956 / What are the bona fide residence and physical presence tests that can allow a U.S. individual to qualify for the foreign earned income exclusion?

A U.S. individual with foreign earned income must satisfy either the bona fide residence test or the physical presence test in order to be eligible to exclude all or a portion of foreign earned income from U.S. income.

Editor’s Note: The IRS relaxed these requirements for 2020 in response to travel restrictions put in place in response to COVID-19. An otherwise qualified individual could still exclude foreign earned income for the period in which the individual was actually present in the foreign country, even if the individual fails to meet the time requirements. To qualify for relief, an individual must establish (1) he or she must have established residency, or have been physically present in either China on or before December 1, 2019, or any other foreign country on or before February 1, 2020; (2) the individual must have departed either China (excluding Hong Kong and Macau) between December 1, 2019, and July 15, 2020, or any other foreign country between February 1, 2020, and July 15, 2020; and (3) individual would have met the requirements of either the bona fide residence test or the physical presence test, but for the COVID-19 emergency.¹

An individual may use the “bona fide residence test” to qualify for the exclusion if the individual is either (a) a U.S. citizen or (b) a U.S. resident alien who is a citizen of a country with which the U.S. has an income tax treaty in effect. The bona fide residence test, as the name suggests, is met if the individual has established a residence in a foreign country. The length of the individual’s stay and the nature of employment are factors considered in determining whether the individual has established a residence in a foreign country, but are not determinative—all of the facts and circumstances of the particular situation must be taken into account.

The IRS has provided bright-line guidance so that the individual must reside in the foreign country for an uninterrupted period that includes an entire tax year, though every individual that resides in a foreign country for at least an entire tax period is not automatically considered to have established a residence.²

Example: Shannon’s domicile (permanent home) is in Brooklyn, New York, but she is assigned to her employer’s London office for an indefinite duration. She rents an apartment in London with a one-year lease, though she intends to eventually return to Brooklyn. Assuming all other factors indicate that Shannon has established a residence in London, she will meet the bona fide residence test even though she plans to return to Brooklyn at some point in the future. If Shannon had, for example, been sent to London for a month-long work assignment with a definite return date, she would not be able to satisfy the bona fide residence test. If Shannon had been assigned to her work post in London for 16 months, she may not be able to meet the bona fide residence test because her presence in London is limited in duration.