The bona fide residence test is an important concept if you are a US taxpayer. We’ll discuss what it is and how you can use it to your advantage.
Key Takeaways
- The bona fide residence test is a concept from the US tax code
- The test assess whether you have your residency outside of the US based on factual elements
- In this way you can qualify for tax benefits which can heavily impact your US liability
- The physical presence test is an alternative for the bona fide residence with the same benefits
What Is The Bona Fide Residence Test?
The Bona Fide Residence Test is a concept from the US tax code. Hence, it’s important to understand this concept if you are a US taxpayer.
You meet the bona fide residence test if you establish your bona fide residence in a foreign country other than the United States. Whether or not this is the case is assessed on a factual basis. There are various elements that the Inland Revenue Service of the United States take into account to make this assessment.
Therefore, we’ll now have a look how you can actually qualify as a bona fide resident of a foreign country.
What Qualifies you as a Bona Fide Resident of a Foreign Country
In order to make an assessment, the IRS refers back to a number of things.
Elements that are taken into account are the purpose of your stay, your activities there and if you pay taxes there or not. Furthermore, the IRS will want to know if your family came with you to see how serious your move is. However, these are just a few examples.
In addition, it’s also important that you don’t make a statement towards the foreign authorities that you’re not a (tax) resident of the country as this will exclude you from the bona fide residence test.
The IRS will make the final assessment once you attach Form 2555 to your income tax return.
Furthermore, it’s important to note that you can only fulfill the bona fide residence test if you have your residence as such in a country which has a double tax treaty with the US. Hence, this excludes some countries.
On top of this, you need to meet the bona fide residence test for at least an uninterrupted period of one full tax year. Once this is the case, you can also benefit from it for part of it during other tax years. We’ll clarify this later on with a few examples.
How This Test Can Benefit You
The United States have a taxation regime that deviates from that of most other countries. Even if you don’t live in the US, you still need to file taxes in the US as long as you’re a US citizen.
This is a unique situation as most countries will leave you alone from a tax point of view as soon as you can prove you don’t have any close ties to the country anymore.
However, US citizens need to keep filing taxes in the US even if they don’t set a foot in the country anymore. This could even lead to some tax liability in the US. Yet, the US tax code provides a few techniques to to minimize any actual tax liability in the US.
However, to benefit from these techniques, you need to meet certain criteria and that’s where the bona fide residence test comes in.
If you meet the bona fide residence test you can qualify for the Foreign Earned Income Exclusion, the Foreign Tax Credit and the Foreign Housing Deduction. If you want to know more about these concepts I suggest you read the articles I linked to. However, all of them enable you to drastically lower your US tax liability.
Difference Between the Bona Fide Residence Test and the Physical Presence Test
For most digital nomads, it will be harder to qualify for the bona fide residence test. The reason is simply that nomads don’t necessarily have a fixed base from which they travel. Therefore, meeting the bona fide residence test might be a challenge.
Yet, in this case you can still qualify for the aforementioned tax breaks. However, then you would need to meet the physical presence test. Therefore, the physical presence test and the bona fide residence test are alternatives for each other.
As the name suggests, the physical presence test focuses more on your physical presence outside of the US. And this without the need of spending your time mainly in one specific country like with the bona fide residence test.
In order to qualify for the physical presence test you basically need to spend at least 330 days outside of the US during a twelve month period partially covering the current tax year.
If you are close to the threshold, you need to make sure which days are counted for your stay outside the US and which not. You can find more details and examples regarding the physical presence test on the website of the IRS.
Bona Fide Residence Test Examples
We’ll now clarify the bona fide residence test with a few practical examples.
Let’s say you are a US citizen who left the US on 1 October 2023 to go and live in Portugal. Furthermore, you move there for an indefinite time without the intention to move back to the US in the short term. You also immediately establish residency in Portugal.
As from 1 January 2025 you will have completed the bona residence test for a full tax year. You will have spend the whole tax year 2024 in Portugal. Consequently, you qualify for the tax benefits linked to the bona fide residence test for tax year 2024.
Moreover, on top of this, you can also benefit from the same tax benefits for tax year 2023 from the date you left the US (1 October 2023).
If you later on decide to move back to the US, the same principle applies. Let’s say you move back to the US on 1 April 2026. You have been a bona fide resident of Portugal for the whole of tax years 2024 and 2025 and for part of tax year 2023. And, you’ll also be a bona fide residence for a partial tax year in 2026.
As you can see from these examples, you can also meet the bona fide residence test for part of the tax year. However, only on the condition this links with a tax year where you were a bona fide resident for a full tax year.
