As tax attorneys in Houston, we see a lot of U.S. citizens whose oil-related jobs require they spend significant time overseas. The wages earned overseas can escape tax in the U.S. This is due to the foreign earned income exclusion. But this exclusion generates quite a few tax disputes with the IRS, which is evidenced by cases like the Bellwood v. Commissioner, T.C. Memo. 2019-135, case. The case shows what facts are necessary to qualify for the foreign earned income exclusion.
Facts & Procedural History
The taxpayer resided in Georgia with his wife and son. He entered into an employment contract to fly helicopters for a U.S. company in Saudi Arabia.
The taxpayer worked a “28 and 28” schedule. This required him to work 28 days in Saudi Arabia and then have 28 days off of work.
While in Saudi Arabia, the taxpayer lived in an apartment provided by his employer. The apartment was fully furnished by the employer.
The taxpayer chose to spend his days off of work in the U.S.
The taxpayer used Turbotax to complete his tax returns. In doing so, he was prompted to complete the Form 2555, Foreign Earned Income Exclusion. This exclusion is often referred to by the acronym FEIE. The FEIE resulted in his wages being excluded from tax in the U.S.
The IRS audited the return and disallowed the FEIE exclusion and litigation ensued. The question for the court was whether the taxpayer was entitled to the FEIE exclusion.
The Foreign Earned Income Exclusion
The general rule is that taxpayers are subject to tax on their worldwide income. Thee FEIE exclusion is an exception for some income for rendering services abroad.
To qualify for the FEIE exclusion, the taxpayer:
- Has to have a “tax home” in a foreign country;
- Must be either a U.S. citizen who is (a) a bona fide resident of the foreign country for the year or (b) physically present in the foreign country for at least 330 full days in a 12 month period; and
- Must have income for performing services abroad.
The “tax home” is generally where the taxpayer works. The rules say that a U.S. citizen will not have a tax home in a foreign country if his “abode” is in the U.S.
The term “abode” is synonymous with home. It refers to where the taxpayer actually lives. This is measured by a number of factors that are used to compare the ties the taxpayer has to the U.S. vs. the foreign country.
The “Tax Home” for the FEIE Exclusion
In this case, the court had little difficulty finding that the taxpayer did not have a tax home in Saudi Arabia.
The taxpayer clearly maintained his abode in the U.S. He lived with his wife and child in Georgia. He spent all of his free time off of work in the U.S. His civic activities were limited in Saudi Arabia as he was not a citizen there. His apartment was a temporary one provided by his employer. The taxpayer didn’t even furnish the apartment himself. This showed that he maintained closer ties to the U.S. and any ties to Saudi Arabia were merely for his job.
These are the exact facts that one has to avoid to qualify for the FEIE exclusion. To qualify for the FEIE exclusion, one genuinely has live in the foreign country. This is easier to establish if the taxpayer’s spouse and children reside in the foreign country and the taxpayer maintains foreign bank accounts (which trigger FBAR reporting requirements), gets a foreign driver’s license, and participates in social activities in the foreign country.
The Bona Fide Resident and Physical Presence Tests
While not an issue in this case, the bona fide resident and physical presence tests can also be problematic.
The bona fide resident test is similar to the tax home requirement. It looks to similar factors to determine whether the taxpayer resided in the foreign country. In most cases we see, taxpayers are typically qualifying under the physical presence test rather than the bona fide resident text.
The physical presence test is easier to establish. Absent travel to lands that are not recognized as foreign countries (such as Antarctica) or to international waters, this test comes down to substantiation.
The taxpayer’s travel arrangements will usually be set out on his or her passport or travel documents and receipts. This provides the records needed to support the FEIE exclusion.
Taxpayers who qualify for the physical presence test will still need to establish their tax home was in another country, as in the Bellwood case. Thus, even with a bright line rule, one still has to establish the other factors for the tax home to qualify for the FEIE exclusion.