Using the Physical Presence Test to Lower Taxes When You Move Back

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One of the tax concessions offered by the United States government to expatriates to lessen double taxation is the Foreign Earned Income Exclusion (FEIE). To qualify an individual must pass the tax home test, and one of two other tests: the Physical Presence test or the Bona Fide Residence test.

So why would you want to qualify for the FEIE? It’s simple. In 2014 you can deduct up to $99,200 of your income which will significantly lower your US taxes. It’s no small deal! If you are moving back to the US, you can still use FEIE (assuming you qualify) to lower your tax responsibility for the part of the year you were abroad.

What is a Tax Home?

To have a tax home in a foreign country means to have the center of one’s employment, duty, or business activities in the foreign country. This is supported by facts such as location of bank accounts, whether family relocated, office location, registrations with embassies, and over such facts and circumstances. Assuming you have been overseas for an extended period of time, it shouldn’t be difficult to have established a tax home there, which will help you qualify for FEIE.

What are the Tests to Qualify for FEIE?

One of the two tests available to expatriates who are trying to qualify for the FEIE is the Physical Presence test (PPT). To qualify under PPT, an individual must be present in a foreign country for 330 full days during a 12-month rolling period, along with maintaining a tax home in the foreign jurisdiction for the 330 days as discussed. A “full day” for purposes of the test means a full 24 hour cycle from midnight to midnight. Actual days of arrival and departure to the foreign country do not count towards the 330 days, unless the taxpayer found himself in the foreign airspace at midnight.

The other test expats often use is the Bona Fide Residence test (BFR). To qualify under this test, you must have been overseas for at least a year and have no plans to return to the US. So if you are repatriating, this test wouldn’t apply to you.

How do I Calculate my Qualifying Days Using the Physical Presence Test?

The PPT is a bit more complicated than the BFR, but it can provide for a greater exclusion figure in years of arrival and years of departure from/to the United States if using the ‘slide days’ provision. During years when you were abroad, the BFR test is generally of greater benefit (especially if you had some significant travel to the United States – for instance, an entire summer), and easier to calculate. But again, expats overseas for shorter periods of time won’t be able to use the BFR.

Apart from determining whether an individual qualifies for the FEIE, the PPT also determines the qualification period (number of days in in period that qualifies for the FEIE, which is used to prorate the FEIE). This is true for the BFR test as well.

Example: John moved back to the United States from China July 1, 2013. He has been utilizing the FEIE for the last 5 years, and intends to do so for his year of departure. He had no US travel days in 2012 or 2013 before his move back home. In its simplest form, the qualifying period would be from January 1, 2013 to July 1, 2013, or 181 days.

Based on the Number of Qualifying Days, the FEIE is Prorated.

Example: $97,600 x (181 / 365) = $48,399 available for exclusion

What is the Slide Days Provision?

If individuals use the slide days provision, they may be able to increase the allowed FEIE. As indicated earlier, to qualify an individual is required to have 330 foreign days in any 12-month period. An individual is allowed 35 US days in the period. As the tax home test only applies to the 330 foreign days, this allows individuals to add US days before or after an assignment into the qualifying period. So for the year of departure, one may ‘move forward’ the 12-month period by a maximum of 35 days (depending on the US travel days already found within the period). This example may explain this a bit more clearly.

Example: Taking the facts from above, John has all 35 days available to him, as he incurred no US travel from 1 July 2012 to 31 June 2013. As such, he moves his qualification period up to 4 August 2013, giving him 216 days.

$97,600 x (216 / 365) = $57,758,

This results in an increase of $9,359.

It is important to note that the FEIE is only available against foreign earned income. Income associated with the US period is US-sourced and cannot be excluded. This is the same rule for individuals who take business trips to the United States during an assignment. Income is sourced between US and foreign workdays. For this reason, it is recommended individuals keep clear track of what income is earned during what period so that it may be allocated properly during tax preparation.

Still Have Questions About the Physical Presence Test?

If you would like more information about the Physical Presence test or the Foreign Earned Income Exclusion, our blog has all the information you need. As always, if you need help with your expat tax return, we are here to help!