Many American taxpayers living abroad or running foreign businesses are well-aware of the problematic system in which citizenship-based taxation collides with that of other developed nations. That is, all other developed nations tax on the basis of physical presence and economic ties. The problem of “double-taxation” occurs when Americans who owe taxes on the basis of citizenship also owe foreign taxes due to their presence or economic activities there.
However, a significant portion of potential double-taxation situations can be offset or eliminated by tax credits and exclusions. The requirements must be satisfied before claiming that these credits or exclusions are complex, which often leads to taxpayer mistakes and unsupportable claims. In particular, the Foreign Earned Income Tax Exclusion is a frequent source of confusion for taxpayers. Do you have tax questions involving living abroad? Contact a Sacramento tax lawyer of NewPoint Law Group, LLP.
What Facts Must One Be Able to Prove to Claim FEIE?
In order to claim the Foreign Earned Income Exclusion, there is a two-prong test that an FEIE claimant must be prepared to satisfy. Taxpayers may be tempted to claim credits and exclusions to reduce their tax bill, but the IRS is aware that credits and exclusions of this type are frequently improperly claimed. Therefore, it is always wise to discuss your intent to claim certain tax benefits with a tax professional prior to filing.
First, and as previously alluded to, a taxpayer must be able to prove that he or she is a bona fide resident of a foreign nation. If the taxpayer is a U.S. citizen or has resident alien status from a nation holding a tax treaty with the United States, he or she will be considered a foreign tax resident after spending one full, uninterrupted tax year in a foreign jurisdiction. Alternatively, certain taxpayers can also qualify on the basis of the physical presence test. The physical presence test generally requires a taxpayer to spend a minimum of 330 full days within one year in a foreign nation to qualify.
The second prong of the test that determines whether one can properly claim FEIE turns on whether the taxpayer has successfully established a foreign tax home. Thus, it takes more than just foreign residence or a foreign home to qualify for FEIE. Establishing a new “tax home” in a foreign nation generally requires the taxpayer to establish a foreign nation as his or her principal place of business. Steps like opening a business, directing tax documents to a foreign address, and many other factors may indicate that the taxpayer has established a foreign tax home.
Recent Tax Court Case Illustrates Scrutiny “Tax Home” Prong Receives
In Hirsch v. Commissioner, T.C. Summ. Op. 2016-37, the IRS conceded that the taxpayer was a foreign resident, but nevertheless successfully maintained that he was not entitled to the claimed FEIE benefit because he had not established a foreign tax home.
In this matter, the taxpayer established his permanent residence in Israel but worked for a U.S.-based financial services firm out of their New York City metro-area office. In fact, this taxpayer was only authorized to seek business and perform services in the United States for U.S. clients. To this end, the taxpayer frequently traveled to New York and New Jersey, spending approximately 30 percent of his time in the United States. Furthermore, the taxpayer took no steps to establish business activities in the foreign nation and was actually explicitly forbidden from doing so by both the scope of his FINRA license and directives issued by his company.
Since the taxpayer had failed to establish this second prong, he was not entitled to receive the benefit of the Foreign Earned Income Tax Exclusion. Taxpayers who can qualify for this tax relief can reduce their taxable income received as wages or, in some cases, as a housing benefit. However, taxpayers who improperly claim this benefit are subject to fines, penalties, interest, and liability for the unpaid tax.
Consult with a Sacramento Tax Attorney Before Claiming FEIE or Other Foreign Tax Benefits
If you are living abroad or have a foreign business and wish to minimize the tax you pay while complying with all tax laws and obligations, contact a Sacramento tax attorney at the NewPoint Law Group, LLP today. If you have concerns regarding potentially overly aggressive tax positions from previous years, our tax law team can help. To schedule a confidential consultation at our Folsom or Roseville tax offices, call 800-358-0305 or contact us online.