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Hi everyone,

I'm hoping someone here has experience with or knowledge about how to go about choosing 12 month periods to qualify for the physical presence test on Form 2555 (Foreign Income Exclusion).

In Pub 54 it gives the following examples of overlapping 12 month periods to qualify for the physical presence test: “You work in New Zealand for a 20-month period from January 1, 2012, through August 31, 2013, except that you spend 28 days in February 2012 and 28 days in February 2013 on vacation in the United States. You are present in New Zealand for at least 330 full days during each of the following two 12-month periods: January 1, 2012 – December 31, 2012 and September 1, 2012 – August 31, 2013. By overlapping the 12-month periods in this way, you meet the physical presence test for the whole 20-month period.”

My question is when each 12-month period should be entered on Form 2555. Am I right in assuming that this example person given in Pub 54 should use the first 12-month period (January 1, 2012 - December 31, 2012) on Form 2555 for the 2012 tax year and the second 12-month period (September 1, 2012 - August 31, 2013) on Form 2555 for the 2013 tax year? Even though part of the second period takes place in 2012? And even though part of the second period was already used in the previous year (September 2012 - December 2012)? Do your 12-month periods from year to year need to “match up” or overlap?

To give some background about my situation, my husband and I live and work in China for Chinese schools and are both US citizens. We plan to stay here indefinitely but don’t feel comfortable using the bona fide residency test to qualify because we only have one-year job contracts and one-year work visas, we don’t own property in China, and we don’t have any children. We just feel that there are not enough substantial long-term ties to guarantee that we’d qualify based on bona fide residency.

So we’re trying to use the physical presence test since it’s straightforward and based purely on objective math. No IRS guys deciding that we’re not “bona fide” enough, haha.

The problem this year is that we took 2 vacations to the US because of our work schedules instead of going just once like we usually do, so we need to figure out how to arrange the 12-month periods to still qualify for the physical presence test. By using weird 12-month periods, we should be able to qualify, but I want to make sure I’m calculating them in the right way so that we don’t get denied the foreign income exclusion and wind up having to pay tax and penalties later just because of a calculation mistake.

This is what I’ve worked out:

We spent 17 days in the US during July 2013 and 45 days in the US during December 2013 - February 2014. We plan to continue working and living in China indefinitely.

I want to use the 12-month period from January 1, 2013 to December 31, 2013 for this year’s Form 2555. We’ve spent 335 full days in foreign countries during that period and 27 days in the US. (The unaccounted for days were spent traveling over international waters.)

Then next year when I file, I can’t use the period from January 1, 2014 to December 31, 2014 because we will only have spent 329 days in a foreign country during that period because we were in the US for all of January and part of February. Instead, for next year’s taxes, I want to use the 12-month period from February 6, 2014 to February 5, 2015. Then we’ll be able to travel to the US for a month next summer and still meet our full 330 days in a foreign country since we won’t be counting any of our vacation time in the US from January/February 2014.

Am I allowed to calculate the 12-month periods in that way? Does it matter that I am not using that period between January 1, 2014 and February 6, 2014 in either this year’s Form 2555 or next year’s?

The instructions for Form 2555 say “The 12-month period on which the physical presence test is based must include 365 or 366 days, part of which must be in 2013. The dates may begin or end in a calendar year other than 2013” but they don’t mention how the 12-month periods should be calculated from year to year - whether it’s okay for me to leave some months out altogether (as I want to do next year).

Does anyone have any ideas about this?
 

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I want to use the 12-month period from January 1, 2013 to December 31, 2013 for this year’s Form 2555. We’ve spent 335 full days in foreign countries during that period and 27 days in the US. (The unaccounted for days were spent traveling over international waters.)
OK - no problem here. You meet the requirements, no question.

Then next year when I file, I can’t use the period from January 1, 2014 to December 31, 2014 because we will only have spent 329 days in a foreign country during that period because we were in the US for all of January and part of February. Instead, for next year’s taxes, I want to use the 12-month period from February 6, 2014 to February 5, 2015. Then we’ll be able to travel to the US for a month next summer and still meet our full 330 days in a foreign country since we won’t be counting any of our vacation time in the US from January/February 2014.
Sure, you can do it this way - however, that means that any "earnings" you have from January 1st to February 5th in 2014 won't be eligible for the earned income exclusion. If you're paid only for the time you're working, there's no problem. If you get paid time off for your vacation time, that may throw your pay for January and the first few days of February into the taxable category. Depending on just how you're paid, I'd be tempted to just treat it as if the longer vacation at the beginning of the year was "between contracts" and see if it flies.

Am I allowed to calculate the 12-month periods in that way? Does it matter that I am not using that period between January 1, 2014 and February 6, 2014 in either this year’s Form 2555 or next year’s?
Yup - actually, you're claiming two distinct 12 month periods, but that's ok.

The instructions for Form 2555 say “The 12-month period on which the physical presence test is based must include 365 or 366 days, part of which must be in 2013. The dates may begin or end in a calendar year other than 2013” but they don’t mention how the 12-month periods should be calculated from year to year - whether it’s okay for me to leave some months out altogether (as I want to do next year).
It should be just fine. Let's say you went back to the States for a full six months in 2014... Your 12 month period would then start July 1st and run until June 30th of 2015. What this would mean is that you wouldn't be able to file your taxes until after June 30th 2015 for 2014 (i.e. until you completed the physical presence test) - and that only your income paid between July 1st and December 31st was subject to the FEIE. (It works that way the first year you are abroad, and the year you move back to the US for good, too.)
Cheers,
Bev
 
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