The physical presence test for excluding foreign earned income

Generally, U.S. citizens and resident aliens are taxed on their worldwide income. However, under Sec. 911, Citizens or Residents of the United States Living Abroad, a natural person whose tax home is in one or more foreign countries, who spends enough time in one or more foreign countries, can exclude a certain amount of foreign earned income and housing costs from gross income. The maximum foreign earned income exclusion amount is adjusted annually for inflation — for tax year 2018 it is $104,100. 

Here is the relevant portion of Sec. 911 discussed in this article:

(d) Definitions and special rules. For purposes of this section—

(1) Qualified individual. The term “qualified individual” means an individual whose tax home is in a foreign country and who is—

(A) a citizen of the United States and establishes to the satisfaction of the Secretary that he has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year, or

(B) a citizen or resident of the United States and who, during any period of 12 consecutive months, is present in a foreign country or countries during at least 330 full days in such period.

This article examines the calculation of 12-month periods that contain at least 330 days mentioned in Sec. 911(d)(1)(B). IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, calls this the physical presence test. To pass the test, a U.S. citizen or resident alien has to be in a foreign country for 330 days during a 12-consecutive-month period. The 12-month period can begin before the taxpayer was in a foreign country or end after the taxpayer leaves a foreign country.

Example 1

Regs. Sec. 1.911-2(d)(3) gives two examples of the physical presence test (the regulations were issued in 1985 and therefore refer to years in the 1980s).

Example (1). B, a U.S. citizen, arrives in Venezuela from New York at 12 noon on April 24, 1982. B remains in Venezuela until 2 p.m. on March 21, 1983, at which time B departs for the United States. Among other possible twelve month periods, B is present in a foreign country an aggregate of 330 full days during each of the following twelve month periods: March 21, 1982 through March 20, 1983; and April 25, 1982 through April 24, 1983.

In diagram form, Example 1 looks like this (the shaded boxes are full days spent in Venezuela, the white boxes are partial days in Venezuela):

The arrival and departure days do not contribute to the “at least 330 full days” requirement because of Regs. Sec.1.911-2(d)(2): “A full day is a continuous period of twenty-four hours beginning with midnight and ending with the following midnight.”

Here are the first of the two 12-month periods given in the example:

The shaded boxes represent days actually spent in Venezuela; the white box represents days that are part of the 12-month period even though they are actually before the taxpayer’s first full day in Venezuela. Regs. Sec. 1.911-2(d)(1) specifically points this out: “The twelve-month period may begin before or after arrival in a foreign country and may end before or after departure.”

Here is the second 12-month period in Example 1. The shaded boxes represent full days in Venezuela; the white box represents days that are part of the 12-month period even though they  actually occur after the taxpayer’s last day in Venezuela.

Note that in both 12-month periods, the 12-month period ends (April 24 in the second period and March 20 in the first period) on the day before the calendar day that the count started from (April 25 in the second period and March 21 in the first period). This is because of Regs. Sec. 1.911-2(d)(1): “A period of twelve consecutive months may begin with any day but must end on the day before the corresponding day in the twelfth succeeding month.” For example, if the 12-month period starts on June 18 of any year, the 12-month period ends on June 17 of the next year; therefore, no calculation is needed. Similarly, if the end date of a 12-month period is Feb. 6, then it is easy to determine that the start date was Feb. 7 of the previous year.

Note also that the first 12-month period—March 21, 1982, through March 20, 1983—begins before the arrival in a foreign country and that the second 12-month period—April 25, 1982,  through April 24, 1983—ends after the departure date from a foreign country, as allowed under Regs. Sec. 1.911-2(d)(1).

When the period for which a taxpayer qualifies for the foreign earned income exclusion includes only part of a year, the maximum allowed exclusion must be adjusted based on the number of qualifying days for the year, see Regs. Sec. 1.911-3(d); the example from IRS Publication 54 discussed below illustrates this.

Example 2

In Example 2 of Regs. Sec. 1.911-2(d)(3), the taxpayer, C, spends some time on the high seas, which is not considered to be in a foreign country, intermixed with time spent in a foreign country. Another example of not being in a foreign country besides the high seas is Antarctica.

Regs. Sec. 1.911-2(h) provides: “The term ‘foreign country’ when used in a geographical sense includes any territory under the sovereignty of a government other than that of the United States.” Federal courts have held that Antarctica is therefore not a foreign country (see Arnett, 473 F.3d 790 (7th Cir. 2007)). In that case, the calculation requires keeping track of both the number of full days spent in a foreign country (which count toward the 330-day requirement) and the number of days not spent in a foreign country (which do not count toward the 330-day requirement).

For taxpayers who spend time in and out of foreign countries, keep in mind the following rule:

The 330 full days need not be consecutive but may be interrupted by periods during which the individual is not present in a foreign country. In computing the minimum 330 full days of presence in a foreign country or countries, all separate periods of such presence during the period of twelve consecutive months are aggregated. A full day is a continuous period of twenty-four hours beginning with midnight and ending with the following midnight. An individual who has been present in a foreign country and then travels over areas not within any foreign country for less than twenty-four hours shall not be deemed outside a foreign country during the period of travel. [Regs. Sec. 1.911-2(d)(2)]

In Struck, T.C. Memo. 2007-42, the Tax Court focused on the following sentence: “An individual who has been present in a foreign country and then travels over areas not within any foreign country for less than twenty-four hours shall not be deemed outside a foreign country during the period of travel.”

Here is how the Tax Court interpreted that sentence: “Although section 911(d)(1)(B) states that an aggregate of 330 full days of physical presence in a foreign country or countries is required, the regulations thereunder define a ‘full day’ to include partial days of travel in or on international airspace, land, or waters from one foreign location to another foreign location. Therefore, a day involving travel in international waters between foreign locations in increments of less than 24 hours is treated as a full day in a foreign country. Sec. 1.911-2(d)(2) and (3), Income Tax Regs” (emphasis added).

Here is a breakdown of C‘s itinerary in Example 2:

• First full day in foreign country (the United Kingdom) is March 7, 1982.
• Last full day in the U.K. is June 24, 1982. This is 110 days in a foreign country.
• From June 25, 1982, to July 24, 1982, C is not in a foreign country because he is either in the United States, on the high seas, or in a foreign country (France) for less than 24 hours.
• From July 25, 1982, through Aug. 21, 1983, C is in France full time. This is 393 days in a foreign country.
• From Aug. 22, 1983, to Sept. 5, 1983, C is not in a foreign country as he is either in the United States or en route to the U.K.

From Sept. 6, 1983, through Dec. 31, 1983, C is in the U.K. full time. This is 117 days in a foreign country.

Diagrammatically, this looks like this:

To calculate the first 12-month period (March 2, 1982, through March 1, 1983) in the example that contains at least 330 days:

Step 1: Beginning with and including the first day in a foreign country, count forward 330 days: March 7, 1982 + 329 = Jan. 30, 1983. Add 30 for June 25, 1982, to July 24, 1982, during which C was not in a foreign country, since those days are contained in the 330-day period that you just counted forward, and you arrive at March 1, 1983. Here is the spreadsheet calculation: =date(1982,3,7) + 329 + 30

Step 2: Go backward 12 months from March 1, 1983, to get the first day of the 12-month period. This gives us March 2, 1982, per Regs. Sec. 1.911-2(d)(1): “A period of twelve consecutive months may begin with any day but must end on the day before the corresponding day in the twelfth succeeding month.” So, the first 12-month period is March 2, 1982, through March 1, 1983, inclusive. Note that the beginning of the 12-month period is before our traveler actually reached a foreign country.

To calculate the second 12-month period (Jan. 21, 1983, through Jan. 20, 1984) in the example that contains at least 330 days:

Step 1: Beginning with and including the last full day in a foreign country, Dec. 31, 1983, count backward 330 days: Dec. 31, 1983 – 329 = Feb. 5, 1983. Go back another 15 days for the days during the 330-day period during which C was not in a foreign country (Aug. 22, 1983, to Sept. 5, 1983), which brings you to Jan. 21, 1983.

Step 2: Go forward 12 months from Jan. 21, 1983, which is the first day of a 12-month period, which ends at Jan. 20, 1984. So, the second 12-month period is Jan. 21, 1983, to Jan. 20, 1984, inclusive. Note that the end of the 12-month period is after C actually left the foreign country.

IRS Publication 54 example

Publication 54, page 20, gives an example similar to Example 2 in the regulations, in which the taxpayer is not continuously in a foreign country, but returns to the United States for 16 days of vacation.

Example. You are physically present and have your tax home in a foreign country for a 16-month period from June 1, 2016, through September 30, 2017, except for 16 days in December 2016 when you were on vacation in the United States.

Here is a diagram of the above scenario:

Figure the physical presence exclusion for 2016 as follows.

1. Beginning with June 1, 2016, count forward 330 full days. Add the 16 days spent in the United States. The 330th day, May 12, 2017, is the last day of a 12-month period. The spreadsheet calculation is: =date(2016,6,1) + 329 + 16

2. Count backward 12 months from May 11, 2017, to find the first day of this 12-month period, May 12, 2016. This 12-month period runs from May 12, 2016, through May 11, 2017.

3. Count the total days during 2016 that fall within this 12-month period. This is 234 days (May 12, 2016–Dec. 31, 2016).

4. Multiply $101,300 (the maximum exclusion for 2016) by the fraction 234/366 to find the maximum exclusion for 2016 ($64,766).

The shaded boxes represent full days actually spent in a foreign country; the white box represents days that are part of the 12 months even though they are before the taxpayer’s first full day in the foreign country.

Figure the exclusion for 2017 in the opposite manner.

1. Beginning with the last full day, Sept. 30, 2017, count backward 330 full days. Do not count the 16 days C spent in the United States (in the table these days are in white). That day, Oct. 20, 2016, is the first day of a 12-month period.

2. Count forward 12 months from Oct. 20, 2016, to find the last day of this 12-month period, Oct. 19, 2017. This 12-month period runs from Oct. 20, 2016, through Oct. 19, 2017.

3. Count the total days during 2017 that fall within this 12-month period. This is 292 days (Jan. 1, 2017–Oct. 19, 2017).

4. Multiply $102,100, the maximum limit, by the fraction 292/365 to find C’s maximum exclusion for 2017 ($81,680).

In summary, when calculating if a taxpayer qualifies for the foreign earned income exclusion using the physical presence rest, keep in mind:

• There are two separate calculations: the “at least 330 days” spent in a foreign country and the 12 consecutive months period in which those at least 330 days fall.
• Sometimes even less than a full day in a foreign country can count toward the at least 330 days.

Allen Schulman (schulman.allen@gmail.com) is an enrolled agent in Lakewood, N.J. To comment on this article or to suggest an idea for another article, contact Sally Schreiber at Sally.Schreiber@aicpa-cima.com.