Figure 4–A Can I Claim the Exclusion or Deduction?

Example 2.   For several years, you were a marketing executive with a producer of machine tools in Toledo, Ohio. In November of last year, your employer transferred you to London, England, for a minimum of 18 months to set up a sales operation for Europe. Before you left, you distributed business cards showing your business and home addresses in London. You kept ownership of your home in Toledo but rented it to another family. You placed your car in storage. In November of last year, you moved your spouse, children, furniture, and family pets to a home your employer rented for you in London.

Shortly after moving, you leased a car and you and your spouse got British driving licenses. Your entire family got library cards for the local public library. You and your spouse opened bank accounts with a London bank and secured consumer credit. You joined a local business league and both you and your spouse became active in the neighborhood civic association and worked with a local charity. Your abode is in London for the time you live there. You satisfy the tax home test in the foreign country.

Temporary or
Indefinite Assignment

The location of your tax home often depends on whether your assignment is temporary or indefinite. If you are temporarily absent from your tax home in the United States on business, you may be able to deduct your away-from-home expenses (for travel, meals, and lodging), but you would not qualify for the foreign earned income exclusion. If your new work assignment is for an indefinite period, your new place of employment becomes your tax home and you would not be able to deduct any of the related expenses that you have in the general area of this new work assignment. If your new tax home is in a foreign country and you meet the other requirements, your earnings may qualify for the foreign earned income exclusion.

If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise. If you expect it to last for more than 1 year, it is indefinite. If you expect it to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary (in the absence of facts and circumstances indicating otherwise) until your expectation changes.

Foreign Country

To meet the bona fide residence test or the physical presence test, you must live in or be present in a foreign country. A foreign country usually is any territory (including the air space and territorial waters) under the sovereignty of a government other than that of the United States.

The term foreign country includes the seabed and subsoil of those submarine areas adjacent to the territorial waters of a foreign country and over which the foreign country has exclusive rights under international law to explore and exploit the natural resources.

The term foreign country does not include Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the Virgin Islands, or U.S. possessions such as 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 Virgin Islands, and the Antarctic region.

American Samoa,
Guam, and the
Commonwealth of the
Northern Mariana Islands

Residence or presence in a U.S. possession does not qualify you for the foreign earned income exclusion. You may, however, qualify for the possession exclusion.

American Samoa.   There is a possession exclusion available to individuals who are bona fide residents of American Samoa for the entire tax year. Gross income from sources within American Samoa, Guam, or the Commonwealth of the Northern Mariana Islands may be eligible for this exclusion. Income that is effectively connected with the conduct of a trade or business within those possessions also may be eligible for this exclusion. Use Form 4563, Exclusion of Income for Bona Fide Residents of American Samoa, to figure the exclusion.

Guam and the Commonwealth of the Northern Mariana Islands.   A possession exclusion will be available to residents of Guam and the Commonwealth of the Northern Mariana Islands if, and when, new implementation agreements take effect between the United States and those possessions.

For more information, see Publication 570.

Puerto Rico
and Virgin Islands

Residents of Puerto Rico and the Virgin Islands cannot claim the foreign earned income exclusion, the foreign housing exclusion, or the possession exclusion.

Puerto Rico.   Generally, if you are a U.S. citizen who is a bona fide resident of Puerto Rico for the entire tax year, you are not subject to U.S. tax on income from Puerto Rican sources. This does not include amounts paid for services performed as an employee of the United States. However, you are subject to U.S. tax on your income from sources outside Puerto Rico. In figuring your U.S. tax, you cannot deduct expenses allocable to income not subject to tax.

Bona Fide Residence Test

You meet the bona fide residence test if you are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. You can use the bona fide residence test to qualify for the exclusions and the deduction only if you are either:

• A U.S. citizen, or
• A 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.

You do not automatically acquire bona fide resident status merely by living in a foreign country or countries for 1 year.

Example.   If you go to a foreign country to work on a particular construction job for a specified period of time, you ordinarily will not be regarded as a bona fide resident of that country even though you work there for 1 tax year or longer. The length of your stay and the nature of your job are only some of the factors to be considered in determining whether you meet the bona fide residence test.

Bona fide residence.   To meet the bona fide residence test, you must have established such a residence in a foreign country.

Your bona fide residence is not necessarily the same as your domicile. Your domicile is your permanent home, the place to which you always return or intend to return.

Example.   You could have your domicile in Cleveland, Ohio, and a bona fide residence in London, England, if you intend to return eventually to Cleveland.

You are clearly not a resident of London in the first instance. However, in the second, you are a resident because your stay in London appears to be permanent. If your residency is not as clearly defined as either of these illustrations, it may be more difficult to decide whether you have established a bona fide residence.

Determination.   Questions of bona fide residence are determined according to each individual case, taking into account factors such as your intention, the purpose of your trip, and the nature and length of your stay abroad.

You must show the Internal Revenue Service (IRS) that you have been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. The IRS decides whether you qualify as a bona fide resident of a foreign country largely on the basis of facts you report on Form 2555. IRS cannot make this determination until you file Form 2555.

Statement to foreign authorities.   You are not considered a bona fide resident of a foreign country if you make a statement to the authorities of that country that you are not a resident of that country and the authorities either:

1. Hold that you are not subject to their income tax laws as a resident, or
2. Have not made a final decision on your status.

Special agreements and treaties.   An income tax exemption provided in a treaty or other international agreement will not in itself prevent you from being a bona fide resident of a foreign country. Whether a treaty prevents you from becoming a bona fide resident of a foreign country is determined under all provisions of the treaty, including specific provisions relating to residence or privileges and immunities.

Example 1.   You are a U.S. citizen employed in the United Kingdom by a U.S. employer under contract with the U.S. Armed Forces. You do not qualify for special status under the North Atlantic Treaty Status of Forces Agreement. You are subject to United Kingdom income taxes and may qualify as a bona fide resident.

Example 2.   You are a U.S. citizen in the United Kingdom who qualifies as an employee of an armed service or as a member of a civilian component under the North Atlantic Treaty Status of Forces Agreement. You do not qualify as a bona fide resident.

Example 3.   You are a U.S. citizen employed in Japan by a U.S. employer under contract with the U.S. Armed Forces. You are subject to the agreement of the Treaty of Mutual Cooperation and Security between the United States and Japan. You do not qualify as a bona fide resident.

Example 4.   You are a U.S. citizen employed as an official by the United Nations in Switzerland. You are exempt from Swiss taxation on the salary or wages paid to you by the United Nations. This does not prevent you from qualifying as a bona fide resident if you meet all the requirements for that status.

Effect of voting by absentee ballot.   If you are a U.S. citizen living abroad, you can vote by absentee ballot in any election held in the United States without risking your status as a bona fide resident of a foreign country.

However, if you give information to the local election officials about the nature and length of your stay abroad that does not match the information you give for the bona fide residence test, the information given in connection with absentee voting will be considered in determining your status, but will not necessarily be conclusive.

Uninterrupted period including entire tax year.   To qualify for bona fide residence, you must reside in a foreign country for an uninterrupted period that includes an entire tax year. An entire tax year is from January 1 through December 31 for taxpayers who file their income tax returns on a calendar year basis.

During the period of bona fide residence in a foreign country, you can leave the country for brief or temporary trips back to the United States or elsewhere for vacation or business. To keep your status as a bona fide resident of a foreign country, you must have a clear intention of returning from such trips, without unreasonable delay, to your foreign residence or to a new bona fide residence in another foreign country.

Example 1.   You arrived with your family in Lisbon, Portugal, on November 1, 2000. Your assignment is indefinite, and you intend to live there with your family until your company sends you to a new post. You immediately established residence there. On April 1, 2001, you arrived in the United States to meet with your employer, leaving your family in Lisbon. You returned to Lisbon on May 1, and continued living there. On January 1, 2002, you completed an uninterrupted period of residence for a full tax year (2001), and you meet the bona fide residence test.

Example 2.   Assume the same facts as in Example 1, except that you transferred back to the United States on December 13, 2001. You would not meet the bona fide residence test because your bona fide residence in the foreign country, although it lasted more than a year, did not include a full tax year. You may, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction under the physical presence test (discussed later).

Bona fide resident for part of a year.   Once you have established bona fide residence in a foreign country for an uninterrupted period that includes an entire tax year, you will qualify as a bona fide resident for the period starting with the date you actually began the residence and ending with the date you abandon the foreign residence. You could qualify as a bona fide resident for an entire tax year plus parts of 1 or 2 other tax years.

Example.   You were a bona fide resident of England from March 1, 2000, through September 14, 2002. On September 15, 2002, you returned to the United States. Since you were a bona fide resident of a foreign country for all of 2001, you also qualify as a bona fide resident from March 1, 2000, through the end of 2000 and from January 1, 2002, through September 14, 2002.

Reassignment.   If you are assigned from one foreign post to another, you may or may not have a break in foreign residence between your assignments, depending on the circumstances.

Example 1.   You were a resident of Pakistan from October 1, 2001, through November 30, 2002. On December 1, 2002, you and your family returned to the United States to wait for an assignment to another foreign country. Your household goods also were returned to the United States.

Your foreign residence ended on November 30, 2002, and did not begin again until after you were assigned to another foreign country and physically entered that country. Since you were not a bona fide resident of a foreign country for the entire tax year of 2001 or 2002, you do not meet the bona fide residence test in either year. You may, however, qualify for the foreign earned income exclusion or the housing exclusion or deduction under the physical presence test, discussed later.

Example 2.   Assume the same facts as in Example 1, except that upon completion of your assignment in Pakistan you were given a new assignment to England. On December 1, 2002, you and your family returned to the United States for a month's vacation. On January 2, 2003, you arrived in England for your new assignment. Because you did not interrupt your bona fide residence abroad, you meet the bona fide residence test.

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