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FEIE- Real World Example of how Bona Fide Residence Test is Applied

June 15, 2021

In our third segment of our Foreign Earned Income Exclusion (FEIE) series, we dive into a recent court case and analyze how bona fide residence factors are applied.

The Foreign Earned Income Exclusion (FEIE) is the low-hanging fruit of the U.S. expat tax world, but it isn’t always the best choice for U.S. taxpayers abroad. Here are a few questions you should consider before taking the FEIE.

So you’ve read part 1: Should You Use the Foreign Earned Income Exclusion (FEIE)? And part 2: What is the Bona Fide Residence Test?

Have you decided you qualify for the FEIE? Wondering what’s the best outcome for your personal tax situation? Let’s look at a recent tax court case, Cutting v. Commissioner, T.C. Memo 2020-158, to see how the bona fide residence factors are applied.

What is the Cutting vs. Commissioner case?

This case involves an airline pilot who claimed the FEIE. Pilots typically have a home base, where each trip, or series of trips begin and end. This pilot’s home base was in the U.S. In several other tax court cases the pilot’s home base was considered to be their principal place of business.

Remember the first rule for eligibility? You must have a foreign tax home, a regular place of business in a foreign country or your abode is in a foreign country. Therefore, if the home base is in the U.S., game over, no foreign tax home, no foreign earned income exclusion.

The tax court case could have stopped right there, but they addressed whether the taxpayer qualified for the FEIE under the bona fide residence test. This analysis clarifies the factors for or against a taxpayer in the eye of the IRS. Here are the factors and how they weighed for or against Cutting:

  1. The intention of the taxpayer. Weight = heavy. Cutting didn’t obtain a resident visa in the foreign country, and didn’t hold a lease, tilting this evidence against the taxpayer.
  2. Establishment of his home temporarily in the foreign country for an indefinite period. Cutting didn’t establish a temporary home, he didn’t have legal right to reside in his foreign spouse’s home. Evidence against the taxpayer.
  3. Participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment. Cutting didn’t provide any evidence that he had assimilated. This was considered neutral.
  4. Physical presence in the foreign country consistent with his employment. Cutting spent the majority of his non-working days in the foreign country. This was evidence in the taxpayer’s favor.
  5. Nature, extent and reasons for temporary absences from his temporary foreign home. Cutting only left the foreign country when he had to work, this was also evidence in favor of the taxpayer.
  6. Assumption of economic burdens and payment of taxes to the foreign country. On his U.S. income tax return, the taxpayer checked that he submitted a statement to the foreign tax authorities that he did not have to pay local taxes. Evidence against.
  7. Status as resident contrasted to that of transient or sojourner. Weight = heavy. Cutting did not pay taxes to the foreign government or establish himself as a resident.
  8. Treatment accorded his income tax status by his employer. Employer withheld Federal and State taxes. Against.
  9. Marital status and residence of his family. Although the taxpayer’s spouse lived in the foreign country, he used the “single” filing status and stated that he did not live with family members abroad on his U.S. income tax return.
  10. Nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time. Cutting was spending time outside the U.S. as his own choice, this factor was not considered.
  11. Good faith in making trip abroad; whether for purpose of tax evasion. Due to the inconsistences in the originally filed U.S. income tax returns, this factor went against the taxpayer.

Need further guidance? We can help.

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