What. A. Year.
When tax geeks arose from their slumber on January 1, 2018, we were greeted by a strange and unfamiliar world. Gone were personal exemptions, Section 199, and 50% bonus depreciation. In their place were a doubled standard deduction, Section 199A, and 100% bonus depreciation. These changes, in addition to countless others, were the end result of a whirlwind legislative process that overhauled our beloved Internal Revenue Code in a mere seven weeks, an act of Congressional hubris that tax professionals will rue for years to come.
As a result of this sweeping new legislation, ever since the calendar turned to 2018, all of our attention has been focused on getting up to speed on the new law. But while we’ve been up to the strained waistline of our pleated Dockers in Opportunity Zones and interest limitations, the century worth of tax law that existed prior to the Tax Cuts and Jobs Act has been completely ignored. Thousands of provisions survived the recent round of reform, and throughout 2018, many of those provisions have found their way into the Tax Court, where disputes between taxpayers and the IRS have ended in all-important judicial precedent.
But anyone who claims to have kept up with the Tax Court in 2018 is flat-out lying. Save for the occasional Wesley Snipes appearance, most of the cases decided by the court in 2018 have gone largely unnoticed, lost to the piles of proposed regulations that have been published on the new law.
And that, quite frankly, is unacceptable. We can’t be like Homer, who once lamented that every time he learned something new, it pushed some old stuff out of his brain. We’ve got to do it all: get a grasp on the new law, while continuing to master the old. After all, Judge Holmes ain’t offering up that word play for no one to read it.
So let’s do this. Over the next twelve weeks, lets dissect one Tax Court case from each month of 2018. Keep in mind, these cases are not necessarily the most important decisions of each month, but rather the ones that I believe to be most useful to your humble workaday tax pro. If you disagree, write your own damn list.
For January’s case, we covered Conner v. Commissioner, T.C. Memo 2018-6, a case addressing whether the sale of real estate generated ordinary income or capital gain.
For February, check out Meruelo v. Commissioner, TC Memo 2018-16, in which we discussed the many ways shareholders in an S corporation screw up trying to obtain “debt basis.”
For March, we went through Simonsen v. Commissioner, 150 T.C. 8, and discovered that the tax treatment of short sales and foreclosures is anything but straightforward.
In April, we looked at Povolny Group, Inc. v. Commissioner, T.C. Memo 2018-37, and discovered that sometimes a loan isn’t a loan.
For May, we beat up Barker v. Commissioner, T.C. Memo 2018-67.
In June, it was Alterman v. Commissioner, TC Memo 2018-83, which took a look at the tax treatment of marijuana facilities.
For July, we covered Martin v. Commissioner, T.C. Memo 2019-109, and learned who qualifies as a real estate professional, or to put it more accurately, who doesn’t.
In August, we took a look at Lakner v. Commissioner, T.C. Memo 2018-127, a case that helped us understand when you can receive a legal settlement or judgment tax-free under Section 104.
When September came around, we broke down Frankel v. Commissioner, T.C. Summary Opinion 2018-45, a case that delved into the numerous traps for the unwary that arise when claiming a deduction for mortgage interest expense.
For October, we took on Felton v. Commissioner, T.C. Memo 2018-168, and learned that a “gift” is not always a gift.
We’ve reached November, and since the government was shut down for half of December, there aren’t a whole lot of cases left to parse through. But that doesn’t mean there aren’t many good cases to discuss. During November, there were interesting decisions on the real estate professional rules, debt v. equity, Section 280E, and Wesley Snipes’ stubborn refusal to pay his tax bill. Unfortunately — or perhaps fortunately — we’ve already discussed each of those in the first ten months of the year, or in the case of Snipes, poked some fun at the decision in our intro.
So for November, we’ll turn our attention to not one, but TWO cases: Leuenberger v. Commissioner, T.C. Summary Opinion 2018-52, and Wentworth v. Commissioner, T.C. Memo 2018-94.
What Makes Them Special?
Both decisions address the same issue: who is a eligible for the foreign earned income exclusion of Section 911? And while that might not whet your appetite for a discussion on tax law, understand, there are far bigger implications when interpreting Section 911 then just whether someone gets an exclusion. Rather, any discussion of the provision requires us to dig into an oft-misunderstood concept: where is a taxpayer’s “tax home?”
Let’s jump in:
Section 911, In General
Contrary to what Mr. Snipes might have you believe, as a U.S. citizen or resident, you must pay U.S. tax on all income, regardless of where it’s earned. Income is not suddenly rendered nontaxable merely because it’s generated from a part time job in Mexico or investing in a Danish company or selling papier-mâché Pope hats outside of the Vatican.
As tends to be the case with the Code, however, there are exceptions to this general rule. One such exception is found in Section 911, which provides that a qualified individual may elect to exclude a limited amount of “foreign earned income.”
Section 911, In General
Section 911(d)(1) defines the term “qualified individual” as an individual whose tax home is in a foreign country and who is—
(A) a citizen of the United States and establishes to the satisfaction of the Secretary that he has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year, or
(B) a citizen or resident of the United States and who, during any period of 12 consecutive months, is present in a foreign country or countries at least 330 full days in such period.
If you break this language down, you’ll see that a taxpayer MUST have his or her “tax home” in a foreign country before anything else matters. Interestingly, the concept of a taxpayer’s “tax home” finds its most frequent application not in Section 911; but rather in Section 162, when determining whether a taxpayer may deduct travel expenses “while away from home.” It’s not enough for a taxpayer to be away from their residence; they must also be away from their tax home. And your “tax home,” the case law tells us, is your economic center. Where do you make your living? For example, a contractor who works on several big projects throughout the year may well find that his “tax home” is the entire area covered by those projects, and thus hotel rooms and travel costs are not deductible.
This is not to say that the determination of one’s tax home is clear, however. While case law has defined a “tax home” as “the vicinity of a taxpayer’s principal place of employment and not where his or her personal residence is located,” identifying that location requires review of a myriad of facts and circumstances.
Making matters more complicated, the case law under Section 911 has established another principle featuring a term of art: a taxpayer cannot have a “tax home” in a foreign country if the taxpayer’s “abode” is in the U.S. Now, we tend to think of an abode as the bricks and mortar we call home, but again, it’s not that simple. Maintenance of a house in the U.S.. — the judicial precedent has established — does not necessarily mean that the taxpayer’s abode is located here.
In seeking to determine a taxpayer’s abode in prior Section 911 cases, the courts have compared a taxpayer’s domestic familial, economic, and personal ties to those in a foreign country. If the ties to the U.S. remain strong, the courts have been quick to conclude that the taxpayer’s abode – and thus his or her tax home – remains in the U.S., particularly if the taxpayer’s work abroad was of a limited duration.
If a taxpayer can satisfy the requirement of having his or her tax home outside the U.S., they must still satisfy the second standard: the taxpayer must EITHER: 1. spend more than 330 days in the foreign country, or 2. Be a “bona fide resident” of the foreign country.
As you’ve probably guessed, you’d prefer to meet the quantitative test; after all, what is a bona fide resident? Again, like a tax home or an abode, it’s a nebulous standard, requiring close look at the facts and circumstances. Below, we’ll see that the 7th Circuit employs an 11 factor test to determine if a taxpayer is a bona fide resident of a foreign country, so this is no simple determination.
So if you’re scoring at home — or even if you’re single — that means there are three terms that need defining before one can conclude if they are eligible for the foreign earned income exclusion (assuming they don’t spend 330 days overseas): 1. Where is their “tax home?” 2. Where is their “abode?” And 3. Are they a “bona fide resident” of a foreign country?
Ok, let’s take a look at the cases.
Facts in Leuenberger and Wentworth
I’m a coward. Always have been; always will be. I intend to live a long, pain-free life before being slowly lowered into the ground as a pristine, unspoiled corpse. And if reaching that goal requires me to push a few kids out of the way in the event of a fire, well, I’ve made my peace with that.
So needless to say, if I ever encounter an unwelcoming job market, my initial reaction will not be to ponder, “Well, let’s see what’s available in the war-torn Middle East.” The two men we’ll discuss below, however, are cut form a different cloth.
Leuenberger
In 2012 and 2013, Larry Leuenberger (Larry) worked full-time as an aircraft captain for Berry Aviation. That, in of itself, is not particularly noteworthy. What is, however, is the fact that Larry chose to do his flying around Afghanistan.
Working a typical rotation of 60-days on, 60-days off, piloted an aircraft around Afghanistan in support of the U.S. Armed Forces. In 2012, Larry was in the U.S. for 173 days, and in Afghanistan at Bagram Air Base for 203. While on deployment, Larry remained exclusively within the friendly confines of the base; this was not a part of the world where you wanted to wander freely, so all of Larry’s housing, meals and transportation were provided for him by his employer.
Throughout 2012 and 2013 Larry maintained a residence in the U.S. in Washington. He had family in Washington, registered three cars there, and maintained a bank account, retirement accounts and brokerage investments in the U.S. He also owned two residences in Washington, one a rental, and one for personal use while in the U.S.
Wentworth
By the time 2009 rolled around, Andrew Wentworth (Andrew) had already done two stints in Iraq: one with the U.S. Marine Corps and another in the private sector. In 2005, after his tour with the Marines, Andrew had contemplated starting college, so he and his parents bought a house in Wisconsin for Andrew to live in while attending school
Alas, the lure of frat house keggers couldn’t match the hold the Middle East had on Andrew, and he left school for a role as security detail for the U.S. Army Corps of Engineers.
In 2009, Andrew took a new job as a security specialist tasked with protecting members of the Department of State. He was hired for a term of “not less than 12 months,” and then began serving a rotation of 105 days on/35 days off. As a result, during 2010 and 2011, Andrew spent more than 75% of his time in Iraq. While in Iraq, he was not permitted to leave the International Zone, and thus, like Larry, had all of his housing, food and transportation provided for him.
As part of his assignments, Andrew visited several sites in Iraq, including the Iraqi National Museum and palace ruins. He also interacted with the Iraqi people who lived and worked in the International Zone; eating lunch with the Iraqi police daily and purchasing various goods from Iraqi vendors. He was a limited speaker of Arabic and knew certain commands in Arabic including “stop,” “put your hands up,” “turn around,” and the all-important “don’t shoot.”
Andrew generally kept Iraqi currency on his person, but he did not maintain any bank accounts in Iraq. In January 2011 he opened three accounts in an Iraqi bank, but he closed them in March 2011 because on a number of occasions the bank did not have cash when he attempted to withdraw money from his accounts, which is generally the minimum requirement for calling oneself a “bank.”
During his 35-day “off periods,” Andrew was required to leave Iraq. And even though his parents were in Wisconsin, he listed a friend’s residence in Tennessee as his “home of record” so he could be flown there for free and listen to country music during his down time. After eventually leaving his employment in 2011, Andrew returned to the U.S. to finish his education with the hope of returning to Iraq with a role in the oil industry.
Taxpayer/IRS Position
On their U.S. tax returns for their respective years at issue, both Larry and Andrew reported their compensation from employment, before then removing some or all of the income by virtue of the “foreign earned income exclusion” of Section 911. In the separate trials, the IRS argued that Larry and Andrew were not eligible for the exclusion. Let’s find out why….and who won.
Compare and Contrast
As a reminder, to be eligible for the exclusion, you must have your “tax home” in the foreign country. But your “tax home” cannot be in a foreign country if your “abode” remains in the U.S.
In Leuenberger, the Tax Court concluded that Larry’ “abode” was in fact in the U.S. during his time in Iraq with Berry Aviation, and thus, by definition, his “tax home” could not be in a foreign country. In support of its conclusion, the court noted that his ties to Afghanistan were “severely limited and transitory,” pointing to the following factors:
- Larry was an authorized contractor working for the Department of Defense in rotational shifts.
- He did not leave the air base where he lived and worked because of safety concerns.
- His family continued to reside in the United States while he worked overseas. I
- In addition to returning to his home in the United States where he lived during the “off” periods of his rotational shifts, he owned and managed multiple investment properties in the United States in 2013, one of which was a “residential apartment complex”.
- He also owned and registered various vehicles in Washington during 2012 and 2013, and maintained a number of bank accounts, brokerage accounts, and retirement accounts.
In contrast, the court explained, Larry had not shown any connection with Afghanistan other than the location of his employment. As a result, he had substantially more economic, familial, and personal ties to the United States during 2012 and 2013, and thus his abode was in the United States during those years.
In Wentworth, the analysis of Andrew’s facts was handled a bit differently. Instead of starting with the “tax home” and “abode” analysis, the court first looked to whether Andrew was a “bona fide resident” of Iraq. Perhaps the court began there because this case would have been appealed to the Seventh Circuit, which has previously employed a detailed factor test to determine if a taxpayer is in fact a “bona fide resident” of a foreign country. The factors are:
- the intention of the taxpayer;
- establishment of his home temporarily in the foreign country for an indefinite period;
- participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment;
- physical presence in the foreign country consistent with his employment;
- nature, extent and reasons for temporary absences from his temporary foreign home;
- assumption of economic burdens and payment of taxes to the foreign country;
- status of resident contrasted to that of transient or sojourner;
- treatment accorded his income tax status by his employer;
- marital status and residence of his family;
- nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time; and
- good faith in making his trip abroad; whether for purpose of tax evasion.
The Tax Court then took on the factors one-by-one.
Factor 1: Intent. The court found clear evidence that Andrew intended to work and remain in Iraq. He had previously been there twice, once with the Marines and once of his own volition. And after his employment ended in 2011, he focused his educational studies on a degree that would return him to Iraq in the oil industry. This factor was for Andrew.
Factor 2: Indefinite home in foreign country. The court found that because Andrew ’s contract was for a period of “not less than 12 months,” he was in Iraq with the expectation that his employment was indefinite. This factor was for Andrew.
Factor 3: Participation in foreign culture. The court took note of the fact that Andrew learned a little Arabic and often mingled with residents of the International Zone, but ultimately concluded that most of his dealings with the local population were tangential to his work. This factor was against Andrew.
Factor 4: Physical presence in foreign country. Andrew spent 75% of his time in Iraq. This factor was for Andrew.
Factor 5: Nature and extent of absences from foreign country. Andrew was required to leave Iraq for 35 days after his 105 day rotation on duty. Thus, this factor was neutral.
Factor 6: Assumption of economic burden to foreign country. Andrew had no expenses and paid no taxes while in Iraq. This factor was against Andrew.
Factor 7: Status compared to transient. The court found that he was more than a transient, but obviously not a full citizen. This factor was neutral.
Factor 8: Treatment by employer. Because Andrew’s employer withheld U.S. taxes, this would normally have been indicative that the employer found him to be a U.S resident ineligible for the foreign earned income exclusion. The Tax Court, however, noted that Andrew could have elected out of any withholding, and thus found this factor neutral.
Factor 9: Marriage and family. While Andrew’s parents and friends were in the U.S., he was not married and had no children. The court found this slightly adverse to Andrew.
Factor 10: Nature of employment. Andrew worked 6 days each week, 12 hours each day, doing dangerous work in a deadly area. This factor favored Andrew.
Factor 11: Good faith v. tax evasion. The Tax Court found no evidence that Andrew was motivated by tax evasion. He properly reported his income before removing it via Section 911.
Based on the factors, the Tax Court concluded that Andrew was a resident of Iraq during the years at issue. As a result, all that was left was to conclude whether his “tax home,” was also in Iraq. And as we learned in Leuenberger, a taxpayer’s tax home cannot be in a foreign country if his abode is in the U.S.
In concluding that, unlike Leuenberger, Andrew’s abode was NOT in the U.S., the court stated:
Petitioner did not have a spouse or children during the years in issue. Petitioner’s parents lived in the United States, but petitioner did not live or stay with them. Instead, on each visit to the United States petitioner stayed with his friend in Tennessee. Petitioner co-owned property in the United States, but his parents, the other co-owners, managed the property while he was in Iraq. He had a valid driver’s license and maintained a bank account in the United States, but his community and familial ties to the United States overall were not strong enough for the Court to find that his “abode” remained within the United States.
Once it was settled that Andrew’s abode was not in the U.S., the court made quick worth of the “tax home” question. All of Andrew’s income was earned in Iraq, so that was clearly the center of his economic universe. As a result, Andrew was entitled to the foreign earned income exclusion in each year.
Conclusion
What’s the lesson? First, don’t go work in a war zone. But if you must, and you’d like to claim a foreign earned income exclusion, you’ll have to REALLY show that you’ve moved not only your economic center, but also your cultural center to the foreign country. Consider the case of Jesse Linde and his 2017 decision in the Tax Court:
Linde was a helicopter pilot in the U.S. Army. After retiring from military service in 1992, he dabbled in auto sales and police work before resuming his piloting career in 1995, later rejoining the Army after the 2001 terrorist attacks.
After retiring from the Army for a second time in 2005, Linde, now in his mid-fifties, faced intense competition from a glut of younger pilots as he tried to find work in the private sector. With each year he became less marketable in the U.S., so in 2009 he took a job as a pilot with a government contractor in Iraq, receiving a residency visa from the Iraqi government.
During 2010, 2011, and 2012, Linde resided in Iraq for 248, 240, and 249 days, respectively. His primary responsibility was to transport government officials throughout Iraq, and he did so on a “60-30” schedule, meaning he would work 60 straight days of 12-hour shifts followed by a 30-day break.
While in Iraq, Linde lived in an unsecured area and mingled with the local community as much as possible, grocery shopping at the local market, dining in restaurants and socializing with the Iraqi interpreters he met at work. He maintained a bank account at the Armed Forces Bank, which provided him funds he could use anywhere in Iraq.
During his 30-day break, Linde was provided free round-trip airfare from Iraq to Kuwait. Once in Kuwait, he would typically travel back to the U.S. to spend time with his family in Alabama. While his family would have preferred to meet Linde in Europe for at least part of his break, the special healthcare needs of Linde’s son-in-law — a disabled Army veteran — made such a trip impossible and forced Linde to return to the U.S.
The IRS assessed a deficiency for each year, asserted that Linde was not entitled to the foreign earned income exclusion because he was not a qualified individual. More specifically, the IRS launched alternative arguments that 1. Linde’s tax home was in the U.S., not Iraq, and 2. Linde was not a bona fide resident of Iraq.
The Tax Court kicked off its analysis by seeking to determine the location of Linde’s abode, which would, in turn, help to determine the location of his “tax home.” In doing so, the court noted that Linde had stronger ties to Iraq than he did to the U.S. during the years in issue. His economic and social life were both in Iraq; he could make a living there that was difficult to match in the U.S., he intended to work there on a permanent basis, and he even went as far as to open up a local bank account. In addition, he became a part of the Iraqi community to the extent possible, maintaining a home in an unsecured area and routinely socializing with locals.
The IRS argument that Linde’s abode remained in the U.S. centered largely around the fact that he owned a home in Alabama and visited his family there during each work break. The court, however, found that Linde credibly testified about the lack of piloting opportunities in the U.S., his desire to remain in Iraq indefinitely, and the effort he made to create a personal life there for himself. In addition, Linde explained to the court that he would have happily met his family in Europe during his work breaks but for his son-in-laws physical limitations.
As a result, the court concluded that Linde’s abode was not in the U.S., clearing the way for the determination that his tax home was located in Iraq. And because Linde’s economic ties were significantly stronger to Iraq than the U.S., it was quickly concluded that Iraq was precisely where his tax home could be found.
Linde then established that he was a bona fide resident of Iraq, credibly testifying that he began working in Iraq with the intention of remaining there indefinitely, an intention that was verified by his actions. Linde spent two-thirds of each year in Iraq, and his absences from Iraq were at the behest of his employer. As a result, despite the fact that Linde spent less than 330 days each year in Iraq, he was a bona fide resident of the country. Having met both requirements of a qualified individual, Linde, like Wentworth, was entitled to exclude the income earned in Iraq under Section 911.