in a foreign country. Likewise, just because someone owns a home abroad does not automatically mean their tax home and abode are outside of the United States; they may not qualify for the FEIE if their abode is in the US. Someone who works abroad for a few years may be concerned if they have no social or financial connections to the foreign country. Could the IRS question the short length of their stay and possibly lean towards disallowing the exclusion? These sorts of questions show just how complex the tax abode topic is.
What About Those Who Work in a Combat Zone?
If you are working in a designated combat zone in support of the Armed Forces of the US, your abode is not considered to be in the US. So long as you meet the requirements of the physical presence test, you should be eligible to exclude your foreign earned income. Combat zones are regularly updated, so be sure to check frequently for the latest designated areas.
How Can Expats Establish a Tax Home in a Foreign Country?
Establishing a tax home in a foreign country is tantamount to establishing a clear, primary connection with your host country. How do you do that? Have proof of your life in the host country in case the IRS ever questions the exclusion claim. For example, perhaps you use the local bank, have joined some local clubs or organizations, participate in a religious service, or even are involved in the community on a general level. When you have foreign accounts for utilities, insurance, a driver’s license, or even a cellphone, it paints the picture that this is the place where you live. It’s your abode, and it’s your tax home. Show that you are less connected to the US, and you should pass the tax home test. If you are a contractor in a combat zone, we recommend keeping the employment contract and your tax documents for the year.
We know that the tax home test is intended to prevent US taxpayers from abusing the Foreign Earned Income Exclusion. Evading income tax is illegal, wherever you are. The FEIE is for expats that have established a life abroad and have social and economic ties to a foreign country, or the special cases of taxpayers supporting the Armed Forces of the US in a combat zone. However, claiming the FEIE after meeting the tax home test and the bona fide residency or physical presence test is completely legal tax avoidance.
International taxation and the FEIE are hot topics for the IRS, especially in our mobile economy where defining one’s abode can be very difficult. The result of claiming the exclusion when you are not entitled can result in a tax bill which may include a 20% percent accuracy-related, late-payment penalty and interest. Our recommendation? Keep good records! If the IRS disallows your use of the FEIE due to you having a tax home or abode within the US, the consequences could be costly, and there may even be complications at the state level depending on your state residency.
Questions About the Tax Home Test?
If you are having trouble determining your tax home for the FEIE, Greenback’s expert accountants can review your situation and provide guidance. Contact Greenback, and we’ll help you get the answers you need!