If the federal tax you pay is dependent on where you are physically located, then COVID-19 likely has thrown a wrench in your physical tax location (and tax situation).
If you were living abroad and had to return to the U.S. because of COVID-19, you may wonder if you’ll have a big tax bill for failing to meet the foreign earned income exclusion requirements.
If you are a non-resident alien who got stuck in the U.S. because of COVID-19, you may be worried that the IRS will consider you a U.S. resident for tax purposes—thereby allowing Uncle Sam to tax your worldwide income.
Here’s good news. The IRS has provided relief in both circumstances if you qualify.
Foreign Earned Income Exclusion
The tax law gives you a huge tax benefit if you live or work abroad, which allows you to exclude a significant amount of your income from federal tax. In 2020, the maximum exclusion is $107,600 per person plus an additional amount for foreign housing costs.
To claim the exclusion, you need
• foreign-sourced earned income,
• a foreign tax home, and
• to meet either the physical presence or the bona fide residence test.
You’ll still be a qualified individual for the foreign earned income exclusion if you had to leave the foreign country because of war, civil unrest, or similar adverse conditions that precluded the normal conduct of business.
The IRS has ruled that COVID-19 is an adverse condition that precluded the normal conduct of business
• in the People’s Republic of China, excluding the Special Administrative Regions of Hong Kong and Macau (China), as of December 1, 2019, and
• globally, as of February 1, 2020.
To use this relief procedure, you had to
• establish residency, or be physically present, in the foreign country on or before the applicable date above, and
• reasonably expect to meet the foreign earned income exclusion requirements but for the COVID-19 pandemic.
The period covered by this relief ends on July 15, 2020.
Exclusion Relief Example
Joe is present in the United Kingdom from January 1, 2020, through March 1, 2020, and expected to work in London for all of calendar year 2020.
Due to COVID-19, Joe leaves the United Kingdom on March 2, 2020, then returns on August 24, 2020, and stays for the remainder of 2020.
Joe is a qualified individual for the foreign earned income exclusion for the following periods:
• January 1, 2020, through March 1, 2020, and
• August 25, 2020, through December 31, 2020.
Because Joe has 188 qualifying days in the calendar year period, his maximum foreign earned income exclusion in 2020 is $55,270.
If you are a citizen or resident of the United States, then you pay federal tax on your worldwide income.
If you are a non-resident alien, then you pay tax only on your U.S. source income. Therefore, if you aren’t a U.S. citizen or resident, but work occasionally in the U.S., you don’t want to become a U.S. resident for tax purposes.
If you are neither a U.S. citizen nor a lawful permanent resident, then you become a U.S. resident for tax purposes for a calendar year if you meet the substantial presence test in that calendar year.
To meet the substantial presence test for a calendar year, you would be present in the U.S. for at least
• 31 days in the current year, and
• 183 days over a three-year period, using the sum of days present in the current year, one-third of the days present in the first preceding year, and one-sixth of the days present in the second preceding year.
Therefore, if you work in the U.S., and couldn’t leave due to COVID-19, your worldwide income could be subject to U.S. tax.
You don’t count certain days toward the substantial presence test, including medical condition exception days, which are days in which you intended to leave the U.S. but were unable to do so because of a medical condition that arose while you were present in the U.S.
If you intended to leave the U.S. during your COVID-19 emergency period, but you were unable to do so due to COVID-19 emergency travel disruptions, you can exclude the COVID-19 emergency period days from the substantial presence test.
Your COVID-19 emergency period is a single period of up to 60 consecutive calendar days that you select, starting on or after February 1, 2020, and on or before April 1, 2020, during which you were physically present in the United States for each day.
You qualify for this relief if
• you were not a U.S. resident at the close of the 2019 tax year;
• you are not a lawful permanent resident at any point in the 2020 tax year;
• you are physically present in the U.S. during your COVID-19 emergency period; and
• you don’t become a U.S. resident in 2020 due to days of your presence outside of your COVID-19 emergency period.
To claim your relief, you will either
• have to file a Form 1040-NR and complete a Form 8843 according to Revenue Procedure 2020-20, or
• not have to file a Form 1040-NR and simply retain appropriate records in case the IRS inquires.
Residency Relief Example
Martha arrived in the United States on August 14, 2019, and anticipated staying for work through March 31, 2020. With this schedule, she would not have met the substantial presence test in either 2019 or 2020.
But due to COVID-19, Martha did not leave the U.S. until May 26, 2020. Without relief, Martha would be a U.S. resident in calendar year 2020 with 192 days of presence:
• 146 days in 2020, and
• 46 days in 2019 (one-third of 139 days).
If Martha selects April 1, 2020, as the start of her COVID-19 emergency period, then she is not a U.S. resident in calendar year 2020 because she’ll have only 136 days of presence:
• 90 days in 2020, and
• 46 days in 2019 (one-third of 139 days).