Foreign Visa Limits May Defeat US Expat Tax Foreign Earned Income Exclusion
American expats must plan their visas and travel carefully. If you declare that you are not resident in a country, you can’t claim the Foreign Earned Income Exclusion on Form 2555 using the bona fide resident test. That means if you have the wrong sort of visa for your work location and come back to the U.S. too much, your tax bill could be much higher.
Expats may claim an exclusion for foreign earned income of up to $91,500 per year. To qualify for this exclusion, an expat must meet either the physical presence test or the bona fide resident test. In addition, the expat must have a tax home in one or more foreign countries. The physical presence test requires that you be outside the U.S. for 330 out of any 365 days. If you travel to the U.S. often, whether for business or R&R, you may not meet this test. For more details, see the link below or my Ezine article “Expat-Tax – Counting the Days to Save Taxes With Form 2555”.
The bona fide resident test allows you to visit the U.S. as often as you wish and still qualify for the foreign earned income exclusion. To qualify, you must genuinely live in a foreign country (or countries) for a period that includes an entire U.S. tax year. For example, if Janet Johnson moves to New Zealand in April, 2009, and lives and works there until January, 2011, she can qualify for the exclusion, even if she returns to the U.S. for a long summer vacation in 2010.
In addition to residing in a foreign country, you must not have declared to that country that you are not resident in that country. Such declarations can be on tax returns, visa applications, or other government filings. If Janet filed a nonresident tax return in New Zealand, she would not qualify for the exclusion. If she had entered New Zealand on a class of visa that prohibited residence, she also would not qualify. In either case, she might save some NZ tax at the cost of much more U.S. tax.
Classes of visa vary widely by country. Sometimes it is expedient to get a visa that gets you in quickly. Be sure you either get the right visa soon or count your days to qualify under the 330 day test.
An employee of one of my clients worked in the UK for over a year. His visa declared that he was not resident. He paid UK tax on that small part of his salary he brought into the UK, but not the rest. This was proper under UK law. He needed the exclusion to avoid paying a lot of U.S. tax, even after the credit for some UK tax. He was single and young, so he traveled Europe on his time off, and to renew his nonresident visa. He qualified for the foreign earned income exclusion, though, by not coming back to the U.S. for more than a few days. He met the 330 day test, so failing as bona fide resident was irrelevant.
Not everyone has the luxury of traveling around and avoiding coming back to the U.S. Your employer may need you Stateside often. Another client’s Paris manager had to come back to the U.S. several times one year. He missed the exclusion. Fortunately for him, the employer’s tax equalization covered him. You may have family needs that arise unexpectedly. Stuff happens. That stuff can turn out to be very expensive if it causes you to pay tax on an extra $91k.
If your tax plan calls for the exclusion on Form 2555, be sure to get the right visa. Otherwise, you MUST plan your travel very carefully and count your days. That extra day off in the U.S. could cost you big if you have the wrong visa for the expat assignment.