Physical presence test

The physical presence test is a tool used by the Internal Revenue Service (IRS) to determine whether a taxpayer qualifies for the foreign earned income exclusion when filing their taxes (IRS 2016,p.3) . The test requires that a person be physically present in a foreign country or countries for at least 330 full days during a consecutive 12 months. The 330 days during which the person is abroad do not need to be consecutive. The physical presence test allows taxpayers to exclude a certain amount of their foreign earned income when filing their taxes in the U.S. In 2015, a taxpayer could exclude up to $100,800. People who qualify for this exclusion are also likely to qualify for the foreign housing deduction, which can also save them money on their taxes. The foreign income exclusion is available to both citizens and resident aliens of the U.S. According to the tax code, a person's reason for being abroad is irrelevant to this test. However, family emergencies, illness and employer directive do not suffice as reasons to allow for the exclusion if one of those reasons causes the taxpayer to be present in a foreign country for less than the required 330 days. Furthermore, a "day" is considered a full 24-hour period, so days of arrival and departure in a foreign country do not count toward the 330 days.A person may travel between foreign countries during their time abroad. Any time spent within the United States while in transit, such as during a layover between flights, does not count against the person's 330 days, as long as the period of time within the U.S. is less than 24 hours.

Rules

The rules are (IRS 2016,p.6):

• If a person's presence in a foreign country violates U.S. law, the government will not view them as physically present in that country for the time in which they violated the law. Any income earned within that country while violating U.S. law is not considered foreign earned income by the IRS.
• The minimum time requirement may also be waived if the taxpayer must leave a foreign country due to war, civil unrest, or another condition that makes the country significantly unsafe or unlivable. If the taxpayer can demonstrate that they could have and would have reasonably met the requirements of the physical presence test if not for the adverse conditions, and that they had a tax home in that country and were a bona fide resident of the country at the time, they may still qualify for the exclusion.
• Pay received as military or civilian income while stationed abroad is not considered foreign earned income by the U.S. government.

To pass the Physical Presence Test, your situation must reflect all of the following: 1) You must be a US citizen or a resident alien 2) You must be outside of the US and its territories for at least 330 days out of a consecutive 365. 3) You must be legally inside your foreign country of residence.

Example

If an American expatriate opens a business in Tokyo, Japan on March 14th 2010 and then stays in Tokyo until February 23rd, he will automatically qualify for the Foreign Earned Income Exclusion. He has successfully passed the Physical Presence Test because he remained in Tokyo for 344 days. If the above expat traveled during those 344 days, but he did not travel to the US or its territories, he would still pass the Physical Presence Test and qualify for the expat exclusions. If the same business owner traveled back to the US for business reasons (or for any other reason) and spent more than fourteen days traveling to the US and on US soil, he would lower his time away below 330 days and no longer qualify for expat exclusions and credits.

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References

• IRS (2016),LB&I International Practice Service Process Unit-Audit,IRS,Washington.
• Kirsch M.S. (2010), The role of physical presence in the taxation of cross-border personal services,Boston College Law Reviewe 993, Vol.51.
• OECD (2012), Interpretation and application of article 5(pernament and establishment)of the OECD model tax convention,OECD,Paris.

Author: Zofia Rey