A U.S. Taxpayer Moved Overseas During the Year. How We Analyzed the Foreign Earned Income Exclusion

The answer was probably yes — but not by the regular deadline, and not for the whole year.

The client's situation

The client is a U.S. citizen and engineer. He worked for a U.S. company until July, then relocated to Europe to work for a local employer under a multi-year contract. His spouse and children moved with him, and they signed a long-term lease. For the year, he had seven months of U.S. wages and about four and a half months of foreign wages.

What went wrong

Nothing had gone wrong yet. The risk was filing too early, before he qualified for the exclusion, or choosing the exclusion automatically without comparing it to the foreign tax credit.

The tax or reporting requirement

U.S. citizens are taxed on worldwide income wherever they live. The foreign earned income exclusion can exclude a limited, inflation-adjusted amount of foreign earned income if the taxpayer has a foreign tax home and meets either:

• The bona fide residence test — residence abroad for an uninterrupted period that includes an entire tax year; or
• The physical presence test — at least 330 full days in a foreign country during any 12 consecutive months.

In the year of the move, the exclusion is prorated based on the qualifying days that fall within that year. U.S. wages earned before the move are not eligible.

The potential IRS exposure

Filing by April without qualifying would mean paying U.S. tax on the foreign wages and later amending. Claiming the exclusion without meeting a test would expose him to tax, interest and possible penalties. Separately, his new foreign bank accounts would likely require an FBAR.

How Chirino USA analyzed the situation

He could not meet the bona fide residence test for his first partial year, so we focused on the physical presence test. Counting from his arrival in mid-August, he would reach 330 full days abroad in the following July, assuming his travel plans held. We chose the 12-month window that maximized the qualifying days falling in the year of the move.

We then compared the exclusion with the foreign tax credit. His new country's income tax rate was higher than the U.S. rate on the same income, so the credit could eliminate U.S. tax on the foreign wages on its own — and claiming the exclusion now could limit flexibility in later years. We modeled both for the move year and the next two years.

How we addressed the issue

Because the physical presence test would not be met until after the automatic June deadline for taxpayers abroad, we filed Form 2350 to extend the filing date until after he qualified. We estimated and paid any expected tax with the extension, since an extension to file is not an extension to pay. We also addressed the state he left, to confirm his residency ended with the move, and set up his FBAR reporting.

The result

The return was filed after he met the 330-day test, using the approach that produced the lower combined tax over the three-year projection — in his case, the foreign tax credit for the foreign wages, with the exclusion kept available as an option for future years. His FBAR and state residency questions were handled in the same filing season.

What other taxpayers in similar situations should know

• In the year you move, the exclusion is usually partial, not full.
• If you have not met the 330-day test by the deadline, an extension may let you wait.
• Compare the exclusion with the foreign tax credit before choosing.
• New foreign accounts often mean a new FBAR obligation.

How Chirino USA can help

Chirino USA Accountants & Advisors specializes in U.S. international tax matters for foreign individuals, foreign-owned U.S. businesses, and Americans in the U.S. and abroad. If your situation sounds similar, we can review what was filed, identify any exposure, and help you decide on the appropriate next step. You can email us or message us on WhatsApp, in English or Spanish.

Sources and official references

• IRS — Foreign Earned Income Exclusion
• IRS — About Form 2350
• IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad