This is Part II of a two-part blog series. After establishing that they have a tax home in a foreign country, taxpayers must still establish that they satisfy the 330 day physical presence test or the bona fide residence test. See IRC section 911(d)(1).

I. 330 Day Physical Presence Test

The 330 day physical presence test is the epitome of a “hard and fast rule.” To satisfy the test, the taxpayer must establish the following (there are “no ifs, ands, or buts about it”):

(1) That he is a U.S. citizen or resident of the United States, and

(2) That he was physically present in a foreign country or countries for at least 330 full days Read More

This blog addresses the foreign earned income exclusion rules as they apply to civilian contractors, and other civilian employees, who work in foreign country combat zones. By “civilian,” I am specifically referring to individuals who are not employees of the United States or any agency of the United States.

I. IRC Section 911 Foreign Earned Income Exclusion

Let’s start with some basics. IRC section 911(a)(1) allows a “qualified individual” to exclude his foreign earned income and housing costs from gross income. In the same way that the foreign tax credit limitation limits the foreign tax credit to the amount of U.S. tax attributable to foreign-source income, IRC section 911(b)(2)(D) limits the amount of foreign earned income that may be excluded to an amount adjusted annually for inflation. Read More

A Gallup Poll released in April 2014 found that two-thirds of Americans believe that the Internal Revenue Service abuses its power. Yet few people realize exactly how much arbitrary power the IRS has through the Courts and the Laws of the United States.

Remember that the IRS like any government agency has a purpose to enforce the laws and like other government agencies the IRS will use all means available to achieve this purpose. For one thing the IRS will conduct undercover operations sometimes even masquerade as professionals to entice other citizens to violate tax laws.

The most common and for many people most cartographic use of power by the IRS is levying bank accounts, paychecks and other sources of income. Unlike a typical creditor, Read More

The third prong of the Harper Test is “whether the arrangement was for “insurance” in its commonly accepted sense.” The case provides further guidance in this paragraph:

Rampart was both organized and operated as an insurance company. It was regulated by the Insurance Registry of Hong Kong. The adequacy of Rampart’s capitalization is not in dispute. The premiums charged by Rampart to its affiliates, as well as to its shippers, were the result of arm’s-length transactions. The policies issued by Rampart were valid and binding. In sum, such policies were insurance policies, and the arrangements between the Harper domestic subsidiaries and Rampart constituted insurance, in the commonly accepted sense. Read More

In looking at the cases, a few points immediately become apparent.

First, all the captives that were challenged by the Internal Revenue Service4 were formed because of business necessity. They are all great examples of the business purpose test outlined in the Frank Lyon case, where has the following factors:

1. there is a genuine multiple-party transaction

2. with economic substance that is

3. compelled or encouraged by business or regulatory realities,

4. that is imbued with tax-independent considerations, and Read More

Today, I want to turn to the Harper Test, which states that a captive must comply with the following three factors:

(1) whether the arrangement involves the existence of an “insurance risk”;

(2) whether there was both risk shifting and risk distribution; and

(3) whether the arrangement was for “insurance” in its commonly accepted sense.

I’ve already discussed the idea of risk shifting and risk distribution. For the next few posts, I want to focus on factors 1 and 3, starting with one, that the arrangement involves the existence of an “insurance risk.” Read More

Analyzing UPS’ situation before and after it established the captive, the tax court noted that UPS performed all the work related to the EVCs before and after the transaction:

Before January 1, 1984, petitioner performed all the functions and activities related to the EVC’s and was liable for the damage or loss of packages up to their declared value. After January 1, 1984, petitioner continued to perform all the functions and activities related to EVC’s, including billing for and receiving EVC’s, and remained liable to shippers whose shipments were damaged or lost while in petitioner’s possession. Petitioner continued to receive shippers’ claims for lost or damaged goods, investigate and adjust such claims, and pay such claims out of the EVC revenue that it had collected from shippers. The difference between petitioner’s EVC activity before and after January 1, 1984 was that after Read More

The UPS case is the last big captive case. However, there is a bit of history between UPS and Harper that we need to explain before moving forward.

In the 1990s, the IRS expanded the scope of their captive litigation, targeting bigger companies. Humana was one of the first truly large, fortune 500 style companies subject to captive litigation. It was not the last. Harper (which I discussed last week) was a large, international company. The service went so far as to argue Allstate — then a subsidiary of Sears — was a captive, even though Allstate wrote a a very small part of their business with Sears. UPS fits with this general case theory of the service generally targeting larger companies after establishing a legal foundation with smaller companies. However, this tactic did not work. The dam started to burst with the Humana (see here, here and here). Read More

Today’s posting will be a bit shorter than most. Although they lost the Humana case, the service continued to file challenges to various captive insurance arrangements. The Harper case — which was a 1991 decision — is important because it gives us a three prong test which a captive must comply with in order to be a “bona fide” captive. The following is from my book:

The court introduced a new three-prong test to determine “the propriety of claimed insurance deductions by a parent or affiliated company to a captive insurance company.” The three prongs are:

(1) whether the arrangement involves the existence of an “insurance risk”; Read More

For background, please see Humana Part I and Humana Part II:

By way of background, in Part I, we looked at the background facts of the case, and learned that Humana was a near-perfect set-up for a captive. The company was forced by business circumstances to form a captive, considered a variety of options (and obviously documented same) and then formed a stand-alone company that was adequately capitalized, independently managed and charged a fair price for its insurance. In Part II, we see a very well tried case for the plaintiff who take full advantage of the facts. In addition, we get the first real explanation (at lease in a case record) of the thinking behind the economic family doctrine. Finally, we see the first real cracks in the economic family doctrine, thanks to some of the insureds not being owners of captive stock. As such, the Read More

Below is an excerpt from my book on the Humana case. As an aside, if you get a bit confused by some of the terms used, you may want to go back and read some of the earlier posts on the captive cases.

Humana lost the trial case but filed a petition for reconsideration. The tax court withdrew its memorandum opinion and issued a full opinion after review by the 19-person court. The written opinion contains a 12-member majority opinion, an 8-person concurrence, a 2- member concurring and a 7-member dissent. The sole reason for Humana’s petition was to get a long opinion which the company could use for the basis of an appeal.

The court first notes the many captive cases heard before Humana that apply directly to Read More

Just to provide some context before moving forward, we’ve been looking at the captive cases in chronological order. We finished with the economic family doctrine. In the conclusion of my analysis to those cases I noted that, most importantly, the IRS was very prepared for captive litigation while the taxpayers weren’t. As a result, the IRS gained a strategic foothold in captive jurisprudence. With Humana, we see the first really good taxpayer push back against the IRS’ efforts. To that end,we’ll be spending some time delving into the decision’s details. The following is an excerpt from my book, U.S. Captive Insurance Law.

Humana was a groundbreaking case because it was the first major victory for a taxpayer in the captive insurance area. Humana was (and is) a publicly traded health care Read More