Foreign Earned Income Exclusion: It Takes a Member of the Priesthood to Understand It
26 USC §911 permits U.S. citizens and resident aliens to exclude more than $80,000 of the income they earn while living outside the United States. An exclusion that big, even if allocated to the number of days abroad in two calendar years, can provide a pretty big tax break. One of the bases for excluding that income exists when a person has a foreign tax home and has been outside the U.S. and physically present in a foreign country or countries for at least 330 full days out of any consecutive 12-month period. Tax Court cases have typically determined that taxpayers whose "abode" remains in the U.S. cannot have a foreign tax home under section 911(d)(3). Therefore, even when a taxpayer lives on foreign soil, the courts are likely to determine that under 911(d)(3) the abode remains in the U.S. where the taxpayer's family lives, where the taxpayer's bank accounts are located, where the taxpayer's residence to which he intends to return after temporary absence is situated in the U.S., continuing to own a car located on U.S. soil and other such connections. However, if taxpayers can clear that initial hurdle, the rest of the requirements prescribed by 911, and the IRS Pub 54 that explains those requirements, are fairly difficult to comprehend.
26 USC §911 permits U.S. citizens and resident aliens to exclude more than $80,000 of the income they earn while living outside the United States. An exclusion that big, even if allocated to the number of days abroad in two calendar years, can provide a pretty big tax break. One of the bases for excluding that income exists when a person has a foreign tax home and has been outside the U.S. and physically present in a foreign country or countries for at least 330 full days out of any consecutive 12-month period. Tax Court cases have typically determined that taxpayers whose "abode" remains in the U.S. cannot have a foreign tax home under section 911(d)(3). Therefore, even when a taxpayer lives on foreign soil, the courts are likely to determine that under 911(d)(3) the abode remains in the U.S. where the taxpayer's family lives, where the taxpayer's bank accounts are located, where the taxpayer's residence to which he intends to return after temporary absence is situated in the U.S., continuing to own a car located on U.S. soil and other such connections. However, if taxpayers can clear that initial hurdle, the rest of the requirements prescribed by 911, and the IRS Pub 54 that explains those requirements, are fairly difficult to comprehend.
To illustrate the confusing complexity of the remaining requirements, I offer this account. Recently, there arose a situation involving a close friend who has earned income from employment while living in a foreign country. He needed to know two things: (1) the first full day of the 330-day period so he could compute exactly how many full days he was in a foreign country, and (2) after he returned to the United States, he needed to know when he must again leave the United States and when he could return in order to fulfill the 330-day requirement.
IRS Pub 54 covers the requirements of the exclusion provided in §911, but the language is a little tough to decipher. The problem in my friend’s situation was that by the time that midnight of the day of his departure arrived, the plane was over foreign soil; but during several hours following, the plane was over international waters and finally reached another foreign airspace the day after departure. One interpretation of the explanations of Pub 54 is that the first day in a foreign country did not start at midnight of the day of departure. Pub 54 seems to express the view that since the plane was over international waters in international airspace after midnight, the first day did not start at midnight of the day of departure. Instead, the language of Pub 54 seems to conclude that the first full day of the 330-day period did not start until the second midnight following the day of departure. So, Pub 54 might be understood to say that since the period after midnight of the day of departure was partially flying over international waters in international airspace, the day was a non-foreign day.
For various reasons, that interpretation was presenting a serious problem for my friend in establishing plans to return to the United States. A case was located that supports an opposite construction of the matter. The case is Struck, TCMemo 2007-42. In this case a taxpayer had a job working on a yacht owned by other persons. For purposes of §911, the government treated each day partially spent in international waters as a non-foreign day. The Tax Court disagreed. Interpreting Regs. §1.911-2(d)(2) and (3), the court establishes the view that when a person travels from one foreign country to another foreign country, and part of the day is spent in international waters, the day still counts as a foreign day because the taxpayer was physically present in a foreign country for the full day. The key is that the taxpayer was traveling from the territorial waters of one foreign country, through international waters, and arrived in the territorial waters of another foreign nation within the same 24-hour period.
The Tax Court writes, “Under section 911, a foreign country includes airspace, lands, and territorial waters under the sovereignty of a country, territory, or possession other than the United States. Farrell v. United States, 313 F.3d 1214, 1216 [90 AFTR 2d 2002-7799] (9th Cir. 2002); Arnett v. Commissioner, 126 T.C. 89, 93-95 (2006), affd. 473 F.3d 790 [99 AFTR 2d 2007-492] (7th Cir. 2007); sec. 1.911-2(g) and (h), Income Tax Regs.” Furthermore, the Tax Court writes, “Although section 911(d)(1)(B) states that an aggregate of 330 full days of physical presence in a foreign country or countries is required, the regulations thereunder define a ‘full day’ to include partial days of travel in or on international airspace, land, or waters from one foreign location to another foreign location. Therefore, a day involving travel in international waters between foreign locations in increments of less than 24 hours is treated as a full day in a foreign country. Sec. 1.911-2(d)(2) and (3), Income Tax Regs.”
Based on Struck the first full day started at midnight of the day of departure and not at midnight of the next day. The plane was over foreign soil at midnight because it was in the airspace of a foreign nation. After midnight, the plane left that foreign airspace and entered airspace over international waters. Some hours later that day, the plane re-entered other foreign airspace over foreign soil and finally landed in yet another foreign country. The plane was in a foreign country at midnight, traveled over international waters en route to another foreign country, and arrived there before midnight of the day following departure. Therefore, the first full day in a foreign country started at the first midnight after departure.
Okay. So we solved the mystery of determining the first full day in a foreign country. Next came the problem that my friend was going to return to the United States before he had been physically present in a foreign country for 330 full days out of the consecutive 12-month period. On that point, Pub 54 is crystal clear. “You can count days you spent abroad for any reason. You do not have to be in a foreign country only for employment purposes. You can be on vacation time.” Thus, shortly after my friend returns to the United States, he is going to be able to fill up the 330-day period abroad by applying some of the tax he saves under §911 and taking a nice vacation – just long enough to complete the 330-day requirement.
Hear our voice: The tax laws are incomprehensible
Gracious! What a horrendously complicated body of rules exists as a result of §911. It is so complicated that citizens will often tend to forget the benefits of the exclusion and just include the whole amount of foreign earned income on their returns. It is the complexity of the rules and the various computations that are required that scare people away. Many folks fear being penalized if they get some part of the whole complicated mess wrong. The complexity creates fear of becoming trapped even after a good faith effort is made to explore the benefits and to meet the requirements. In other cases, the complexity of the scheme causes some good-faith taxpayers to claim the exclusion when they do not meet the confusing requirements. They often are penalized for negligence when in reality the law is so complicated that an ordinary, literate human can reasonably be expected to misunderstand the statute. How many laymen do you suppose know how to research the tax law in order to find cases that will provide the guidance they need? The whole scheme is so complicated that taxpayers are forced to approach and compensate some member of the priesthood of accountants and lawyers who spend their lives comprehending the mysteries of these scriptures. Is that the kind of system we should have?
IRS Pub 54 covers the requirements of the exclusion provided in §911, but the language is a little tough to decipher. The problem in my friend’s situation was that by the time that midnight of the day of his departure arrived, the plane was over foreign soil; but during several hours following, the plane was over international waters and finally reached another foreign airspace the day after departure. One interpretation of the explanations of Pub 54 is that the first day in a foreign country did not start at midnight of the day of departure. Pub 54 seems to express the view that since the plane was over international waters in international airspace after midnight, the first day did not start at midnight of the day of departure. Instead, the language of Pub 54 seems to conclude that the first full day of the 330-day period did not start until the second midnight following the day of departure. So, Pub 54 might be understood to say that since the period after midnight of the day of departure was partially flying over international waters in international airspace, the day was a non-foreign day.
For various reasons, that interpretation was presenting a serious problem for my friend in establishing plans to return to the United States. A case was located that supports an opposite construction of the matter. The case is Struck, TCMemo 2007-42. In this case a taxpayer had a job working on a yacht owned by other persons. For purposes of §911, the government treated each day partially spent in international waters as a non-foreign day. The Tax Court disagreed. Interpreting Regs. §1.911-2(d)(2) and (3), the court establishes the view that when a person travels from one foreign country to another foreign country, and part of the day is spent in international waters, the day still counts as a foreign day because the taxpayer was physically present in a foreign country for the full day. The key is that the taxpayer was traveling from the territorial waters of one foreign country, through international waters, and arrived in the territorial waters of another foreign nation within the same 24-hour period.
The Tax Court writes, “Under section 911, a foreign country includes airspace, lands, and territorial waters under the sovereignty of a country, territory, or possession other than the United States. Farrell v. United States, 313 F.3d 1214, 1216 [90 AFTR 2d 2002-7799] (9th Cir. 2002); Arnett v. Commissioner, 126 T.C. 89, 93-95 (2006), affd. 473 F.3d 790 [99 AFTR 2d 2007-492] (7th Cir. 2007); sec. 1.911-2(g) and (h), Income Tax Regs.” Furthermore, the Tax Court writes, “Although section 911(d)(1)(B) states that an aggregate of 330 full days of physical presence in a foreign country or countries is required, the regulations thereunder define a ‘full day’ to include partial days of travel in or on international airspace, land, or waters from one foreign location to another foreign location. Therefore, a day involving travel in international waters between foreign locations in increments of less than 24 hours is treated as a full day in a foreign country. Sec. 1.911-2(d)(2) and (3), Income Tax Regs.”
Based on Struck the first full day started at midnight of the day of departure and not at midnight of the next day. The plane was over foreign soil at midnight because it was in the airspace of a foreign nation. After midnight, the plane left that foreign airspace and entered airspace over international waters. Some hours later that day, the plane re-entered other foreign airspace over foreign soil and finally landed in yet another foreign country. The plane was in a foreign country at midnight, traveled over international waters en route to another foreign country, and arrived there before midnight of the day following departure. Therefore, the first full day in a foreign country started at the first midnight after departure.
Okay. So we solved the mystery of determining the first full day in a foreign country. Next came the problem that my friend was going to return to the United States before he had been physically present in a foreign country for 330 full days out of the consecutive 12-month period. On that point, Pub 54 is crystal clear. “You can count days you spent abroad for any reason. You do not have to be in a foreign country only for employment purposes. You can be on vacation time.” Thus, shortly after my friend returns to the United States, he is going to be able to fill up the 330-day period abroad by applying some of the tax he saves under §911 and taking a nice vacation – just long enough to complete the 330-day requirement.
Hear our voice: The tax laws are incomprehensible
Gracious! What a horrendously complicated body of rules exists as a result of §911. It is so complicated that citizens will often tend to forget the benefits of the exclusion and just include the whole amount of foreign earned income on their returns. It is the complexity of the rules and the various computations that are required that scare people away. Many folks fear being penalized if they get some part of the whole complicated mess wrong. The complexity creates fear of becoming trapped even after a good faith effort is made to explore the benefits and to meet the requirements. In other cases, the complexity of the scheme causes some good-faith taxpayers to claim the exclusion when they do not meet the confusing requirements. They often are penalized for negligence when in reality the law is so complicated that an ordinary, literate human can reasonably be expected to misunderstand the statute. How many laymen do you suppose know how to research the tax law in order to find cases that will provide the guidance they need? The whole scheme is so complicated that taxpayers are forced to approach and compensate some member of the priesthood of accountants and lawyers who spend their lives comprehending the mysteries of these scriptures. Is that the kind of system we should have?
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