The Foreign Earned Income Exclusion (FEIE) is a special provision for U.S. taxpayers living outside the U.S. and its territories. For information on how to qualify for the exclusion see here. This article will review when you can qualify.
To initially qualify for either the Physical Presence Test (PPT) or the Bona Fide Residence Test (BFRT) for a particular tax year the end date of the qualification period must occur in the relevant tax year. However, this may then allow an earlier period in a prior tax year to also be qualified.
This means that, for the PPT, a calendar year taxpayer moving after February 4 (or February 5 if a leap year) cannot qualify for the FEIE until the end of the second tax year as the period of qualification (330 days out of 365 days) will not end during the first tax year (i.e. it will not end before December 31 of the first year living overseas).
For a taxpayer qualifying under the BFRT the time requirement is for a full tax year. This means that a calendar year taxpayer must be an overseas resident from January 1 to December 31 to qualify under this test. Therefore, a taxpayer cannot qualify under the BFRT for a part year residency in their first year and must complete a full tax year as a Bone Fide Resident to qualify. However, once qualifying at the end of their second year living overseas the taxpayer can then qualify as a bona fide resident from the beginning of their residence period (the date they took up residency in their first tax year living overseas) and apply their Bona Fide Residence status to the partial first year living overseas.
In such a case, the taxpayer might file a Form 2350 and obtain a filing extension until the end of January of the third year in which they are resident overseas.
Note: The Form 2350 is an application for an extension of the time to file which if granted does not provide an extension of time to pay. The extension is not automatic and must be granted by the IRS.
Example (for a calendar year taxpayer):
February 15: Taxpayer moves to Australia (and does not return to the U.S.)
January 11: The taxpayer meets the PPT (having spent 330 days out of the prior 365 days in a consecutive 12-month period) outside the U.S.
However, the taxpayer cannot yet claim on a 2018 tax return that they meet the PPT as the date on which they meet the test is not in the 2018 tax year.
February 28: The taxpayer could meet the time component of the BFRT, but as a calendar year taxpayer the time component (a full tax year) will not be met until December 31, 2019.
January 1: The taxpayer can now claim the FEIE for the tax year ending December 31, 2019 and therefore can extend the qualification back to the applicable period in the tax year ending December 31, 2018.
January 31: If the taxpayer filed a Form 2350 for the 2018 tax year the extension, if granted, would expire on January 31, 2020. This gives the taxpayer all of January of 2020 to file their 2018 tax return.
Form 2350 – Application for Extension of Time to File U.S. Income Tax Return
This form must be filed by the initial due date for the return. This is only applicable if you expect to file a Form 2555 to exclude income utilizing the FEIE and are waiting to qualify. If the extension is granted, it will be until 30 days after the date on which you expect to satisfy either the BFRT of the PPT.
However, the Form 2350 does not provide an extension of the time to pay. Because of this it is important to correctly calculate the client’s tax liability and pay that liability on time. Given that it is difficult, particularly for the BFRT, to be certain that the client will in fact remain resident until the end of the second tax year, it may be better to file and pay without the FEIE and then file an amended return to claim back the initial overpayment. This could avoid late payment interest and penalties.
In summary, it is often not possible to obtain the benefits of the FEIE when timely filing the tax return for the year in which the taxpayer first moves overseas. It may be necessary to file an amended return once meeting the relevant qualifications or to file a Form 2350 to request a special extension of the time to file the return.