The IRS has provided Time Waivers for Exclusion for taxpayers who were working abroad and returned to the U.S. because of the COVID-19 pandemic before meeting the foreign residency requirements that would qualify them to exclude or deduct all or a portion of the income they earned while working in a foreign country.
Article Highlights:
- Foreign Income Exclusion
- COVID-19 Interference
- Maximum Exclusion
- Waivers
- Example
Background
U.S. citizens and resident aliens are taxed on their worldwide income whether they live inside the U.S. or abroad. However, qualifying U.S. citizens and resident aliens who live and work abroad are often eligible for significant tax breaks: All or part of their foreign salary, wages, or amounts received as compensation for their personal services may be excluded from U.S. income tax.
This exclusion applies to both employees and self-employed individuals. But, it is not available to federal government employees. The maximum amount that can be excluded is inflation-adjusted for each year. For 2019, the cap was $105,900. For 2020, it is $107,600. There are two ways workers qualify for an exclusion. One is by living abroad for an uninterrupted period of a full year. The other is by residing in a foreign country for 330 days in any consecutive 12-month period.
The first way is called the bona fide residence test and the second is the physical presence test.
However, through no fault their own, many of these individuals were forced to interrupt their foreign work assignments and residency to return to the U.S. due to the COVID-19 outbreak, and in doing so, would no longer meet the foreign residency or presence requirements to qualify for the exclusion.
Luckily for these taxpayers, the tax code includes a provision that allows the IRS to waive the required foreign residency and presence periods in case of war, civil unrest, or other adverse conditions. Using that provision, the IRS has provided COVID-19 waivers:
- Beginning December 1, 2019 for those who were in the People’s Republic of China. This excludes Hong Kong and Macau. And,
- Beginning February 1, 2020, for those in other countries.
In both cases, unless extended, these waiver periods end after July 15, 2020.
Thus, if the taxpayer leaves a foreign country on or after the date that country is subject to relief from the residency requirements, the taxpayer can meet the bona fide residence test or physical presence test without meeting the minimum time requirement. However, in figuring the exclusion, the number of qualifying days includes only days of actual bona fide residence or physical presence within the country. Here is an example of how the waiver works.
A U.S. citizen established China residency on July 15, 2019. He was working in China for his U.S. employer. To meet the normal 330-day requirement for physical presence, he would have to remain in China until June 9, 2020. Because of COVID-19, he returned to the U.S. on February 1, 2020. He spent only 201 days in China (170 during 2019 and 31 in 2020). However, the IRS has provided relief from December 1, 2019 through July 15, 2020. Therefore, he qualifies for prorated 2019 and 2020 exclusions.
For 2019
Using the 12-month period of July 15, 2019 through July 14, 2020, his 2019 maximum exclusion would be 46.58% (170/365) of the annual exclusion or $49,328 (.4658 x $105,900). Plus, he’s allowed a housing allowance based on the actual days spent in the foreign country.
For 2020
Using that same 12-month period and return date to the U.S. (February 1, 2020), and assuming he did not return to China, his 2020 maximum exclusion would be 8.47% (31/366) of the annual exclusion or $9,114 (.0847 x $107,600), plus a housing allowance based on the actual days there.
