SEAMEN ON YACHT QUALIFY FOR FOREIGN EARNED INCOME EXCLUSION

Myron and Thelma Struck, TC Memo 2007-42 The Tax Court has concluded that taxpayers employed on a yacht that was operated primarily in foreign territorial waters met the foreign physical presence requirement and could claim the foreign earned income exclusion under Code Sec. 911.
Background. A U.S. citizen who has a tax home in a foreign country and meets either the bona fide foreign residence test or the foreign physical presence test can elect to exclude foreign earned income from his gross income. (Code Sec. 911(a)(1)) The exclusion can't exceed his foreign earned income for the year, as computed on a daily basis at an annual rate of $80,000, indexed for inflation for post-2005 years ($82,400 for 2006; $85,700 for 2007). (Code Sec. 911(b))
A taxpayer meets the foreign residence test if he is a bona fide resident of one or more foreign countries for an uninterrupted period including an entire tax year. A taxpayer meets the foreign presence test if, in any period of 12 consecutive months, he is present in one or more foreign countries during at least 330 full days. (Code Sec. 911(d)(1)) A foreign country includes airspace, lands, and territorial waters under the sovereignty of a country, territory, or possession other than the U.S. Because international waters are not under the sovereignty of any one country, time spent in international waters generally does not apply toward the 330 foreign day requirement.
A taxpayer who has an abode in the U.S. is not treated as having a tax home in a foreign country. (Code Sec. 911(d)(3))

Facts. Myron Struck was employed as a yacht captain and his wife, Thelma, was employed as a chef and stewardess on a yacht that was operated primarily in foreign territorial waters. Except for approximately 2 weeks when on vacation in the U.S., the Strucks lived on the yacht. In addition to unimproved property, they owned a townhouse in California, which was rented out and managed by real estate professionals. They apparently claimed a state property tax homeowner's exemption (allowed to a owner-occupied principal residence) on the townhouse. They also maintained bank accounts, registered and garaged two vehicles at a relative's property, and maintained their driver's licenses in California.
For the years at issue, 2001 and 2002, the Strucks each claimed the foreign earned income exclusion, including with their returns a Form 2555-EZ, Foreign Earned Income Exclusion. On the Forms 2555-EZ, they listed the address of a relative in California for their “foreign address” and indicated an applicable period of Jan. 1 to Nov. 30, 2001, and Jan. 1 to May 15, 2002.
Concluding that the Strucks did not have a foreign tax home for 2001 and 2002, IRS disallowed the exclusions. During the audit, the Strucks amended their Forms 2555-EZ, listing a Costa Rica foreign address and new applicable periods of Nov. 30, 2000 to Nov. 30, 2001, and May 16, 2001 to May 15, 2002.

Taxpayers qualify for the exclusion. The Tax Court concluded that the Strucks met the foreign physical presence requirement for both years in issue. They were physically present in foreign countries—including foreign waters that counted as part of foreign countries—for 330 days for 2001 (using an applicable period of Jan. 7, 2001 to Jan. 6, 2002) and for 333 days for 2002 (using an applicable period of May 16, 2001 to May 15, 2002). The Court based its conclusion on Myron's testimony, which it found credible, and other evidence, including a review by the U.S. Navy of the log in which Myron entered the yacht's longitude and latitude coordinates every 4 hours while at sea.

During 2001 and until May 5, 2002, the Strucks' business consisted principally of traveling in international and foreign waters to foreign countries on the yacht. They had neither a regular or principal place of business, nor a specific abode in a real and substantial sense during this time. However, while the Court concluded that the Strucks were itinerants, it also found that they had a foreign tax home during the 300-plus days they were physically present in a foreign country during the applicable periods and that they therefor they had a foreign tax home for purposes of the claimed foreign earned income exclusion.

RIA observation: The Court noted—without further comment—that IRS didn't argue that as itinerants the taxpayers had no foreign tax home for purposes of the Code Sec. 911 foreign earned income exclusion. For purposes of Code Sec. 162(a)(2), an itinerant taxpayer is treated as having no tax home and so denied an “away from home” business travel expense deduction.
Noting that neither Code Sec. 911 nor its regs define “abode,” the Court concluded that the Strucks, who had limited ties to the U.S. and whose townhouse was leased to others and unavailable to them, did not have an abode in the U.S. during the applicable periods.

It also found that IRS had erred when it treated each day that involved a partial day of travel in international waters as a nonforeign day in calculating the Strucks' foreign physical presence. Reg. § 1.911-2(d)(2) and Reg. § 1.911-2(d)(3) clearly provide that a partial day of travel in international waters in traveling from one foreign country to another foreign country is to be treated as a full foreign day.

Proof of Mailing - Leaving with Deskclerk Not Sufficient

A recent Tax Court decision holds that leaving a Fed Express envelope with a hotel desk clerk with the understanding that the package would go out that day with Federal Express and hand marking the date on the package is not sufficient to prove that the tax materials were timely mailed. No one knows what happened, but the Federal Express package was officially marked by Federal Express in its printed code the next day (a day too late to avoid problems). The Tax Court stated that the Official Federal Express date was for filing purposes the only valid date that could be accepted. It is important that you make certain if filing by UPS, DHL or Fed Express that it has been dated in print by Federal Express the date you intended it to be sent. You cannot rely on others and you must be certain Federal Express does not date it the next day in error.

2006 IRS AUDIT STATISTICS - ARE YOU IN DANGER?

As reported in a statement issued by IRS Commissioner Mark W. Everson, IRS has continued its strong audit enforcement efforts for Fiscal Year 2006. Principally because of a strong rise in collections, enforcement revenues—the monies from collection, examination, and document matching activities—has increased 3% to a record $48.7 billion.

Individual enforcement. For the 2006 fiscal year that ended Sept. 30, total individual returns audited increased by over 6% to 1,293,681 from 1,215,000 in 2005. This is the highest number since '98. While correspondence or letter exams increased, there was an even bigger increase of nearly 23% from the previous year in the traditional, sit-down field audits.

As an important part of its enforcement effort, IRS has targeted high-income taxpayers. Audits of individuals with income of $1,000,000 and higher increased to 17,015 from 12,835, a nearly 33% increase. This translates into about 1 in every 16 of these taxpayers being audited last year. In addition, audits of individuals with incomes over $100,000 exceeded 257,000, an 18% increase from 2005. This is the highest figure in more than a decade.

Business enforcement. IRS has placed more emphasis in the area of flow-through returns involving S corporations and partnerships. Efforts to review S corporations and partnerships increased while other IRS activity involving small business and large corporations remained relatively stable. Audits of S corporation returns increased to 13,984 from 10,417, a 34% increase; this is the highest level since 2000. Audits of partnerships increased to 9,777 from 8,489, a 15% increase; this is the highest level since '98.

Audits of small businesses organized as corporations remained about the same: 17,871 audits were completed in 2006, up slightly from 17,858 in 2005. Audits of larger corporations—those with assets over $10 million—declined by 2.2%, to 10,591 from 10,829 in 2005.

Don D. Nelson, is one of the world's acknowledged U.S. Expatriate Tax Experts with over 31 years experience in providing services to clients everywhere in the world. This Blog will be updated regularly with the latest developments in expatriate and US international tax laws which will affect US Citizens living and working abroad.

Visit his website to for answers to most of your questions about US expatriate and foreign taxation at http://www.taxmeless.com or email Don at donnelsonattycpa@yahoo.com

Taxation of Civilian Workers in Combat Zones

Some confusion regarding taxation of civilian workers in combat zones [IRS Headliner Volume 178, 08/31/2006]: The IRS has become aware of some misunderstanding of the income exclusion rules for non-military personnel. Under IRC §112, certain compensation received for active service in a combat zone by members of the Armed Forces is excludable from gross income, and, therefore not subject to federal income tax withholding. However, this exclusion only applies to compensation paid by the U.S. Armed Forces to members of the Armed Forces. Under current law, neither federal civilian employees nor civilian defense contractors deployed with U.S. forces qualify for the exclusion while working in a combat zone or qualified hazardous duty area. (Note that members of the merchant marines are not considered members of the U.S. Armed Forces under IRC §7701(a)(15), and do not qualify for the exclusion either.) Contract workers in combat zones may still qualify for other income exclusions. For example, a U.S. citizen or resident alien living abroad, while taxed on their worldwide income, may qualify to exclude up to $82,400 of their foreign earnings from income, as well as qualify for the foreign housing exclusion and the foreign housing deduction. In addition, if certain requirements are met, contract workers may be able to exclude the value of meals and lodging provided by their employer from income.

Guantanamo Bay Civilians Now Elgible for Foreign Earned Income Exclusion

Notice 2006-84, 2006-41 IRB
IRS has issued a notice which provides that the U.S. Naval Base at Guantanamo Bay is not located within a restricted country and that qualified individuals who are performing services at the U.S. Naval Base there are eligible for the income and housing exclusion under Code Sec. 911 .

Terminating US Residency Permanently Requires Yet Another Form

Past U.S. residents or residents are reminded that individuals who have expatriated or terminated their U.S. residency status must file Form 8854, Initial and Annual Expatriation Information Statement. Form 8854 must also be filed to comply with the annual information reporting requirements of Internal Revenue Code section 6039G, if the person is subject to tax under Section 877 of the Code. A $10,000 penalty may be imposed for failure to file Form 8854 when required.

IRS is sending notices to expatriates who have not complied with the Form 8854 requirements, including the imposition of the $10,000 penalty where appropriate. Failure to file or not include all the required information or the inclusion of incorrect information could lead to a penalty.

WWW.IRS.gov contains information about the Expatriation Tax including changes made to expatriation tax rules due to the American Jobs Creation Act of 2004

Employer Provided Housing is Taxable to Expat Employees

The taxpayers were liable for taxes on the value of the lodging provided by a government contractor. Hargrove et al. v. Commissioner, T.C. Memo 2006-159 (8/8/2006).

During at least some of the time during the 1999 – 2002 tax years, several couples worked for TRW Overseas Inc. at the Joint Defense Space Research Facility/Joint Defense Space Communication Station (defense facility) in Pine Gap, Australia. TRW was a U.S. government contractor that provided services at the facility.

The work for TRW required accepting assigned housing in Alice Springs, Australia, which was approximately 22 miles from the defense facility and was outside of its physical boundaries. The housing was scattered throughout Alice Springs and was on publicly accessible roads that were adjacent to homes available to the general public. While living in Alice Springs, the taxpayers did not pay any rent or utility expenses and did not conduct any TRW or defense facility work from the homes.

The IRS determined that the couples were liable for deficiencies for one or more years for the 1999 – 2002 tax years as the result of excluding the value of their housing from income and that some of them owed corresponding accuracy-related penalties. The taxpayers filed Tax Court petitions in which they argued that Code Section 119 gave them the right to exclude the value of their employment-related housing from their income and that Code Section 912 provided an exclusion for certain living allowances. The taxpayers also asked the Tax Court to review the accuracy-related penalties’ propriety.

The Tax Court held that the couples were liable for the taxes assessed. According to the Tax Court, the couples could not exclude the value of the housing that TRW provided from their taxable income because – although accepting the lodging was a condition of employment and it was furnished for TRW’s convenience – the lodging was not on TRW’s business premises. It said Dole v. Commissioner, 43 T.C. 697 (1965), established that the phrase “on the business premises” means either living quarters that are an integral part of the business property or premises on which an employer conducts some of its business activities. The Alice Springs housing was not integral to TRW’s business, and the couples’ occupancy of that housing did not serve any important TRW business function. The court also concluded that the income exclusion under Code Section 912 did not apply to the living allowances because that provision is limited to civilian officers and employees of the U.S. government.

Finally, the court upheld the accuracy-related penalties because the couples did not show any reasonable cause for the underpayment or that they acted in good faith regarding it. More specifically, they did not provide adequate justification for the disallowed exclusions under Code Sections 911 and 912.

Form 926 Required for Transfers to Foreign Corps.

U.S. persons, domestic corporations and domestic estates or trusts who exchange or transfer property to a foreign corporation must file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation,to report the transaction.

Required U.S. entities should make sure they file timely to avoid any potential failure to file penalties. They also must file Form 5471 in most situations with their annual income tax return.

US Enterepreneurs Living Abroad May Need To File Special Forms

If you live abroad and have your own business, you may need to file special forms with your tax return. If you own more than 10% of a foreign corporation, you may be required to file Form 5471 or pay penalties of $10,000 US for each failure to file the form. This forms reports on the ownership, income and expenses of the foreign corporation.

If you operate through a foreign partnership, you may be required to file Form 8865 which reports on the ownership, income and expenses of that partnership. Again failure to file this form can result in a $10,000 per year penalty.

If you have a foreign bank account, stock market account, or other financial accounts that any tiem during the year had more than $10,000US in it or a group of such accounts, you must file Form TDF 90.22-1 which is not filed with your tax return, but is due 6/30 of each year. It reports information on the account and its ownership.

Corporate Tax Equilization Policies for Executives Working Abroad

Corporate tax equilization policies are not always fair to corporate executives working abroad. If you participate in such a program and suspect it is not fair, you can have it reviewed by an expert to determine if you are actually benefiting. If you live in a low tax country, in most instances no tax equilization is better than equiliztion. That will often leave you with much more money in your pocket.

1031 Tax Free Exchanges Outside of US

1031 Tax Free Real Estate Exchanges are not allowed out of or into the US to or from a foreign country. Therefore, taxes must be paid if you sell your US property and want to reinvest it abroad. However, 1031 exchanges are allowed between one foreign property and another (so long as both are located outside of the US).

Voting While Living Abroad in US Presidential Elections

Even though you no longer have a residence in any US state, you can still vote in any US presidential election by following certain procedures mandated by the federal government. It can all be done by mail and you will vote by mail with an absentee ballot. Just click the title to this piece and you will be brought to a page that tells you how.

Status of Forces Agreements May Cause Problems

If you are living in a foreign country and do not have to pay income taxes in that country due to a status of forces agreement because you work for a civilian contractor hired by the US military or government, it may adversely affect you ability to claim the Section 911 foreign earned income exclusion. Revenue Rulings have held that for Vietnam and Japan such an agreement will not allow you to use the bonafide residence test to qualify for the exclusion. One ruling does hold that due to the facts and circumstances and wording of the status of forces agreement with the UK, a residence can still claim the exclusion.