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This is an update on my previous post warning about the dangers of assuming the Foreign Earned Income Exclusion will prevent you from having to pay taxes. If you are thinking this, or think the FEI Exclusion will apply to you, please read this post, and my previous post, linked HERE.
This post is based on some IRS actions taken over the last year or so involving the status of a taxpayers tax home in a foreign country. You see, most people think that meeting either the presence test or the bona fide residence test is enough to qualify for the exclusion. This is not true. For both tests, you have to establish a tax home in the foreign country. Put simply, you need stronger ties to the foreign country than to the United States. Factors involved in this are living quarters, community ties, financial ties, and social ties. If you have family, a home and your bank in the U.S., this does not bode well. If you live on a military base in the foreign country, and rarely leave it, this is not good either. If you are there are a one year contract, that can be trouble too. You need to establish bona fide ties in the foreign country. These can include housing, banking (keep accounts less than $10,000 at all times), friends, family, community activity etc. You can even try learning the language. This is one of those "facts and circumstances" things, so there is no definitive test for your foreign tax home, but the more you do the better you are. The longer you stay and the stronger ties you establish, the safer you will be.
As with my other post, the point is to be careful, and plan ahead. Have them withhold from your checks as though the exclusion didn't exist, and, even if you get a refund using the exclusion, don't spend the money for a while, since the IRS can come back and take it away. Obviously if you have a rock solid tax home in a foreign country, like wife, kids, banking and community involvement, you can ignore these warnings.