Physical Presence Test: Requirements and Exemptions [2024]

When living abroad, understanding the various tax requirements and exemptions is important for expats to manage their finances effectively.

One of the U.S. tax system's key components affecting expats is the Physical Presence Test.

The Physical Presence Test, a criterion used by the Internal Revenue Service (IRS), is designed to determine whether a U.S. citizen or resident alien qualifies for the Foreign Earned Income Exclusion (FEIE).

This test requires that the individual be physically present in a foreign country or countries for at least 330 full days during a consecutive 12-month period. Meeting this requirement can allow eligible expats to exclude a significant portion of their foreign earned income from U.S. federal taxation.

TLDR

The Physical Presence Test helps U.S. expats exclude up to $126,500 of foreign-earned income from federal taxes by spending 330 full days abroad in a 12-month period.

This exclusion doesn’t apply to state taxes. To avoid state income taxes, expats can change their domicile to states with no income tax, like Florida or South Dakota.

Accurate record-keeping is essential to avoid penalties.

What is the Physical Presence Test?

The Physical Presence Test is a method established by the IRS to determine whether a U.S. citizen or resident alien qualifies for the Foreign Earned Income Exclusion (FEIE).

This test aims to ascertain whether an individual has spent sufficient time abroad to justify excluding a portion of their foreign earned income from U.S. taxation.

The test is straightforward: the taxpayer must be physically present in one or more foreign countries for at least 330 full days within any consecutive 12-month period.

How it is used to determine tax residency

The Physical Presence Test is crucial in determining an individual's tax residency status concerning the Foreign Earned Income Exclusion.

However, it does not determine overall tax residency for all purposes. Instead, it specifically assesses eligibility for the exclusion based on physical presence in foreign territories.

By passing this test, ex-pats can exclude up to a certain limit of their foreign-earned income from U.S. federal income tax, reducing their overall tax liability.

This test is particularly beneficial for individuals who move frequently between countries or who spend extended periods abroad without necessarily establishing a permanent residence in a foreign country.

Requirements for meeting the test

To meet the Physical Presence Test, expats must fulfill the following requirements:

330 Full Days: The individual must be physically present in a foreign country or countries for at least 330 full days within a 12-month period. A full day is defined as a 24-hour period that starts at midnight. Partial days, travel days, and days spent in the U.S. do not count towards the 330-day total.
Consecutive 12-Month Period: The 330 days must be counted within any consecutive 12-month period. This period does not have to align with the calendar year and can begin or end on any date.
Foreign Country: The time spent must be in one or more foreign countries. Time spent in international waters, airspace, or U.S. territories does not count toward 330 days.
Travel Considerations: Days spent traveling to and from foreign countries do not count towards the 330 days unless the travel is between foreign countries and no part of the travel period includes time spent in the United States.

Why is the physical presence test important for expats?

The Physical Presence Test is crucial for determining eligibility for several key tax benefits, including:

Foreign Earned Income Exclusion (FEIE)

As mentioned, qualifying for the FEIE allows expats to exclude up to $126,500 of their foreign-earned income from U.S. taxation in 2024. This exclusion applies to earned income, such as salaries and self-employment earnings, but not to passive income like interest, dividends, or capital gains.

Additionally, this exclusion can be combined with the Foreign Housing Exclusion or Deduction, further reducing taxable income by excluding qualified housing expenses incurred while living abroad.

Foreign Housing Exclusion (FHE)

In addition to the FEIE, qualifying expats can exclude or deduct certain housing expenses, such as rent, utilities, and insurance, from their taxable income. This benefit is only available if the taxpayer qualifies under the Physical Presence Test or the Bona Fide Residence Test.

Common misconceptions about the Physical Presence Test

Confusion with other residency tests

A common misconception is confusing the Physical Presence Test with other residency tests, such as the Bona Fide Residence Test. While both tests determine eligibility for the Foreign Earned Income Exclusion (FEIE), they have distinct criteria and purposes.

The Physical Presence Test is strictly quantitative, requiring 330 full days in a foreign country within a 12-month period, whereas the Bona Fide Residence Test assesses whether an expat has established a genuine, indefinite residence in a foreign country for an entire tax year.

Physical Presence Test vs. Bona Fide Residence Test

The Physical Presence Test and the Bona Fide Residence Test differ significantly. The Physical Presence Test focuses solely on the number of days spent abroad, without considering the individual's intentions or the nature of their stay.

In contrast, the Bona Fide Residence Test requires an expat to demonstrate their intention to make a foreign country their permanent home, including maintaining a home, paying local taxes, and integrating into the community.

This test allows for more flexibility regarding short visits back to the U.S., provided the expat maintains strong ties to the foreign country.

Misunderstanding of the requirements

Many expats misunderstand the strict requirements of the Physical Presence Test. For instance, time spent in international waters, airspace, or U.S. territories does not count towards the 330-day requirement.

Additionally, days spent in the U.S. must be carefully tracked, even for short trips, as they can affect eligibility. Expats often mistakenly believe that any time spent abroad counts, when only full days spent in a foreign country qualify.

FEIE applies only to federal taxes

Another common misconception is that the Foreign Earned Income Exclusion (FEIE) applies to state taxes.

In reality, the FEIE only reduces federal income taxes. State income taxes may still apply depending on the state of your last domicile in the U.S. To mitigate state tax liabilities, expats such as Florida or South Dakota can change their domicile to a state with no income tax.

Services like SavvyNomad help expats establish residency in these states by providing a legal address, mail forwarding, and assistance with state residency filings, thus eliminating state income tax obligations.

Florida and South Dakota domiciles for expats

Tips for expats to ensure compliance with the Physical Presence Test

Keeping accurate records of time spent in foreign country

Maintaining meticulous records is vital for expats qualifying for the Foreign Earned Income Exclusion (FEIE) through the Physical Presence Test.

Here are key strategies for accurate record-keeping:

Documentation: Retain all travel-related documents, including airline tickets, hotel receipts, and credit card statements showing transactions abroad. These records serve as concrete evidence of your physical presence in foreign countries.
Travel Diary: Keep a detailed travel diary or calendar to log each day spent abroad. This diary should include dates of travel, countries visited, and any layovers, ensuring a clear picture of your travel patterns.
Electronic Records: Utilize digital tools to store and organize your records. Scanned copies of documents and electronic spreadsheets can simplify tracking and ensure you have backups of important information.
Consistent Updates: Regularly update your records to reflect any changes in your travel schedule or residency status. This practice helps prevent discrepancies and ensures accuracy when filing your tax return.

Understanding how to calculate days of presence

Accurately calculating your days of presence is crucial to meeting the 330-day requirement for the Physical Presence Test.

Here's how to do it:

Full Days Definition: A full day is defined as 24 consecutive hours spent in a foreign country from midnight to midnight. Days spent traveling to or from the U.S. or in international waters do not count towards the 330 days.
Travel Interruptions: If your travel involves layovers in the U.S. that are less than 24 hours, these do not count as days spent in the U.S. However, if the layover exceeds 24 hours, those days cannot be counted towards the 330 days.
Flexible Periods: The 12-month period used to calculate the 330 days does not need to align with the calendar year. You can choose any consecutive 12-month period that provides the greatest benefit, even if it overlaps with another period.
Example Calculation: For instance, if you leave the U.S. on January 1 and arrive in a foreign country on January 2, your first full day counted would be January 3. If you then travel between foreign countries without exceeding 24-hour layovers in the U.S., all those days count towards the 330-day requirement.

Exemptions to the Physical Presence Test

Certain exemptions can waive the 330-day requirement under specific conditions:

War or Civil Unrest: If you are forced to leave a foreign country due to war, civil unrest, or similar adverse conditions, you may still qualify for the FEIE despite not meeting the 330-day requirement. This exemption acknowledges that such unforeseen circumstances can disrupt your plans to remain abroad.
Medical Condition: The Medical Condition Exception allows individuals who cannot leave the U.S. due to a medical condition that arose while they were in the country to exclude those days from their physical presence calculation. To claim this, you must file Form 8843, which requires a statement from a physician confirming the medical condition and its impact on your ability to travel.
Closer Connection Exception: For certain nonresident aliens, the Closer Connection Exception to the Substantial Presence Test may apply if they can demonstrate a closer connection to a foreign country than to the U.S. This is particularly relevant for international students and other temporary residents.

FAQ

What are the two most common types of residency tests?

The two most common types of residency tests used to qualify for the Foreign Earned Income Exclusion (FEIE) are the Physical Presence Test and the Bona Fide Residence Test.

The Physical Presence Test requires that you be physically present in a foreign country for at least 330 full days during any consecutive 12-month period.

The Bona Fide Residence Test, on the other hand, requires you to establish a bona fide residence in a foreign country for an entire tax year, demonstrating an intent to remain there indefinitely.

What is an example of proof of physical presence?

Proof of physical presence can include various forms of documentation, such as airline tickets, hotel receipts, credit card statements showing transactions in foreign countries, utility bills, rental agreements, and work contracts.

Keeping a detailed travel diary or calendar that logs each day spent abroad is also useful.

These documents provide concrete evidence of your time spent in foreign countries, which is essential for meeting the 330-day requirement of the Physical Presence Test.

What is the difference between a bona fide residence test and a physical presence test?

The Bona Fide Residence Test requires you to establish a bona fide residence in a foreign country for an entire tax year, demonstrating your intent to stay indefinitely.

This involves factors like maintaining a home, paying local taxes, and integrating into the local community.

The Physical Presence Test, however, is more straightforward and quantitative, requiring that you be physically present in a foreign country for at least 330 full days within any consecutive 12-month period, regardless of your intentions or the nature of your stay.

What does a physical presence mean?

Physical presence means being physically located in a foreign country for a full 24-hour day from midnight to midnight.

This excludes time spent in international waters, airspace, or U.S. territories.

For the Physical Presence Test, you need to accumulate at least 330 such full days within any consecutive 12-month period to qualify for the FEIE.

What is the substantial presence test?

The Substantial Presence Test determines whether an individual is considered a U.S. resident for tax purposes based on the number of days they are physically present in the U.S.

It calculates residency based on the total days present in the current year, plus a fraction of the days from the previous two years. Specifically, it includes all days present in the current year, 1/3 of the days from the previous year, and 1/6 of the days from the year before that.

If this total equals or exceeds 183 days, and you were present in the U.S. for at least 31 days in the current year, you meet the test and are considered a resident for tax purposes.

How does the IRS verify the physical presence test?

The IRS verifies the Physical Presence Test through the documentation provided by the taxpayer. This includes detailed travel records, such as flight itineraries, accommodation receipts, and other evidence of physical presence in foreign countries.

Taxpayers must maintain meticulous records and may need to provide this documentation during an audit to prove they met the 330-day requirement.

How do you calculate the physical presence test?

To calculate the Physical Presence Test, you must ensure you were physically present in a foreign country for at least 330 full days within any consecutive 12-month period.

A full day is defined as 24 consecutive hours from midnight to midnight spent in a foreign country. Days spent in transit, international waters, or U.S. territories do not count.

You can choose any 12-month period that maximizes your days abroad and meets the requirements.

What is the meaning of bona fide residence?

Bona fide residence is a genuine, permanent residence in a foreign country where you intend to remain indefinitely.

To establish bona fide residence, you must live in the foreign country for an entire tax year and demonstrate your intent to make it your permanent home.

This can involve factors such as maintaining a home, paying local taxes, and integrating into the community.