New Law Allows Combat-Zone Contract Workers to Claim Foreign Exclusion
In a recent online update, the IRS reminded taxpayers that starting with the 2018 tax year, contractors or employees of contractors supporting the U.S. Armed Forces in designated combat zones will qualify for the foreign earned income exclusion (“FEIE”) even if their “abode” is considered to be in the United States while they are abroad.
Over the past number of years, the issue of “abode” has been heavily litigated in the Tax Court, with the majority of decisions favoring the IRS. This new law is a welcome change for the many contract workers who previously could not qualify for the exclusion.
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 and no abode in the United States, 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 2018, the maximum exclusion amount is $103,900 per qualifying person.
What Is a “Tax Home” and What Is an “Abode”?
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.
A Brief History of the Defense Contractor Cases
In a series of cases decided over the last several years, the Tax Court analyzed the FEIE in the context of taxpayers working under their employers’ contracts with the Department of Defense. Generally, these cases achieved mixed results in the Court, with the key issue being whether the taxpayer was considered to have an abode in the United States.
In two of the more recent defense contractor cases, for instance, the Tax Court decided in favor of one taxpayer (See Linde v. Commissioner, T.C. Memo 2017-180), while deciding against the other taxpayer (See Qunell v. Commissioner, T.C. Summary Opinion 2016-86). In the former case, because the taxpayer developed community ties during his stay in Iraq, the Tax Court upheld the taxpayer’s FEIE claim. In the latter case, because the taxpayer did not establish any family or personal ties in Afghanistan and kept his home and family in the U.S., the Court found the abode of the taxpayer to be in the United States and disallowed the taxpayer’s FEIE claim.
A lengthy analysis of these and other defense contractor cases can be found in our published article on the foreign earned income exclusion.
New Law for Combat-Zone Contract Workers
The Bipartisan Budget Act of 2018 changes the tax home requirement for contractors or employees of contractors supporting the U.S. Armed Forces in designated combat zones, enabling them to claim the foreign earned income exclusion even if their “abode” is in the United States. The new law is effective starting with the 2018 tax year.
The IRS maintains a list of designated combat zones, which can be found here:
For taxpayers staying in areas that are not designated combat zones, the previous rules and court interpretations should seemingly continue to apply.
The Takeaway for U.S. Expats
In light of the continuing trend of courts and legislators focusing on the foreign earned income exclusion, it’s important for expats to have solid justification for their FEIE claims.
At Expat Tax Professionals, our experts have extensive experience in utilizing all of the tax benefits available to U.S. expats, including the FEIE, foreign tax credits, foreign housing exclusion, treaty benefits, and more.
We have helped many expats significantly reduce or eliminate their U.S. tax obligations using one or more of these benefits. We are ready to help you with your U.S. tax filings. Contact us today!
By Ephraim Moss, Esq. & Joshua Ashman, CPA