Before you accept an assignment to work and earn income abroad, understand what needs to happen in order to achieve tax benefits that are available. In one such case, an individual was working in Russia for a number of years and was audited by the IRS. The result of the audit concluded he had not taken the necessary steps, and therefore had the tax benefits stripped away. As many work abroad situations can vary and include a number of incentives, you need to understand the requirements so you don’t end up with an unwelcome surprise.
A recent U.S. Tax Court decision has again pointed out that the ability to exclude foreign earnings can be quite illusory for many taxpayers. When asking about a potential foreign assignment and the ability to exclude some or all of the earnings while on that assignment, the employee does not always ask the right questions. As a result, the employee is surprised when they do not receive the exclusion anticipated and they receive their tax bill for the year. In this 2015 case, the taxpayer worked for an oil drilling company in Russia and ended up with a deficiency of taxes along with penalties for four years. The Case is T.C. Memo 2015-12 – Joel B. Evans and Donna R. Evans v. Commissioner.
It is important to note that Tax Court Memorandum decisions are “facts and circumstances” cases. They generally are decided based upon the facts and circumstances of the particular taxpayer’s return.
The taxpayer worked for a drilling company that operated in Russia for all of the years under audit. He took the position that his “tax home” was in Russia, therefore allowing him an ability to exclude his wages earned while in Russia. His work was usually done in 30 days on-duty and 30 days off-duty periods. In his off-duty periods he would usually return to the U.S. He maintained a residence in the U.S., and he would spend some of his time there while home. His daughter would stay with the taxpayer’s parents in their home in the same Louisiana town when he was on assignment in Russia. When back in the U.S. he would spend most of his time at his parent’s home, and he would spend some days at his own residence.
The Foreign Earned Income Exclusion was enacted to aid a taxpayer when there is a duplication of costs related to his or her work. There are generally two tests for qualification for the exclusion when work is performed in a foreign country. These two tests are the “bona fide residence test” or the “physical presence test”. However, before one can apply either of these tests, the taxpayer must show that they have a “tax home” in the foreign country. Essentially, to pass either of these two tests, the taxpayer must have a foreign tax home in order to see if they can actually apply the tests.
In the case at hand, the taxpayer failed to show that he could establish a tax home in Russia. Although he incurred the costs of maintaining a residence in Louisiana, he failed to incur the costs of maintaining two residences. While in Russia, his housing costs were taken care of by his employer who provided for his housing. In addition, no family member ever accompanied him, and most importantly, by his maintaining an “abode” within the United States, he was unable to establish that his tax home was in Russia. As a result, the Court reasoned that they never needed to decide whether the taxpayer was either a bona fide resident or passed the physical presence tests.
The Court noted that the possession of an “abode” within the United States was fatal to his claim, and that they did not even need to say whether he passed either of the two tests.
In an earlier decision, the Fifth Circuit Court of Appeals had described why the Code Section relating to the Foreign Earned Income Exclusion added the proviso concerning “abode” as a means to limit the benefits to taxpayers who actually incurred duplicate costs of maintaining a residence in two locales.
The Internal Revenue Code Section for the exclusion makes one’s tax home dependent upon the travel away from home deduction. The regulations note that maintaining a dwelling in the United States is not always fatal to showing that their abode is in another country for a period of time. To establish that one’s abode is other than in the United States, the taxpayer must pass three objective factors.
These factors are:
1) “Whether the taxpayer performs a portion of business in the vicinity of the claimed abode and uses such abode(for purposes of lodging) while performing said business there;”
2) “Whether the taxpayers living expenses incurred at his claimed abode are duplicated because his business requires him to be away there from;” and
3) “Whether the taxpayer
- has not abandoned the vicinity of his historical place of lodging and his claimed abode are both located,
- has a member or members of his family (marital or lineal only) currently residing at his claimed abode, or
- uses his claimed abode frequently for his period of lodging.”
In conclusion, if one is considering taking a foreign assignment for a period of time, before doing so, they should seek professional guidance as to planning for the assignment and how to “jump through the hoops” to avoid a large tax bill. The Foreign Earned Income Exclusion was placed into the Internal Revenue Code in order to assist taxpayers who end up with a duplication of costs in maintaining a home. It also brings to mind that the term “abode” has critical application when trying to argue residence issues with many states for tax purposes, but that is a topic for another day.
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