Dateline: Kuala Lumpur, Malaysia
Should you’re a US citizen trying to legally scale back your tax burden, likelihood is you’ve thought-about pursuing Overseas Earned Revenue Exclusion.
Since the US makes use of a system of citizenship-based taxation, US residents and everlasting residents should file revenue tax yearly – no matter whether or not they truly stay in the US.
Subsequently, in contrast to nations that use residential tax techniques, comparable to Canada or the UK, US residents can’t merely reduce sure ties, depart the nation, and turn into tax non-residents.
As an alternative, they will use Overseas Earned Revenue Exclusion.
Overseas Earned Revenue Exclusion is the US reply to those tax non-residency procedures. When you nonetheless need to file tax annually as a US individual, you possibly can exclude a big portion of your lively revenue should you reside and work overseas.
Overseas Earned Revenue Exclusion is thus the spine of any technique to legally scale back your taxes as a US citizen or everlasting resident. Nevertheless, to qualify for it, you need to meet the necessities of certainly one of two exams:
The Bodily Presence Test or the Bona Fide Residence Test.
Of those two exams, the Bodily Presence Test is the easier one by far. To qualify beneath it, you will need to spend greater than 330 days outdoors of the US throughout that tax yr – nothing extra, nothing much less.
Though you’re restricted to only 30 days in the US per yr, qualifying for Overseas Earned Revenue Exclusion underneath the Bodily Presence Test is pretty simple.
The Bona Fide Residence Test, on the different hand, provides you extra time in the US per yr, however assembly its necessities could be a bit tougher.
To qualify beneath the Bona Fide Residence Test, you have to be a tax resident of one other nation for multiple tax yr, and you have to set up that residency with the intention of completely leaving the US.
Whereas this check provides you the potential to spend extra than simply 30 days in the US, it’s a harder threshold to satisfy, so even minor missteps might trigger you to lose your offshore tax standing.
For those who’re considering of utilizing the Bona Fide Residence Test to qualify for Overseas Earned Revenue Exclusion, you then’ll want to know whether or not you possibly can – and will – use it to decrease your US tax invoice.
Who Ought to Use the Bona Fide Residence Test?
Though you’ll be able to simply qualify for Overseas Earned Revenue Exclusion underneath the Bodily Presence Test, it severely limits the period of time which you can spend in the US.
For many individuals trying to get out of the US tax internet, this isn’t a lot of a problem.
Earlier than I renounced my US citizenship, I used the Bodily Presence Test to qualify for revenue exclusion, and admittedly, I wasn’t too upset about limiting my days in the US.
I felt extra snug making buddies and assembly ladies outdoors of the US, and I needed to be a part of different cultures. I had no want to spend a lot – if any – time again house.
So, for me, the Bodily Presence Test labored greatest, and the similar goes for a lot of different individuals who need to go offshore and grow to be international residents.
If you wish to transfer offshore completely, then you definitely’ll possible discover it straightforward to restrict the time you spend in the US.
Nevertheless, that’s not the case for everybody.
Chances are you’ll need to spend greater than 30 days with your loved ones annually, otherwise you may want extra flexibility to take care of your US enterprise pursuits.
US individuals who don’t need to restrict their time in the US to only 30 days ought to subsequently think about using the Bona Fide Residence Test to qualify for revenue exclusion.
How Can You Qualify for the Bona Fide Residence Test?
Though I usually advocate that folks use the Bodily Presence Test to qualify for Overseas Earned Revenue Exclusion, utilizing the Bona Fide Residence check may be useful in some instances.
To satisfy the necessities of the Bona Fide Residence Test, you need to:
- Be a tax resident of a overseas nation for multiple uninterrupted tax yr;
- Intend to reside in that nation for an prolonged or indefinite period of time; and
- Not qualify as a US individual underneath the Substantial Presence Test.
These necessities aren’t terribly complicated, however assembly the threshold of the Bona Fide Residence Test isn’t so simple as simply staying out of the US. Dangerous info and poor planning can simply trigger you to lose your offshore standing.
For instance, a number of weeks in the past, a pair approached me claiming that that they had discovered a method to qualify underneath the Bona Fide Residence Test and spend most of their yr in the US.
That they had just lately attended an offshore convention the place they discovered about getting tax residency in Panama, the place you solely have to spend a day in the nation per yr to take care of your tax resident standing.
Then, in line with the couple, they might spend the majority of their time in the US whereas qualifying for the Bona Fide Residence Test as a consequence of their Panamanian tax residency.
Sadly for them, it’s not that straightforward.
Whereas getting a second residence in Panama isn’t the worst concept, their plan falls far in need of assembly the necessities of the Bona Fide Residence Test.
That’s the drawback with these sorts of conferences – they make going offshore sound fast and easy when, in actuality, it takes time, endurance, and planning.
Considered one of the many misconceptions floating round about the Bona Fide Residence Test is that you could simply set up tax residence elsewhere to qualify beneath it.
Whereas that’s definitely essential, it gained’t occur in a single day, and it’s essential do extra than simply say you pay tax elsewhere to reap the benefits of Overseas Earned Revenue Exclusion.
Though it’s pretty straightforward to get a second residence in Panama, it doesn’t assure that you simply’ll qualify for Overseas Earned Revenue Exclusion.
Set up a Overseas Tax Residence
Should you plan to make use of the Bona Fide Residence Test, the most necessary a part of your offshore technique is establishing tax residence out of the country.
Fortuitously, in lots of nations, getting tax residency isn’t too troublesome – even in low- or no-tax nations.
In Costa Rica, for instance, anybody with a month-to-month revenue of over $2,500 can grow to be a tax resident quite simply, and in close by Guatemala, it’s essential to make solely $1,000 per thirty days to qualify.
If South America isn’t your cup of tea, then you’ll be able to head to glamorous Monaco, the place you should purchase residence or citizenship by funding, or you possibly can transfer to bustling Kuala Lumpur, Malaysia.
Nevertheless, establishing tax residence in any of those nations comes with some type of catch.
If you determine the place you need to set up your offshore tax residence, you’ll want to think about elements like time, residency necessities, and price.
Getting your residency allow in Costa Rica takes a minimum of six months – if you’ll find a reliable lawyer, that’s – and to take care of tax residency in Guatemala, it’s essential spend almost all your time there.
Monaco and Malaysia, on the different hand, are simpler, however costlier.
Malaysia requires you to purchase actual property or deposit round $70,000 in a Malaysian financial institution, and to get citizenship or residence by funding in Monaco, anticipate to spend upwards of $1,100,000.
Subsequently, as you propose to determine bona fide residence outdoors of the US, you ought to be positive you perceive how one can set up tax residence in your nation of selection and put together accordingly.
Reside There for an Indefinite or Prolonged Quantity of Time
After you determine a overseas tax residence, it’s essential to truly stay there to make use of the Bona Fide Residence Test.
You’ll be able to’t simply say you’re a tax resident and name it a day.
Put merely, your tax residence must be your new residence, and it is advisable plan to stay there for the foreseeable future.
To see how this requirement works, let’s check out a few examples.
Suppose you’re a US citizen who accepts a place at a agency in Berlin.
If the place is a hard and fast 2-year contract, then you wouldn’t be capable of declare exclusion underneath the Bona Fide Residence Test as a result of the time period of your keep isn’t indefinite when you solely plan to remain for two years.
On the different hand, if the place is long-term, you can simply set up bona fide residence in Germany.
Since you would set up tax residence in Germany whereas shifting there completely for the place, you’d qualify for exclusion beneath the Bona Fide Residence Test.
Though the IRS could make case-by-case selections for frequent enterprise vacationers, you finally have to spend most of your time in your nation of residence to qualify underneath this check.
Claiming Overseas Earned Revenue Exclusion underneath the Bona Fide Residence Test isn’t so simple as claiming you pay tax elsewhere.
This requirement is why I typically recommend utilizing the Bodily Presence Test over the Bona Fide Residence Test.
The Bodily Presence Test merely requires you to be out of the nation. The IRS doesn’t essentially care the place you’re dwelling or if in case you have tax residence elsewhere.
Bona fide residence, nevertheless, is far more troublesome to determine.
You have to plan your travels so that you simply spend sufficient time there, and also you want to have the ability to justify your tax residence as your actual house to the IRS.
Keep away from Triggering the Substantial Presence Test
When you’ve discovered and established your new bona fide residence, you then want to think about the Substantial Presence Test when you journey steadily to the US.
One other widespread false impression about the Bona Fide Residence Test is that it grants you limitless time in the US so long as you keep your offshore tax residence.
Nevertheless, even when you meet all of the necessities of the Bona Fide Residence Test, you possibly can nonetheless lose your Overseas Earned Revenue Exclusion via the Substantial Presence Test.
The IRS makes use of the Substantial Presence Test to find out whether or not or not somebody is a US individual for tax causes.
Beneath this check, an individual can solely spend roughly 90-120 days in the US per yr, and in the event that they exceed that restrict, their full revenue turns into taxable by the IRS.
Though this check is generally utilized to non-residents utilizing vacationer visas, it additionally applies to anybody utilizing the Bona Fide Residence Test to say Overseas Earned Revenue Exclusion.
For instance, suppose Jackie strikes to Costa Rica and establishes bona fide residence there, however she must often go to the US to help her enterprise companion.
A enterprise emergency arises, and Jackie wants to increase her keep in the US for 2 weeks. Nevertheless, she has already maxed out the variety of days that she will spend in the US this yr.
On this state of affairs, Jackie would lose her Overseas Earned Revenue Exclusion by triggering the Substantial Presence Test.
US individuals planning to make use of the Bona Fide Residence Test to qualify for exclusion ought to thus rigorously calculate the period of time that they will spend in the US to take care of their tax standing.
For US residents and everlasting residents looking for Overseas Earned Revenue Exclusion, the Bona Fide Residence Test supplies a helpful various to the Bodily Presence Test.
In contrast to the Bodily Presence Test, which considerably limits the time which you can spend in the US, US individuals who qualify for exclusion underneath the Bona Fide Residence Test can comfortably spend Three-Four months in the US per yr.
Nevertheless, assembly the check’s necessities might be tough at occasions, so with out correct planning and knowledge, your offshore tax technique might go awry.
When you’re excited about studying extra about how you should use the Bona Fide Residence Test to benefit from Overseas Earned Revenue Exclusion, click on right here.
Andrew Henderson is the world’s most sought-after marketing consultant on authorized offshore tax discount, funding immigration, and international citizenship. He works solely with six- and seven-figure entrepreneurs and buyers who need to “go where they’re treated best”. He has been researching and truly doing these things personally since 2007.