How do COVID travel disruptions impact the foreign earned income exclusion?
Question of the week: Can someone who planned to live and work abroad for 2020 but returned to the US because of COVID-19 exclude foreign earned income in 2020?
Q. A client had to cut short his expected two-year stay in Croatia because of COVID-19. Can he exclude his foreign earned income from the early part of 2020?
Just after the first of the year my client “Harvey” was sent by his company to work in Croatia. Arrangements were made for long-term leases on a house and car for him in Zagreb, paying up the remaining months’ rent on his U.S. apartment, and storage for his car.
The idea was for him to stay abroad at least two years to expand his company’s operations. Instead, because of coronavirus, his company and the U.S. embassy agreed it was best for him to return to the States for a while, which he did at the end of March. He is pretty sure he’ll be able to return to Zagreb in October.
He certainly expected to meet the physical presence test in 2020 but, unfortunately, he won’t be in Croatia long enough to meet it. Is there any way he can exclude the income he’ll earn in the short time he’ll live and work in Croatia this year?
A. Under IRS relief, your client may be able to apply the adverse conditions waiver to qualify for the foreign earned income exclusion.
The IRS recently provided guidance in Rev. Proc. 2020-27 that may allow your client to qualify for the foreign earned income exclusion (FEIE) on Form 2555.
Under §911(d)(4), an individual who is required to leave a country because of war, civil unrest, or other similar adverse conditions will be treated as qualified for the FEIE if the individual establishes a reasonable expectation of meeting the physical presence or bona fide residence test but for the adverse conditions. Each year the IRS provides a list of countries for which the eligibility requirements for the FEIE are waived because of adverse conditions.
Rev. Proc. 2020-27 explains that the COVID-19 health emergency is an adverse condition that precludes the normal conduct of business. Accordingly, the adverse condition waiver applies to:
- The People’s Republic of China (excluding Hong Kong and Macau) as of December 1, 2019, and
- globally as of February 1, 2020.
The waiver period covered by Rev. Proc. 2020-27 ends July 15, 2020.
The COVID-19 adverse conditions waiver means that an individual will qualify for the FEIE for the period the individual is in the foreign country provided the individual:
- Established residency or was physically present in the foreign country before the applicable dates,
- Leaves the country on or after the applicable dates but on or before July 15, 2020, and
- Can demonstrate a reasonable expectation of meeting FEIE requirements but for the COVID-19 emergency.
Applying the guidance of Rev. Proc. 2020-27 to “Harvey,” it appears that his intent was to become a resident of Croatia and certainly to be physically present in the country long enough to qualify for the FEIE. He resided in the country before February 1 and left the country sometime between February 1 and July 15.
Thus, the period that he was in Croatia from early January through mid-March and possibly again from mid-October through the end of the year will qualify for the FEIE (subject to the usual annual limit) even though he will not meet the physical presence test for 2020.
Note that this relief would apply to the short time your client spent in Croatia earlier this year, even if it turns out he is unable to return to Croatia before next year or at all, as long has he establishes that he reasonably expected to meet the physical presence test and had to leave the country solely because of the COVID-19 emergency.