How to Pass the IRC Section 937 Bona Fide Residency Test

To qualify as a bona fide resident of a U.S. territory under the IRC Section 937 bona fide residency test, you have to pass three separate tests every year: a physical presence test, a tax home test, and a closer connection test. All three apply to American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands. Passing all three lets you exclude most territory-sourced income from your federal return under Sections 931 or 933.{¹ Failing any one of them means the exclusion disappears, along with the tax savings that usually motivated the move.

Federal employees are outside the exclusion regardless of where they live. Salary paid by the U.S. government does not qualify for the Section 931 or 933 exclusion, so passing the residency test does not shield that pay.{²{³

Physical Presence Test

The most common way to satisfy the presence test is to spend at least 183 days in the territory during the taxable year, with any part of a day counting as a full day.{¹ If 183 days doesn’t fit your travel pattern, the regulations offer four alternatives. Meeting any one of them satisfies the test:

Presence in the territory for at least 549 days across the current year and the two preceding years, with at least 60 days in each of those three years.
No more than 90 days in the United States during the taxable year.
U.S. earned income below the Section 861(a)(3)(B) threshold, combined with more days in the territory than in the United States.
No significant connection to the United States during the taxable year.

Time spent in the United States for less than 24 hours while in transit between two places outside the territory generally does not count as a U.S. day.{⁴ Days you were forced out of the territory by a federally declared disaster, or days spent in the United States as an inpatient for medical treatment, still count toward territorial presence. Keep the evacuation order or medical records; you will need them if the IRS asks.

Tax Home Test

Presence alone isn’t enough. Your tax home must sit inside the territory for the entire year.{⁴ Your tax home is the general area of your main place of business or employment. If you have no regular workplace, the IRS looks at where you regularly live.

Remote workers and people running businesses on both sides of the water tend to struggle here. If income-producing activity is split between a territory operation and a mainland one, the IRS compares where your professional time and revenue are concentrated. A secondary mainland office isn’t automatically fatal, but the territorial location has to be the clear primary hub. When the mainland side outweighs the territorial one in either time or revenue, the tax home test fails.

Closer Connection Test

The third test looks at where your personal life is actually centered. Even with enough territorial days and a territorial workplace, the IRS can still deny bona fide residency if your strongest personal ties remain on the mainland.{⁴ The comparison is your connections to the territory against your combined connections to the United States and any foreign country.

The factors the IRS weighs include:

Where your spouse and children live.
Where you own or lease a residence, including any jointly owned mainland home.
Where your furniture, clothing, and vehicles are located.
Where you conduct banking and where account statements are mailed.
Where you hold a driver’s license and where you are registered to vote.
Memberships in social, cultural, political, or religious organizations.
How often you travel back to the mainland for family, vacation, or business.

No single factor decides it. A weak showing across several categories can sink the claim even when one or two point the right way. Keeping a mainland home available for personal use is a flag auditors watch for. The burden of proof is on you, so documenting territorial ties in real time is far easier than reconstructing them under audit.

Special Rule for the Year You Move

You cannot literally be present for 183 days or maintain a territorial tax home for a full year if you relocate partway through it. The regulations solve this with a transition-year rule.{⁵ You satisfy the tax home and closer connection tests for the move year only if all three conditions hold:

You were not a bona fide resident of the territory for any of the three taxable years immediately before the move.
For the last 183 days of the move year, you had no tax home outside the territory and no closer connection to the United States or a foreign country.
You remain a bona fide resident of the territory for each of the three taxable years immediately after the move.

The third condition is a trap. Moving to Puerto Rico in 2026 and leaving before the end of 2029 retroactively invalidates the transition-year relief for 2026, which can trigger back taxes, interest, and penalties for the year you thought was already settled.

Military and Student Exceptions

Active-duty service members get a one-way carve-out. If you already qualified as a bona fide resident of a territory in a prior year, you are treated as continuing to meet all three tests in a later year when military orders take you away from the territory or station you on the mainland.{⁶ The reverse does not work: being ordered to a territory does not create bona fide residency if you weren’t already a resident.

Students get a narrower break. Days spent temporarily in the United States as a full-time student don’t count as U.S. days for the physical presence test, and those days are also disregarded when evaluating whether your tax home shifted off the territory.{⁶ The exception does not extend to the closer connection test, so if mainland school life pulls your personal ties back with it, that still counts against you.

When You Have To File Form 8898

You must file Form 8898 for any tax year in which you begin or end bona fide residency in a territory, provided your worldwide gross income exceeds $75,000.{⁷ The form asks for the exact date residency began or ended, whether you maintained a home in both places at the same time, and a breakdown of mainland versus territorial earnings.

The deadline matches your Form 1040 due date, including extensions. Form 8898 does not travel with your tax return. Send it separately to:

Internal Revenue Service
3651 S. IH 35
MS 4301 AUSC
Austin, TX 78741

Keep a copy and proof of mailing. The form is signed under penalty of perjury, so pulling together utility bills, lease agreements, and property tax records before you complete it makes the dates and addresses easier to defend if the IRS follows up.

What Happens If You Fail

If you claim bona fide residency and the IRS later determines you did not meet all three tests, the exclusions vanish. The territory-sourced income you left off the return gets added back, and you owe the resulting federal tax plus interest running from the original due date.

Section 6688 adds a $1,000 penalty for failing to file Form 8898, or for filing it with incomplete or incorrect information.{⁸ The penalty reaches individuals with worldwide gross income above $75,000 who took a position that they became or ceased to be bona fide residents.{⁹ You can escape it only by showing reasonable cause and the absence of willful neglect. The IRS has not published detailed criteria for what qualifies, so the safer course is to file correctly and on time.

The bigger financial risk isn’t the $1,000 itself. It’s the full federal tax bill on income you thought was excluded, years of compounding interest, and any accuracy-related penalties layered on top. That total can easily exceed the savings that made the move attractive in the first place.

1
Office of the Law Revision Counsel. 26 USC 937 – Residence and Source Rules Involving Possessions
2
Office of the Law Revision Counsel. 26 USC 931 – Income From Sources Within Guam, American Samoa, or the Northern Mariana Islands
3
Office of the Law Revision Counsel. 26 USC 933 – Income From Sources Within Puerto Rico
4
eCFR. 26 CFR 1.937-1 – Bona Fide Residency in a Possession
5
Department of the Treasury. Treasury Decision 9248 – Residence Rules Involving US Possessions
6
Federal Register. Residence Rules Involving US Possessions
7
Internal Revenue Service. Instructions for Form 8898 – Statement for Individuals Who Begin or End Bona Fide Residence in a US Territory
8
Office of the Law Revision Counsel. 26 USC 6688 – Misuse of Agreement Authority
9
Internal Revenue Service. IRM 20.1.9 – International Penalties