U.S. Citizens Abroad: Understanding Tax Benefits and Tests
November 28, 2023
If you are a U.S. citizen earning income in a foreign country, you may be required to pay taxes to the U.S. government and the country you work in. There are provisions to help mitigate this situation and reduce your U.S. tax liability. These benefits are based on meeting specific criteria related to your tax home, foreign earned income, and residency status in a foreign country.
Tax Home: Your tax home is generally your regular place of business or employment. If you have more than one regular place of business, it's where your principal place of business or employment is located. If you don't have a principal place of business, it's where you maintain your family, economic, and personal ties.
Foreign Country: A foreign country, for tax purposes, includes any territory under the sovereignty of a government other than that of the United States. It excludes U.S. territories like Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa.
Bona Fide Residence Test: To qualify for this test, you must be a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year (e.g., January 1 through December 31). During this period, you can leave the foreign country for brief trips to the U.S. or elsewhere for vacation or business. However, you must intend to return to your foreign residence without unreasonable delay. Determining a bona fide resident is based on various factors, such as your intention, establishment of a home, participation in local activities, and nature of employment in a foreign country. The reasons for temporary absences are also considered in determining your bona fide residence.
Physical Presence Test: To meet this test, you must be physically present in a foreign country for at least 330 full days during 12 consecutive months. It doesn't matter why you are present in a foreign country; it can be for business, vacation, or a combination of reasons. A full day is defined as 24 consecutive hours, beginning at midnight. Certain days are excluded from the 330-day count, such as traveling to and from the U.S. over international waters or for specific reasons like illness, family emergencies, war, or civil unrest.
The maximum foreign-earned income exclusion amount is adjusted annually for inflation. For tax year 2023, the maximum exclusion is $120,000 per person. It doesn't matter if you work at a U.S.-based company or a company based in the country where you live.
Meeting either the Bona Fide Residence Test or the Physical Presence Test is essential to qualify for tax benefits related to foreign-earned income exclusion and housing exclusion or deduction. These benefits allow you to exclude a certain amount of your foreign-earned income from U.S. taxation and may also provide deductions for housing expenses incurred while working abroad.
These exclusions and deductions are calculated on a daily basis, and it's essential to maximize the number of days spent in a foreign country within the 12 months and within the tax year to optimize your tax benefits.
Contact Your CPA
If you are working and earning income in a foreign country, it's advisable to consult with a tax professional who specializes in international tax matters. They can help you assess eligibility for tax benefits, ensure compliance with U.S. tax laws, and help you plan your finances for maximum tax efficiency while working abroad.