American taxpayers must report their worldwide income on their US tax returns, should they have a filing obligation. The foreign earned income exclusion may assist lower their US tax liability though should they qualify for it and elect to use it. I will discuss the FEIE three prong tests and how you should plan for it to be eligible to exclude some or all of your foreign earned income.
United States resident aliens such as foreign nationals who have been granted a permanent resident permit (green cards) and foreign nationals who meet the substantial presence test are generally subject to tax on their worldwide income and gains similar to U.S. citizens with some exceptions.
A U.S. citizen or resident alien who earns income in a foreign country may also be taxed on that income by the foreign host country, which can lead to double taxation. Several Internal Revenue Codes (IRC) provisions are intended to help mitigate this situation, including the foreign earned income exclusion and the housing exclusion or deduction, under IRC section 911.
Do I qualify for foreign earned income exclusion?
To qualify for the foreign income and housing exclusion tax benefits, you must be a qualified individual under IRC section 911(d)(1), that is a U.S. taxpayer who:
has tax home in a foreign country,
has foreign earned income, and
is a U.S. citizen or a resident alien who meets the bona fide residence test (BFR) or the physical presence test (PPT) in a foreign country.
Tax Home
A tax home, under Section 911(d)(3), is generally the taxpayer’s regular place of business or employment. If the individual has more than one regular place of business, then the tax home is located at his or her principal place of business or employment. If the individual has no principal place of business because of the nature of the business, or because the individual is not engaged in a trade or business, his or her tax home is at the individual’s regular place of abode. The location of the abode is based on where the taxpayer maintains their family, economic and personal ties.
Special circumstances for certain individuals: Individuals serving in an area designated by the President of the United States by Executive order as a combat zone for purposes of section 112 in support of the Armed Forces of the United States have a foreign tax home despite the fact that their abode is within the United States. Plan accordingly!
Foreign country
A foreign country includes any territory under the sovereignty of a government other than that of the United States. This excludes international waters and airspace above them, Antarctica or U.S. territories such as Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa. The days spent in the excluded area listed above do not count as days in a foreign country. Plan accordingly!
Foreign earned income
Under I.R.C. § 911(b), foreign earned income means an amount received by a qualified individual from sources within a foreign country or countries which constitute earned income attributable to services performed by such individual during the qualification period. This is the period during which the qualified individual meets the bona fide residency test or the physical presence test.
Earned income under section 911(d)(2) means wages, salaries, or professional fees (such as freelance fee, gig payments), and other amounts received as compensation for personal services actually rendered, exception applies.
The source of your earned income is the place where you perform the services for which you received the income. That is, foreign earned income is therefore income you receive for performing personal services within a foreign country. Where or how you are paid has no effect on the source of the income. For example, the income you receive for work physically done in Mexico is income from a foreign source even if the income is paid directly to your bank account in the United States and the entity paying you is located in Japan, UK, or United States.
Generally, dividends, interest, annuities, pensions, unemployment income, portion of a compensation that represents distribution of earnings of profits from a corporation, salary paid by the United or its agency, and social security and welfare type benefits are not earned income for foreign earned income exclusion purposes.
Bona fide Residence Test
To meet the bona fide residence test under the foreign earned income exclusion (FEIE) section 911, an individual must generally be:
(1) A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year (for example, January 1 through December 31, for calendar-year taxpayers), or
(2) A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, (example from January 1 through December 31, for calendar-year taxpayers)
Please note that the BFR test is not met if you submitted a statement of nonresidence to the authorities of a foreign country in which you earned income and the authorities hold that you aren't subject to their income tax laws by reason of nonresidency in the foreign country.
How a temporary absence from a foreign country affects a Foreign Earned Income Exclusion qualification?
During the period of bona fide residence in a foreign country, the taxpayers can leave the country for brief or temporary trips back to the United States or elsewhere for vacation or business. However, to keep their status as a bona fide resident of a foreign country, they must have a clear intention of returning from such trips, without unreasonable delay, to their foreign residence or to a new bona fide residence in another foreign country.
The determination of a bona fide resident is based on all the facts and circumstances. The Courts have considered the length of stay plus additional factors such as:
a taxpayer’s intention,
establishment of a home in a foreign country,
participation in social and cultural activities in a foreign community,
nature and duration of employment, and
reasons for temporary absences from the foreign home.
Once you have a clear intention to and in fact return to a foreign country after a temporary presence in the US, you could argue that you are still a bona fide resident of a foreign country for FEIE purpose. However, personal services income earned within the United States is U.S. source and therefore not eligible for FEIE.
Physical Presence Test
To meet this test, the individual taxpayer must be physically present in a foreign country for at least 330 full days during 12 consecutive months. It can begin with any day of the month. A full day is a period of 24 consecutive hours, beginning at midnight. Additionally, an individual's physical presence in a foreign country may be for any reason such as for business purposes or vacation time, or any combination of purposes.
Certain days are excluded and do not count as days spent in a foreign country if they are:
spent on traveling to and from the United States over international waters (in transit),
to recover from an illness,
family emergencies,
war or civil unrest, or
under orders from superiors.
Waiver of Time Requirement in foreign countries
There are sometimes adverse conditions and emergencies that may require an individual to leave a country. Without the time requirement waiver under IRC section 911(d)(4), this individual may not qualify to take a partial foreign earned income exclusion under section 911. Therefore, the IRS may waive the time requirements under certain circumstances.
Both the bona fide residence test and the physical presence test contain minimum time requirements. The minimum time requirements can be waived, however, if you must leave a
foreign country because of war, civil unrest, or similar adverse conditions in that country. You
must be able to show that you reasonably could have expected to meet the minimum time requirements if not for the adverse conditions. To qualify for the waiver, you must actually have
your tax home in the foreign country and be a bona fide resident of or be physically present
in the foreign country on or before the beginning date of the waiver. The Internal Revenue Service generally publishes in the Internal Revenue Bulletin a list of countries that qualify for the waiver and the effective date or dates.
For example, you were on a 2 years assignment as a contractor in Iraq starting June 30, 2019, and you repatriated to the US on March 20, 2020 earlier than expected due to adverse conditions in Iraq. Assuming you or your employer didn't have any intention to end your contract early, then you qualify for the FEIE based on the IRS Rev. Proc. 2021-21. However, the exclusion of foreign income applies to the time you were actually working in the Iraq. All personal services income earned while in the US is US source and doesn't qualify for the Foreign Earned Income Exclusion.
United States COVID-19: Waiver of Sec. 911 FEIE Time Requirements
IRS expands the Foreign Earned Income Exclusion eligibility due to Covid-19 under the Revenue Procedure 2020-27 for qualified individuals. COVID-19 emergency is an adverse condition for the time limit requirement.
The qualifying period for the exclusion of foreign earned income includes the time spent in the US from the dates below to July 15, 2020:
December 1, 2019, for expats who left China (excluding Hong Kong and Macau)
February 1, 2020, for expats who left any other foreign countries
Example:
Under this Revenue Procedure 2020-27, an American expat who was present in the United Kingdom on January 1 through March 1, 2020, establishes that he or she reasonably expected to work in the United Kingdom for the entire calendar year, but departed the United Kingdom on March 2, 2020, due to the COVID-19 Emergency, and returns to the United Kingdom on August 25, 2020, for the remainder of the calendar year, would be a qualified individual for 2020 with respect to the period between January 1 through March 1, 2020, and August 25 through December 31, 2020, assuming the individual has met the other requirements for qualification under section 911. In this case, as discussed, if you are considered a tax resident of the UK for the entire year, you may treaty resource the income earned in the US during the emergency stay.
How do you plan for it, if you should be traveling extensively?
Digital Nomads. One of the best ways is to always use a reference date. Ask yourself: when did I leave the US? This date is when you intend to go abroad for work for a period lasting more than 12 months. It's very important to have that intent to reside abroad. Having something in writing on an assignment letter signed by your employer if seconded to a foreign country is an intent. Booking long term air travel and stay in one or multiples countries for a combined period of 12 months or longer may be considered intent as well.
330 days in foreign countries: You know the date when you left the US. Now add 365 days. You have a new date. You need now to make sure you have a foreign tax home. To meet this definition and the physical presence test, you need to maintain that foreign tax home for at least 330 days in a foreign country or foreign countries within the 12-month period following the date you left the US.
Travel records: With your high-tech gears/equipment you frequently (or seldom but not me, I assure you!) use, there must be one that you can use to track your US and foreign travel, including working and not working. Therefore, keeping records of your whereabouts should not be an issue.
Forget B.F.R. if you are a true digital nomad and travelers! In the world of Covid-19, remote work became the norm for many individuals. This was the norm however for digital nomads. Many of our clients who are travelers have been working remotely from outside of the US for US or foreign companies for many years. For these individuals who are likely not bona fide residents of any foreign country, the Physical presence test is their best option. Based on the fact that their work locations are by default their tax home and they constantly travel (not so much in 2020 and perhaps 2021!), meeting the PPT test is easier than ever. Of course, if you, by mistake or unintentionally, maintain an abode in the US, the whole FEIE plan is shattered. Exception applies! Income tax is hiked! States will want their shares as well. Look out for California if you maintained a domicile/kept ties!
States: You meet the F.E.I.E. for federal tax purpose but for certain states where you are considered a resident, it's a no go. In certain circumstances. You will likely be fine be fine if you are from one of those states, such as Ohio or Arizona, for example, that conform with the federal FEIE, IRC section 911. Best plan is to review the residency and domicile and FEIE rules of the states you last resided prior to backpacking abroad!
Vacation while working: I heard you! You travel to very nice places without breaking the bank (compare to certain US cities). You enjoy the beautiful views while working remotely. Well, what else to say? A lot but can't fit in this blog post. email us your questions and we may discuss it later here or in our Q&A page
Revoking your choice to exclude foreign earned income
Once you elect to take the FEIE under section 911, you are bound to it for all subsequent taxable years unless you make an election to revoke that choice. A taxpayer may revoke an election to take FEIE for any taxable year after the taxable year for which such election was made. Except with the consent of the Internal revenue service via a private letter ruling, any taxpayer who makes such a revocation for any taxable year may not make another election under this section 911 for any subsequent taxable year before the 6th taxable year after the taxable year for which such revocation was made.
Basically, if you revoked a choice of FEIE and within 5 years again wish to choose the same exclusion, you must apply for IRS approval.
Foreign tax credit may be an alternative and a better option than the FEIE. We have seen it many times. If you plan to reside long term in an overall higher taxing jurisdiction than the US at certain income level and types of income, then check out the section 901, foreign tax credit option and compare the two. Plan accordingly!
Bottom Line:
You should be aware of the qualification rules for the foreign earned income exclusion and also how to stay qualified for the F.E.I.E. if you must travel back to the U.S. and outside of a foreign country defined earlier.
How can Whin Global help?
Because the foreign earned income exclusion and the housing exclusion or deduction is calculated on a daily basis, maximizing the number of days in a foreign country within the 12-month period and within the tax year increases your tax benefits.
Aside from the codes, regulations, and court cases, IRS Pub 54 may help. So read up and get in touch if you need help.
Call our office or contact us to discuss your situation and to review your eligibility to take the foreign earned income exclusion (FEIE) and the housing exclusion or deduction, and to plan for the maximum tax benefit. We are here to assist you. There are alternatives to the foreign earned income exclusion if you do not qualify for it.
Whin Global provides U.S. domestic and expat tax compliance and consulting services to American expats, resident aliens, and nonresident individuals and small businesses with US tax and/or foreign financial reporting needs. Get in touch for a tax consultation.
(Originally published January 8, 2020)