The Foreign Service Journal, January-February 2020

68 JANUARY-FEBRUARY 2020 | THE FOREIGN SERVICE JOURNAL AFSA NEWS Cuts and Jobs Act of 2017 repealed IRC Sec. 71 and 26 CFR 1.71-1, versions of which remain online from various sources. Foreign Earned Income Exclusion Taxpayers living and working overseas may be eligible for the FEIE. In 2019 the first $105,900 earned overseas as a (nongovernment) employee or self-employed person may be exempt from federal income taxes but not from self-employ- ment taxes. To receive this exclusion the taxpayer must: (1) Establish a tax home in a foreign country, which is the general area of the taxpayer’s “main place of business, employment or post of duty” (i.e., where the taxpayer is “per- manently or indefinitely engaged to work as an employee or self-employed individual”); and (2) Either (a) meet the “bona-fide residence” test, which requires that the taxpayer be a bona-fide resident of a foreign country for an uninterrupted period that includes an entire tax year, or (b) meet the “physical presence” test, which requires the taxpayer to be present in a foreign country for at least 330 full (midnight-to-midnight) days during any 12-month period (the 12-month period may be different from the tax year). Travel days to and from the United States do not count toward the total for days inside the foreign country (they are considered U.S. days). Members have successfully used the physical presence test when bona-fide residence cannot be established. Those who rely on physical presence should contemporaneously document travel days and retain copies of visas and tickets to substantiate their calculation. AFSA understands that IRS auditors have denied the FEIE for Foreign Service spouses and dependents for failing to meet the bona-fide residence or tax home elements of this test. The U.S. Tax Court has explained that the congressional purpose of the FEIE was to offset duplicative costs of main- taining distinct U.S. and foreign households. Increasing ties to the foreign country by personally paying for a foreign house- hold, paying local taxes, waiving diplomatic immunity for mat- ters related to your job, paying for vacation travel back to the United States, becoming a resident of the foreign country and working in the foreign country long-term are other factors the federal courts have cumulatively recognized as establishing a foreign tax home. The U.S. Tax Court took up five FEIE cases in 2019, three involving members of the military and one, a civilian pilot. The best further reading in this regard is Haskins v. IRS , 2019 TC Memo 87 (July 11, 2019) because the intricate fact pattern is provided in full and the court includes a complete FEIE analy- sis for foreign presence and foreign tax home. Unfortunately, since Ms. Haskins’ abode was stateside even though she was abroad with a foreign tax home, hers is not a model case for FEIE planning or dispute resolution before the IRS (of which the Tax Court is part). These cases (e.g., Bellwood v. IRS , 2019 TC Memo 135, pp. 14-21 [Oct. 7, 2019]) are available via Google Scholar and the U.S. Tax Court website by searching “foreign income” and “exclusion” or the case citations. Regarding calculating income for other benefits, taxpayers must add the amount excluded under the FEIE back to AGI to figure what their tax liability would be prior to calculating what they owe with the FEIE exclusion. For example, a Foreign Ser- vice employee earns $80,000 with a teacher spouse earning $30,000. All else being equal, tax liability on $110,000 gross income is $15,917; tax on $30,000 foreign income is $3,212; and net tax liability is $15,917 minus $3,212, yielding $12,705 due. Many other tax credits and deductions (e.g., Traditional IRA and Roth IRA contributions) also work this way. As a final note, if all the taxpayer or spouse’s income is excluded under the FEIE in a tax year, then the taxpayer will not qualify for the Child and Dependent Care credit that year. Foreign Accounts and Asset Reporting When a U.S. person (defined as a citizen, resident or green card holder) has offshore income, assets, accounts and/ or entities, U.S. income tax and reporting obligations can become a minefield of potential penalties. Many additional reporting forms apply to such taxpayers, but only a handful of accountants and tax attorneys have the expertise to identify which forms need to be completed and to complete them cor- rectly. The penalties for failing to file or making mistakes on such forms can be draconian. U.S. persons are taxed on their worldwide income. Mem- bers of the Foreign Service must report a wide variety of offshore assets and activities on specific U.S. reporting forms, even if such activities occur abroad. For example, U.S. persons with ownership or signature authority over a foreign bank account of any value must denote this interest in Part III of Schedule B of Form 1040. This often-overlooked section is not only part of the signed 1040 (under penalty of perjury), but it also lets the IRS know whether it can expect a Foreign Bank and Financial Accounts Report (FBAR) from that taxpayer. A misstatement on Schedule B can be used by the IRS against the taxpayer when assessing reporting penalties. The separately filed FBAR (via the BSA e-filing system) may also be essential—penalties associated with failing to file or filing an erroneous FBAR are enormous. This form is required from taxpayers with non-U.S. bank accounts and other offshore assets (including some life insurance poli- cies and pensions) that have an aggregate value of more than $10,000 at any time during the year. Failing to report an account on an FBAR can lead to penalties ranging from