The Foreign Service Journal, January-February 2023

AFSA NEWS 66 JANUARY-FEBRUARY 2023 | THE FOREIGN SERVICE JOURNAL in the proposed regulations, the IRS issued Notice 2022-53 on Oct. 7, 2022, which postpones the implementation of the final regulations regarding RMDs to no earlier than the 2023 distribution calendar and eliminates penalties for non-EDBs required to take RMDs under the 2019 SECURE Act who did not take RMDs during 2021 and 2022. We must await the final regulations to know if taxpayers who did not take RMDs in 2021 and 2022 will be required to take those RMDs together with 2023 or if taxpayers can forgo entirely 2021 and 2022 RMDs and just start taking RMDs correctly in 2023. Foreign Earned Income Exclusion (FEIE) Taxpayers living and working overseas may be eligible for the FEIE. In 2022, the first $112,000 of gross taxable income earned overseas as a non-U.S. government employee or self- employed person may be excluded from federal income taxes but not from self-employment taxes. To qualify to claim this exclusion, the taxpayer must: (1) Establish a tax home in a foreign country; (2) Either (a) meet the “bona fide residence” test, or (b) meet the “physical presence” test; and (3) File a Form 1040 tax return with Form 2555 for the year the FEIE is claimed. Tax Home The tax home is the general area of the taxpayer’s “main place of business, employment, or post of duty” (i.e., where the taxpayer is “permanently or indefinitely engaged to work as an employee or self-employed individual”). The U.S. Tax Court has explained that the congressional purpose of the FEIE is to offset duplicative costs of maintain- ing distinct U.S. and foreign households. Increasing ties to the foreign country by personally paying for a foreign household, paying local taxes, waiving diplomatic immunity for matters 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. Bona Fide Residence Test The bona fide residence test is a facts and circumstances test aimed at assessing whether the taxpayer intends to make a home outside the United States for an indefinite period. This test requires that the taxpayer be a bona fide resident of a foreign country for an uninterrupted period that includes (at a minimum) an entire tax year (Jan. 1 through Dec. 31). The taxpayer may leave the foreign country for brief or temporary trips back to the United States (for periods not greater than six months in a calendar year) or elsewhere during the bona fide resident period but must have a clear intention of returning to the foreign country. Physical Presence Test The physical presence test requires that a taxpayer be pres- ent in a foreign country for at least 330 full (midnight-to- midnight) days during any 12 consecutive months that begin or end in the tax return filing year (the 12-month period may be different from the tax year). Taxpayers who qualify for the physical presence test using a 12-month period other than a full calendar year are required to prorate the maximum exclusion allowed for that tax year. Travel days to and from the United States generally do not count toward the total for days inside the foreign country (they are considered U.S. days). Other FEIE Considerations 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. Members of the Foreign Service community 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. Taxpayers should note that the FEIE excludes the income from the bottom tax brackets, thus leaving remaining ordinary income on the return to be taxed at the higher tax brackets applicable to the return. Consequently, for certain married taxpayers, filing separately may result in a combined lower tax liability than filing jointly. We recommend that taxpayers consult with a qualified tax professional to ascertain the most advantageous filing status for each tax year. Foreign Accounts and Asset Reporting U.S. tax reporting is often more complicated for members of the Foreign Service community, particularly when offshore postings give rise to offshore assets. It is common for non–For- eign Service spouses to take jobs in the local economy, through which foreign bank account and pension interests are acquired, giving rise to enhanced U.S. tax and reporting obligations. Similarly, many Foreign Service spouses own businesses orga- nized outside the United States, which require additional U.S. reporting beyond income and deduction items. Even the most well-intentioned and diligent taxpayers can run afoul of the minefield of reporting requirements that exist for U.S. persons (citizens, residents, and Green Card holders) who have offshore income and assets. As the pool of accountants and tax attor- neys with the expertise to identify and correctly complete the specific forms that need be filed is limited, it can be a challenge