Foreign income tax exclusions of up to $80,000 may be available to US citizens and resident aliens who have a tax residence abroad. These exclusions protect these individuals from having to pay income taxes to the United States and the country where they currently reside.
Meeting the physical presence test requirements is one way to be eligible for this kind of tax deduction.
The Physical Presence Test: An Overview
Taxpayers are able to exclude a specific amount of their foreign-earned income under the physical presence test. If you are a citizen or resident alien of the United States and reside overseas, your worldwide income is subject to taxation. However, you may be eligible to deduct your overseas profits from income up to a certain level, which is $108,700 for 2021 and $112,200 for 2022. This figure is updated annually for inflation.
People who are eligible for this exception are probably also eligible for the foreign dwelling deduction, which can result in further tax savings.
Citizens and resident aliens of the United States are both eligible for foreign income exclusion. The tax statute states that this test is unaffected by a person’s cause for being abroad.
However, if one of these factors results in the taxpayer being present in a foreign nation for less than the necessary 330 days, family emergencies, illness, and employer orders do not qualify as sufficient grounds to permit the exclusion. Furthermore, a foreign nation’s days of arrival and departure do not count toward the 330 days because a “day” is defined as a full 24-hour period.
While overseas, a person may move between different nations. Any transit time spent in the United States, such as a layover between flights, is not included in the person’s 330-day limit as long as the time spent there is under 24 hours.
What Do I Need to Do to Pass the Physical Presence Test?
If you spend 330 complete days physically present in a foreign nation or country during the course of a 12-month period, you may be eligible under the physical presence test. The prerequisites are explained in full below:
- Vacation: 330 days in complete vacation time may be incorporated into the 330 qualifying days, which do not need to be consecutive.
- Full days: A full day is one that lasts 24 hours straight and starts at midnight. Your first full day will therefore start on July 5 if you arrive in Paris at 9 a.m. on July 4.
12 Straight Months
The following four guidelines can help you determine the 12-month period:
- Your 12-month period can start on any day of the month, and it expires one year from that day on the calendar the day before.
- Consecutive months must make up your 12-month timeframe.
- You can choose the 12-month term that gives you the best outcome; you are not required to start your 12-month period on the first full day you spend in a foreign nation or end it on the day you leave.
12-month intervals may overlap when evaluating whether the period falls under a longer stay in the foreign country.
The rule does not always apply. The government will not consider a person to have been physically present in a foreign country during the time that they broke the law if their presence there violates American law. The IRS does not regard any income obtained there while breaking American law as having been earned abroad.
The taxpayer may also be exempt from the minimum time requirement if they are forced to leave a foreign country because of a war, civil disturbance, or any situation that renders it extremely hazardous or uninhabitable.
Suppose the taxpayer can show that, absent the unfavorable circumstances, they reasonably could have and would have complied with the physical presence test requirements, that they had a tax home in that nation and were a bona fide resident of that nation at the time. In that case, they may still be eligible for the exclusion.
The US government does not classify pay received as military or civilian compensation while stationed abroad as foreign-earned income.
Do I Have the Freedom to Travel?
Yes. However, you will lose whole days if any portion of your trip is not abroad and goes longer than 24 hours.
What Distinctions Does This Test Have From the Bona Fide Residence Test?
The only factor considered in the physical presence test is your time spent in a foreign nation or country. This test, unlike the bona fide residence test, is unaffected by the type of residence you establish, your plans to return, or the length and reason for your international stay.
What Happens If I Cannot Be Present Physically?
If an illness, a family emergency, a vacation, or instructions from your employer prevents you from being there for the required amount of time, you do not pass the physical presence test.
However, if one of the IRS’s exceptions applies to you, you can still be eligible.
Things to Think About
Remember that every day you spend on US soil counts against you. The entire day will be taken away, even if you just fly in for a meeting in the late afternoon.
Those who can demonstrate their actual presence in a foreign country are eligible for large tax exemptions and credits (including the Foreign Housing Credit, the Foreign Earned Income Exclusion, and the Foreign Tax Credit). Therefore, it is in the best interest of expats to spend less than 35 days out of every 365 in the US.
Any 365-day timeline is applicable to the Physical Presence Test. Any day in any month may be used to start the count. There are no exceptions allowed for emergency travel, and the test is fairly straightforward. Any time spent in the US counts toward the required 330 days. In addition, days spent traveling (to the US) count toward the 330-day limit. You can still receive a tax bill from the IRS even if you satisfy the physical presence test and meet the requirements for the exceptions. This is as a result of the exclusion solely applying to money made abroad.
A resident of the United States who established a business in Tokyo, Japan, on March 14th, 2020, and remains there until February 23rd is automatically eligible for the Foreign Earned Income Exclusion. They passed the Physical Presence Test because they spent 344 days in Tokyo.
The ex-pat mentioned above would nonetheless pass the Physical Presence Test and be eligible for the ex-pat exclusions even if they traveled during those 344 days but did not go to the US or any of its territories.
The same business owner would reduce their time away below 330 days and lose eligibility for ex-pat exclusions and credits if he returned to the US for business (or for any other reason) and spent more than fourteen days flying to and on US soil.
What Happens If I’m Uncertain About the Test?
You may need to speak with a tax attorney if you have concerns about the physical presence test and how it might apply to you. If doubts or problems occur, speaking with an attorney could help you avoid paying a lot of taxes.