Foreign Income Exclusion

Discussion Letter

The following discussion and thoughts relate to individuals qualifying for the foreign income exclusion.

The Major Issue = Abode Versus Tax Home

Under IRC 911 an individual’s “tax home” is considered to be located at your regular place of work (i.e., in the foreign country). But the major issue we deal with for rotating workers is establishing one’s abode as being where one’s tax home is located. The following discussion explains. Background and Law “Abode” has been variously defined as one’s home, habitation, residence, domicile, or place of dwelling. Black’s Law Dictionary 7 (5th Edition. 1979). While an exact definition of “abode” depends upon the context in which the word is used, it clearly does not mean one’s principal place of business. Thus, “abode” has a domestic rather than a vocational meaning, and stands in contrast to “tax home” as defined for purposes of IRC 162(a)(2).

The critical issue in cases that the IRS has delved into is whether the taxpayer maintained an abode in the United States or in the foreign country. An abode has been defined as one’s home, habitation, residence, domicile, or place of dwelling. The ultimate determination of abode rests upon where the taxpayer retains stronger significant economic, familial, and personal ties — to the United States or to the foreign country.

In order to determine where a taxpayer’s abode is located, it is necessary to examine and compare the taxpayer’s ties (i.e., his familial, economic, and personal ties) to the foreign country with his domestic ties to the United States. Also, it is important to understand that temporary presences in the United States, such as rotating back and forth, does not mean that the taxpayer’s abode is in the United States during such presence. See IRC 911(d)(1)(A). Furthermore, the taxpayer’s maintenance of a dwelling in the United States, whether or not the dwelling is used by his spouse and dependents, does not mean that his abode is in the United States.

This may all sound like semantics, but it indicates that the issue for workers that rotate back and forth is the determination of whether the taxpayer’s abode is in the foreign country where they work which is similar to tax home or whether the taxpayer has maintained stronger ties in the USA than they have in the foreign country. If ever an IRS audit, which are extremely rare, there will be a comparison of the taxpayer’s ties to the USA to his ties to the foreign country. Even though a taxpayer has ties to a foreign country, the IRS may attempt to argue that the taxpayer’s abode is within the USA.

Specific Recommendations

The following is a list of specific recommendations that help create ties into the foreign country. These are all recommendations — not requirements. The more recommendations you put in place, the stronger your qualification if IRS would ever question. The more important ones are listed first:

  • Attempt to establish a banking relationship in foreign country by opening a bank account. Also, if possible, set up a credit card through your foreign bank or a store in foreign country.
  • Do not register or vote in the USA.
  • Attempt participation in activities on a social, religious or cultural basis. Any social participation in the foreign community further establishes your ties into that country. This is helpful to be able to claim, no matter how minor the involvement might be.
  • Joining social, professional or even just a health club further creates ties into foreign country.
  • Ability to speak the foreign language (even if barely) is helpful though not a requirement.
  • Open charge accounts in stores in foreign country if possible.
  • Recommend use of foreign doctors and foreign medical services when available (even if just a physical.)
  • Obtain foreign drivers licenses if able to, though not necessary.

Other Considerations

  • If we determine that you possibly qualify and you receive W-2 wages, we recommend to file a W-4 with your payroll department to reduce the withholding of income taxes. This form provides the authority for your payroll department to reduce withholding. We are available to assist you in the filings and in dealing with your payroll department.
    • Consider this a crucial recommendation. When we file your return claiming the exclusion and if taxes were withheld, it creates a large refund. The IRS, like you and I, hates to dig into their pockets and pay out refunds. These refunds could red flag the return. So reducing the amount of federal withholding is wise.
  • When you work internationally, in some situations, your earned income is not considered “employment” for FICA and FUTA purposes. Therefore, no social security taxes are required if you decide to “opt out” — you have that choice based on an IRS pronouncement. Also, we have come across a number of cases where the client’s prior tax practitioner calculated Social Security taxes in error on previously filed tax returns. This results in us preparing amended returns for refunds of these social security dollars.
  • As previously discussed under “other benefits”, we have also had great success amending prior filed returns where the worker failed to claim the exclusion and we determine that they do qualify. We are able to work with up to three years of prior filed returns as these years are considered open years based on the Statute of Limitation.
  • Also, if there are foreign tax credits that a taxpayer had available, but were not taken on tax return, we work with special IRC code sections that allow us to go back 10 years and amend for refunds. This is a jewel hidden deep in the code.

In Summary

We have been very successful in applying international oil and gas workers for the foreign income exclusion. All the recommendations are important and are to be considered. Some points carry more weight than others, some points you can control and some are beyond your control. It is our responsibility to make you aware of what IRS is looking for. It is your responsibility to adapt as many recommendations as possible.

If you are unsure of any of the above points or how to implement them, we will gladly provide guidance and assist you. Don’t hesitate to contact us. This is a very misunderstood area of the tax code that most tax attorneys and CPAs are missing the ball on. We don’t believe in overpaying Uncle Sam one penny and we are sure you all share the same philosophy.