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U.S. Expatriates and International Workers: Beware of Exceptions to the Foreign Income Exclusion

U.S. citizens, resident aliens, and others who are U.S. taxpayers face a unique mode of taxation in the United States. That is, U.S. taxpayers are taxed on their worldwide income regardless of where it was earned. Predictably and understandably, this method of taxation results in many expatriates worrying about whether they will face double taxation--paying taxes on their income to both the nation they are living in and to the IRS. While there are provisions in the U.S. Tax Code and various tax treaties to address the issue of double-taxation, these provisions can be difficult to understand, create problems for laypersons in ascertaining whether he or she qualifies, and it can present difficult in maintaining compliance in future tax years as circumstances and finances change. However, the foreign earned income exclusion can be an essential tool in ensuring that an expatriate taxpayer does not face double-taxation and pay more than his or her fair share.

What is the Foreign Earned Income Exclusion?

The foreign earned income exclusion is one way the Tax Code accounts for the problems created by our status-based system of taxation. In general, U.S. citizens or permanent legal residents living abroad are eligible to claim the exclusion. The amount of the exclusion is adjusted each year based on the rate of inflation. The amount of exclusion for current and past tax years is as follows:

  • 2015: $100,800
  • 2014: $99,200
  • 2013: $97,600
  • 2012: $95,100

In addition to this income exclusion, the taxpayer may also qualify to exclude the value of employer-provided meals, lodging and certain fringe benefits. However, despite the initial appeal of this provision, it is subject to some limitations and inequities.

Government Employees and Others Working Overseas, Typically, do not Qualify

To begin with, government employees are typically ineligible for the foreign income exclusion even if they are living and working in a foreign country.

Those who Perform Work Outside of a Nation-State May not be Eligible

A two year-old D.C. Circuit Court decision, Rogers v. Commissioner, may place the value of the foreign income exclusion in jeopardy for thousands of expatriates. Rogers involved a U.S. taxpayer who lived in Hong Kong and worked as a flight attendant for United Airlines.

The taxpayer's employment duties required her to arrive nearly two hours before take-off to perform unpaid preparation duties. Per the terms of the employment contract, flight attendants are paid on the basis of their hours of flight time. Flight time includes the period from where the airplane leaves the terminal to the time it arrives at its destination. Being that this flight attendant was assigned to a trans-Pacific route, the majority of this taxpayer's compensable time was spent while the plane was over the Pacific Ocean and not within the borders of any country. This resulted in the IRS' determination that the taxpayer owed a tax deficiency because the income was not, "attributable to services performed by an individual in a foreign country or countries." On appeal to the Tax Court, the IRS Commissioner's determination was upheld because the taxpayer, "could only exclude the portion of [the taxpayer's] earnings that were related to her time spent working in or over foreign countries."

At the next level of appeal at the United States Court of Appeals, the court dismissed the taxpayer's challenge, stating that the Commissioner's decision was in accord with the Section 911 IRS agency regulations, and the decision in the matter was not inconsistent with precedent. Similarly situated taxpayers must now exercise caution when determining whether their income qualifies for the exclusion. The same rule would apply to someone who works on a ship in international waters.

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