Following the trend of the past several years, the Tax Court continues to review foreign earned income exclusion cases at a relatively high rate. In most of the recent cases, the Tax Court has denied the FEIE claims on a number of different grounds.
Recently, the Tax Court decided two cases involving taxpayers working in the Middle East in the field of security, rejecting the FEIE claims in both cases. In one instance, the Court denied the FEIE claim based on the fact that the taxpayer was employed by a U.S. government agency, and in the other instance, the Court found that the taxpayer’s “abode” was in the United States.
Basics of the Foreign Earned Income Exclusion
Provided that an individual can satisfy either the bona fide residence test (substantive change in residence based on facts and circumstances) or the physical presence test (present in a foreign country for 330 full days during any period of 12 consecutive months) and is able to establish a tax home in a foreign country, such individual can exclude from income a portion of his or her foreign earned income.
Foreign earned income is generally pay for personal services performed overseas, such as wages, salaries, or professional fees. It does not include passive income items, such as dividends, royalties, rent, pensions, and capital gains. It also does not include amounts paid by the United States or an agency thereof to an employee of the United States or an agency thereof.
The foreign earned income exclusion amount is adjusted annually for inflation. For tax year 2016, the maximum foreign earned income exclusion is up to $101,300 per qualifying person. If filing individuals are married and both work abroad and meet either the bona fide residence test or physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $202,600 for the 2016 tax year.
What is a Tax Home?
In order for an individual to qualify for the FEIE, his or her “tax home” must be in a foreign country. The general rule is that a “tax home” is located in the vicinity of the taxpayer’s regular or principal (if more than one regular) place of business or employment, regardless of where you maintain your family home.
Your tax home is the place where you are “permanently” or “indefinitely” engaged to work as an employee or self-employed individual. If you do not have a regular or principal place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither (no regular place of business or living), then you are considered an “itinerant” and your tax home is wherever you work.
The “tax home” rule is subject to an important overriding exception – an individual is not considered to have a tax home in a foreign country for any period during which the individual’s “abode” is in the United States. “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling. Thus, in contrast to “tax home,” “abode” has a domestic rather than vocational meaning. The location of your abode often will depend on where you maintain your economic, family, and personal ties.
Owens v. Commissioner (T.C. Summary Opinion 2016-83)
In the Owens case decided in December of 2016, the taxpayer was employed by a U.S. government agency called the Red River Army Depot (RRAD) as a heavy mobile equipment mechanic leader or supervisor in Kuwait. RRAD is in Texas and is part of the Army Tank-Automotive and Armaments Command, which is an agency of the U.S. Department of the Army.
The Tax Court held that even though the taxpayer may have otherwise passed the main FEIE qualification requirements, he was disqualified because he was employed by an agency of the United States. Fortunately for the taxpayer, the Court did not uphold penalties in its decision, because the IRS’s notice of deficiency did not include any penalties.
Lock v. Commissioner (T.C. Summary Opinion 2017-10)
In the Lock case decided just last week, the taxpayer was employed by a private security company and U.S. Government contractor to provide protection in Iraq for high-ranking U.S. Government officials.
The company provided the taxpayer with modest living quarters. He primarily associated with his fellow Americans working for his company. He spent all of his vacation time on trips to visit his family and friends in Florida. He was also registered to vote in Florida, maintained a Florida driver’s license, and he owned two trucks, a boat, and a trailer. The taxpayer’s wife and son resided in the U.S. during his time abroad. He and his and wife separated and then divorced during his time abroad.
Under these circumstances, the Court held that the taxpayer’s abode continued to be in the U.S. during his time abroad, because his sole tie to Iraq was though his employment, and all of the other aspects of his life, including his personal and social ties, were strongly connected to the U.S. The Court therefore held that the taxpayer did not qualify for the foreign earned income exclusion.
In light of the current trend of the IRS and Tax Court focusing on the foreign earned income exclusion, it’s important for expats to have solid justification for their FEIE claims.