Complete Guide to the Bona Fide Residence Test
Living abroad is a trending topic and popular lifestyle choice for many Americans for more than one good reason! Not only do they enjoy traveling and exploring new places, but they also get the opportunity to gain insight into another culture that’s different from their own. The benefits of living abroad are many becoming a popular topic that continues to rise in popularity.
Life in a foreign country also opens the door to a whole new network of contacts and connections. In a way, it forces the individual to be a self-starter and step out of their comfort zone. Now, one of the bigger reasons that Americans enjoy living in a foreign place is because they can qualify for the Foreign Earned Income Exclusion (FEIE).
If you are not yet aware, FEIE enables taxpayers from the U.S. to exclude a certain amount of the salary earned while living abroad from their income taxes. They may also qualify for foreign housing exclusions and be able to deduct some foreign housing expenses like utilities and rent.
Americans living abroad who qualify for FEIE are also exempt from the minimum health coverage requirements meaning they’re not subject to a penalty. These are the primary financial benefits Americans receive when they qualify for Bona Fide Residence.
In this guide, you will find everything you need to know about the Bona Fide Residence Test process. We’ll cover the following questions to give you an overall understanding of what Bona Fide Residence is:
What is the Bona Fide Residence Test?
What benefits does it bring?
Are you eligible for it?
How do you take this test?
Are you ready? Good. Let’s get started!
What Does Bona Fide Mean?
In a literal sense, Bona Fide means, “without intention to deceive”. In this context, a Bona Fide resident is an individual who is one of the following:
- A U.S. Citizen.
- A U.S. resident alien that is a citizen in a country that the U.S. has a treaty of income tax with.
When an American leaves the country to live elsewhere, they can qualify to take the Bona Fide Residence Test and benefit from the advantages we mentioned above. But only after a period of time.
Many individuals believe that after living in a foreign country for one year, they automatically receive their bona fide resident status. But this is not the case!
To qualify for deductions, you need to Pass the Bona Fide Residence Test. Basically, prove you have a home in the new country. Expats should never assume that they automatically qualify simply because they have been living outside the U.S. for a period of time.
Qualifications and Income Exclusion
So how do you know if you’re eligible for this exclusion? Before you can claim and take advantage of the exclusions and deductions you must meet each and every one of these four requirements:
- Be a U.S. Citizen or resident alien residing in a country with a U.S. tax treaty.
- You need to have a residence in a foreign country.
- You must live in that country for a complete tax year.
- You must not have plans of leaving your country of residence to return to the U.S.
The requirements are very straightforward, but we do want to clarify the fourth requirement because it can easily be confused.
For example, if an individual travels to Germany for a 2-year work contract and stays in this country for the entire two years, they do not qualify for a Bona Fide Residence Test because they had predetermined plans of moving back to the U.S.
Another good example is buying a home in Switzerland and spending about seven months here every year with family. This doesn’t qualify because you still maintain a residence in the United States.
Here are some examples of individuals who DO qualify for the credits and exclusions:
- An individual accepted a long-term job in South Korea. After his/her first year, they will qualify for the deductions available to Bona Fide Residents because there are no immediate plans of someday moving to the U.S. This doesn’t mean that they won’t or can’t move back one day. But for now, they don’t plan to.
- An expat moves to Ireland for work. After three months, his company sends him back to the United States for a 3-week training before going back to his residence in Ireland. After a year, he will be a Bona Fide Resident because he has an established residence in Ireland and no plans to move back to the States.
Individuals who pass the test can receive:
- Foreign Tax Credit
- Foreign Housing Credit
- Foreign Earned Income Exclusion
Bona Fide vs. Physical Presence
Before you can apply for bona fide residence, you need to meet this specification: you’ve lived abroad for a whole tax year without living anywhere else in that period. Specifically January 1st through December 31st for all taxpayers filing income tax returns by a calendar year.
Take this example for instance. You arrived with your family to a foreign country on September 1, 2014, immediately established residence there and returned to the United States on December 13, 2015. Even though you have been there for a year, you did not meet the full tax year. Therefore, you do not qualify.
You may still qualify for the Physical Presence Test which offers some benefits. Here’s how:
- Be present (physically) in a foreign country for 330 days (during a consecutive period of 12 months).
- The 330 days do not need to be consecutive, and you can count all the days spent abroad whether it be for business or pleasure reasons.
This test does not require as much as the Bona Fide one, and it applies to both U.S. citizens and resident aliens from the U.S.
So how does this differ from the Bona Fide Residence Test? To meet the requirements, you need to be a resident of the foreign country for a consecutive 12 months or uninterrupted timeframe that includes a complete Tax Year. Additionally, you also need to have an established address abroad.
It’s much easier to qualify for the Physical Presence Test than it is for the Bona Fide Residence.
IRS Publication 54 and Form 2555
So, how do you know if you can qualify for bona fide resident status? First, you must have an established residence in a foreign country. It cannot be the same address as your home in the U.S. – or the place where you plan on returning one day.
Each individual case is different. In other words, the IRS takes different factors into account. These considerations include:
- Purpose of trip
- Length of your stay abroad
If you have an earned income within a foreign country, you need to fill out Part II of Form 2555 which is for taxpayers qualifying under Bona Fide Residence exam. This will prove that you’ve been a bona fide resident of the foreign country for a continuous period that included a whole tax year.
How To Fill Out Form 2555
Using the information that you report on Form 2555; the IRS will come to a decision as to whether or not you qualify for bona fide residency. A decision will not be made until you submit this form and if you do qualify, you’re looking at deductions and income exclusions!
Remember: you cannot deduct or exclude more than your total foreign earned income for the year. Filling out this form is simple, but if you get stuck in the process, here are a few things you can try:
- Click here to review the instructions on how to fill out this form.
- Seek the assistance of an International Tax Expert.
- If you know someone who is a Bona Fide Resident, go to them for guidance.
Download the Tax Form
If you meet all of the requirements to satisfy the Bona Fide Residence Test, you can download Form 2555 online here. The instructions to fill out this form can be located here, and if you would like some further background information on Publication 54, we encourage you to click here.
On Form 2555 you can enter the information for the Physical Presence Test in Part III, which is the Taxpayers Qualifying Under Physical Presence Test. You can always hire the help of a preparer to help you with this process, which will help ensure you do it correctly the first time, saving you time and possible expense. An experienced preparer will be able to answer any questions such as how much you need to make to file taxes when living abroad.
If you have moved abroad and are not 100% sure whether or when you’ll return to America, it’s highly likely that you’ll qualify after your first year living abroad. To be sure, you can always seek the help of an international tax expert. They will be able to walk you through the process and help you fill out Form 2555 if necessary.
We hope this complete guide has clarified any doubts or concerns you may have had about the Bona Fide Residence Test. If you believe that you qualify, we encourage you to download Form 2555 and submit it at your earliest convenience.
Remember, even if you don’t qualify for this test, try the Physical Presence Test which has some benefits. But if you’re asking yourself, “Do I have to file taxes when living abroad if I don’t qualify?” the answer is yes!
You’ll need to report your minimum income to file taxes and if you’re a qualified bona fide resident, you’ll receive some financial benefits. Again, if you don’t feel comfortable handling this on your own, you can always hire a preparer to help.
Qualifying for the Bona Fide Residence Test brings many benefits for Americans who are living overseas. If this happens to be your case, don’t wait any longer to find out if you are eligible for this type of residency. If you are, you are looking at financial benefits, exclusions, and deductions. Best of luck!