Based Abroad

To meet the Physical Presence Test, you must be physically present in a foreign country for 330 full days during a period of 12 consecutive months. What does this mean? The IRS considers a travel day as a day in the US—which means you have 34 days to be traveling to, from, and in the US. The IRS defines a full day as a 24 hr period beginning at midnight. Time you spend flying over foreign water or a foreign country is not considered physically present in a foreign country, thus, these travel days count against you.

The term “foreign country” does not include U.S. possessions such as Puerto Rico, Guam, and the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa. For purposes of the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction, the terms “foreign,” “abroad,” and “overseas” refer to areas outside the United States, American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, Puerto Rico, the U.S. Virgin Islands, and the Antarctic region. The term “foreign country” does not include ships and aircraft traveling in or above international waters, nor does it include offshore installations which are located outside the territorial waters of any individual nation.

You can count days you spent abroad for any reason. You do not have to be in a foreign country only for employment purposes. You can be on vacation time. You do not meet the physical presence test if illness, family problems, a vacation, or your employer’s orders cause you to be present for less than the required amount of time.

However, the minimum time requirement can be waived 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, and that you had a tax home in the foreign country and were a bona fide resident of, or physically present in, the foreign country on or before the beginning date of the waiver.

This qualification is the most difficult to meet, but offers the greatest flexibility and simplicity in taking the foreign income exclusion.

Make sure you track your travel to the day. Should an Audit arise, the burden of proof will be on you to show documentation that you were physically present in a foreign country for 330 full days. Please note that, unlike Bona Fide Residence, meeting the federal Physical Presence requirements will not necessarily exempt you from paying state income tax.

To meet the bona fide residence test, you must have established such a residence in a foreign country. The bona fide residence test applies to U.S. citizens and to any U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect.

The term “foreign country” does not include U.S. possessions such as Puerto Rico, Guam, and the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa. For purposes of the foreign earned income exclusion, the foreign housing exclusion, and the foreign housing deduction, the terms “foreign,” “abroad,” and “overseas” refer to areas outside the United States, American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, Puerto Rico, the U.S. Virgin Islands, and the Antarctic region. The term “foreign country” does not include ships and aircraft traveling in or above international waters, nor does it include offshore installations which are located outside the territorial waters of any individual nation.

To qualify as a bona fide resident – you must establish residency in the foreign country. The IRS refers to Tax Home when discussing this deduction. They state in tax code that: You are not considered to have a tax home in a foreign country for any period in which your abode is in the United States. “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. “Abode” has a domestic rather than a vocational meaning and does not mean the same as “tax home.” The location of your abode often will depend on where you maintain your economic, family, and personal ties. (Title 26, sub-title A, Chapter 1, Sub-Chapter N, Part 3, Section 911, Paragraph 3,)

Example: You accept a contract with a foreign carrier based in Dubai. You are provided with an apartment to live in on your days off. Your wife and children remain in the United States. On days off of any duration, you return home to the U.S. All of your personal items, heirlooms, photographs, golf clubs, boat etc. are located in the U.S. as are your bank, investment and retirement accounts. In this example, you do not qualify for foreign income exclusion. We are not able to prove that we have established a residency which qualifies as an “abode”.

The intent of this law is to provide tax relief to those people living abroad who do not reside or earn their income in the U.S. It is argued that they are not taking advantage of public services in the U.S. and should not be required to pay income tax to support these services and benefits. When we look at this “intent” it is obvious that the above example does not qualify for the earned income exclusion.

The other determining factor for this test is duration. You must be a bona fide resident of a foreign country for one entire tax year, January 1 to December 31 of any year. For example, if you were based abroad in July of 2021, your qualifying period doesn’t even start until January 1 of 2022 and will not be completed until January 1 of 2023. There is a special extension that we file in this situation with the IRS to grant an extension of time until the qualifying period can be met. If any tax is to be due on the return, it must be paid in a timely manner – April 15 of the following year. We would calculate your return under the assumption that you will be meeting the requirement. Once you have met this requirement, your return is then simply sent to the IRS for filing. If you should not meet the duration requirement, your return would be recalculated without the foreign income exclusion. If you have any questions on this process—please call, we will be happy to discuss it with you.

2023 Exclusion amount and limits:

• Maximum foreign earned income exclusion is the smaller of $###,### ($###,### if Spouse also qualifies) or foreign earned income minus the foreign housing exclusion ($###.## / day)
• Housing expense floor: $##,### ($##.## / day, 16% of the maximum exclusion amount)
• Housing expense limit (locations not listed specifically): $##,### ($##.## / day, 30% of the maximum exclusion amount)

Foreign Earned Income Exclusion requirements:

• The tax home must be in a foreign country
• There must be foreign earned income
• Must be a U.S. citizen or resident alien who meets either the Bona Fide Resident or Physical Presence Tests

Tax Home vs. Abode:

• “Abode” is generally determined by where you maintain your family, economic, and personal ties.
• For flight crew members, their tax home is generally their base. However, even if they are based in a foreign country, and they have an abode in the U.S. they are not eligible for the exclusion.
• Conversely, if the crew member has an abode in a foreign country but is based in the U.S., they will not qualify for the exclusion.
• Maintaining a house in the U.S., whether or not the spouse and/or dependents use it, does NOT necessarily disqualify a taxpayer from taking the exclusion, however the taxpayer must be prepared to show they do not reside in the U.S.

Bona Fide Resident vs. Physical Presence:

• The Bona Fide Resident Test requires the taxpayer to be a resident of a foreign country or countries for an entire calendar year (January 1 – December 31). Trips back to the U.S. and its possessions are not an issue if the intent is to make your abode in the foreign country and the length of the assignment is indefinite.
• The Physical Presence Test requires that the taxpayer be physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive. The physical presence test is based only on how long you stay in a foreign country or countries. It does not depend on the kind of residence established, intentions about returning, or the nature or purpose of the stay abroad. Also, meeting the federal Physical Presence test does not exempt the taxpayer from paying state income taxes.

Part year Exclusions:

• The foreign earned income and housing exclusion amounts will be prorated for part years based on the number of days present in the foreign country. A taxpayer may make less than the maximum allowed amount, but all may not be excluded due to prorating.
• Form 2350 (Extension to file request) may be filed if the taxpayer expects to qualify for the exclusion, but not until after the return is due. Extensions are generally 30 days after the date the exclusion requirements are met.

Definition of Foreign Earned Income for flight crew members:

• The place the services are performed determines whether the income is foreign, not the location of the employer. For example, United Airlines employs many U.S. citizens with both their tax home (base) and abode in foreign countries.
• The definition of “foreign country” requires that international flight crew members must apportion their income based on the time spent over international waters, the U.S., and U.S. possessions and territories. “Flight Time Apportionment”, based on the average flight time per segment is used to calculate the amount of foreign earned income. We use this information and the client Year End Audit Report to calculate U.S. taxable income for United Airlines employees. The report also allows us to determine the percentage of flight deductions and credit for foreign taxes paid on non-excluded income.
• Total time worked in and over foreign countries
• Total time worked X Total wages earned = Foreign income

Employee vs. Self-Employed

• Many pilots working for foreign airlines refer to themselves as “contract pilots”. This does not necessarily translate to self-employment since they invariably meet the Common Law Rules for an employee. Employees of foreign employers based outside the U.S. are generally not subject to U.S. Social Security and Medicare tax withholding.

Effects of choosing the Foreign Earned Income:

• The tax for nonexcluded income will be figured using the tax rate for ALL income, including the excluded amount.
• Flight deductions, including per diem and union dues, must be prorated to the percentage of non-excluded income reported. Deductions are not allowed for excluded income. For example, if 65% of the income earned was determined to be foreign, only 35% of the professional deductions and per diem would have to be allowed on the 2106 or Schedule A.
• Income taxes paid to a foreign country must also be prorated based on the percentage of excluded income. If 65% of the income is foreign, only 35% of the income taxes paid to another country would be allowed on Form 1116. The actual wages reported on Form 1116 would be the amount remaining after the exclusion (the 35%).
• Foreign moving expenses must also be prorated.
• Once the choice is made to take the Exclusion, the choice remains in effect for that year and all subsequent years unless the choice is revoked in writing. If the choice is revoked, a letter ruling is required if the individual wants to take the exclusion again within a 5 year period. Some taxpayers will benefit more, or just as much, from taking the Foreign Tax Credit for income tax paid to the resident country than by taking the exclusion. Once the exclusion is taken, you can no longer choose between the two scenarios. The exclusion should not be taken without careful consideration of the situation
• Claiming the Exclusion disqualifies the taxpayer for EIC.
• Excluded income cannot be considered when determining IRA or Roth contribution limits, however it is considered when calculating any possible deduction.