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Understand the Bona Fide Residence Test

Introduction

The foreign earned income exclusion allows qualifying expats to exclude a significant amount of their foreign earned income from U.S. taxation. However, eligibility for this benefit hinges on meeting  either the Bona Fide Residence Test or the Physical Presence Test.

The Bona Fide Residence Test

The Bona Fide Residence Test is one of the two tests that expats would need to pass in order to qualify for the foreign earned income exclusion. The test evaluates whether an individual has established a genuine residence in a foreign country. Unlike transient or temporary stays, bona fide residence implies a degree of permanence and integration into the local society. However, the concept of "bona fide residence" is subjective and hinges on various factors, making it a complex terrain to navigate without professional guidance.

Bona Fide Residence Test vs. Physical Presence Test

While both tests aim to validate an expat's foreign residency status, they differ significantly:

  • Bona Fide Residence Test focuses on the nature and conditions of your stay in a foreign country, including your intention, the establishment of your home, and social engagements.

  • Physical Presence Test, by contrast, is more straightforward, requiring you to be physically present in a foreign country for at least 330 full days during a consecutive 12-month period.

Criteria for Qualifying for the Bona Fide Residence Test

Qualifying for the Bona Fide Residence Test involves meeting several conditions:

  • Establishing a residence in one foreign country for an uninterrupted tax year.

  • Demonstrating clear intention of residing in said country, either indefinitely or for a significant period.

  • Compliance with the legal requirements of the foreign jurisdiction for residency.

Examples of Qualification Scenarios

  • An expat accepting a multi-year employment contract in Germany, renting a local home, and engaging in community activities would likely qualify.

  • Conversely, someone residing in a foreign country merely for vacation or short-term work assignments may not meet the criteria.

Partial Year Bona Fide Residence

In instances where you establish bona fide residence mid-year, a prorated exclusion based on your residency start date may apply. Navigating these calculations can be intricate and demands thorough understanding or consultation with a tax professional.

Preparing for the Bona Fide Residence Test

Preparation is pivotal. Expats should:

  • Maintain detailed records of physical presence and ties to the foreign country.

  • Keep documentation, such as residential leases, utility bills, or a local driver's license.

  • Consult with a tax advisor specializing in expat tax law to review your unique circumstances.

Conclusion

The Bona Fide Residence Test, while offering substantial tax benefits, is fraught with complexities. Misinterpretation of the rules can lead to costly tax consequences. Therefore, seeking the expertise of a professional specializing in expat tax situations is paramount.

 

CPAs for Expats is here to guide you every step of the way

 

Join the satisfied expats who trust CPAs for Expats and gain peace of mind knowing your US taxes are in capable hands. Unlock the full potential of your tax benefits by partnering with us for all your expat tax needs. Contact CPAs for Expats now and embark on a stress-free tax journey.

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