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Wood v. Commissioner (T.C. Memo. 2021-103)

On August 18, 2021, the Tax Court issued a Memorandum Opinion in the case of Wood v. Commissioner (T.C. Memo. 2021-103). The primary issues presented in Wood were whether the petitioner is entitled to exclude from gross income, as “foreign earned income” under IRC § 911(a)(1), the wages she earned while employed as a contractor on a U.S. military base in Afghanistan; and (2) whether the petitioner is liable for a late-filing penalty under IRC § 6651(a)(1) for 2015.

Background

Wood v. Commissioner (T.C. Memo. 2021-103)The petitioner was a defense contractor in Afghanistan. She spent 22 days in the United States during 2012, 42 days during 2013, zero days during 2014, and 40 days during 2015 (including June 7-23). The petitioner returned to Texas in April 2016 when her employment ended due to a military drawdown in Afghanistan; however, she immediately began looking for other defense contracting work in Afghanistan. In December 2016, petitioner obtained a new position at Kandahar Airfield. She accepted the offer and departed for Afghanistan in December 2016. She continued to live and work at Kandahar Airfield through the date of trial. She credibly testified—and the Tax Court found—that she planned to continue working as an overseas contractor as long as these jobs continue to be available to her.

An IRS revenue agent contacted the petitioner in 2015 about her failure to file returns. On May 26, 2015, the IRS received the petitioner’s Forms 1040, U.S. Individual Income Tax Return, for 2012-14. She explained in a cover letter that she had been confused about the need to file U.S. tax returns while working on a U.S. military base overseas and that she filed these returns as soon as she became aware that they were delinquent. The IRS received the petitioner’s Form 1040 for 2015 on October 26, 2017. On April 3, 2018, she provided the RA with a copy of her Form 1040 for 2016. All five returns were prepared by a tax preparation company that specialized in work for Americans living abroad.

On August 24, 2018, the IRS sent the petitioner timely notices of deficiency for 2012-16, and she timely petitioned this Court. After concessions by both parties, the sole issues remaining for decision are whether the petitioner’s wages from AC First qualified for the foreign earned income (FEI) exclusion and whether she is liable for a late-filing addition to tax for 2015.

Foreign Earned Income Exclusion

IRC § 61(a) provides that gross income means “all income from whatever source derived.” Citizens of the United States are taxed on their worldwide income unless a specific exclusion applies. Specking v. Commissioner, 117 T.C. 95, 101-102 (2001), aff’d sub nom. Haessly v. Commissioner, 68 F. App’x 44 (9th Cir. 2003), and aff’d sub nom. Umbach v. Commissioner, 357 F.3d 1108 (10th Cir. 2003). Exclusions from gross income are construed narrowly, and a taxpayer must clearly establish her entitlement to any such exclusion. Id. at 101.

IRC § 911(a)(1) provides that a “qualified individual” may elect to exclude from gross income, subject to limitations set forth in IRC § 911(b)(2), her “foreign earned income.” Foreign earned income is “the amount received by such individual from sources within a foreign country or countries which constitute earned income attributable to services performed by such individual.” IRC § 911(b)(1)(A). The IRS does not dispute that the compensation petitioner received as a contractor in Afghanistan was “foreign earned income.”

To be a “qualified individual” entitled to this exclusion, a taxpayer must satisfy two distinct requirements. First, she must either be a “bona fide resident” of one or more foreign countries or be physically present abroad for a specified period. IRC § 911(d)(1). Second, she must show that her “tax home is in a foreign country.” IRC § 911(d)(1) (flush language).

Bona Fide Residence

Under IRC § 911(d)(1)(A), a taxpayer must establish that she “has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year.” The Tax Court has construed this provision “to set a higher-than-ordinary standard of proof—i.e., ‘strong proof’—of bona fide resident status in a foreign country.” Acone v. Commissioner, T.C. Memo. 2017-162 (citing Schoneberger v. Commissioner, 74 T.C. 1016, 1024 (1980)). This standard of proof “is higher than preponderance of the evidence.” Id. The petitioner contends that she was a bona fide resident of Afghanistan during 2012-15, and the Tax Court agreed.

Whether an individual has taken up bona fide residence in a foreign country depends on the facts and circumstances of the case. The factors that courts have consulted in determining bona fide residency include the following:[1]

  1. intention of the taxpayer;
  2. establishment of her home temporarily in the foreign country for an indefinite period;
  3. participation in the activities of her chosen community on social and cultural levels, identification with the daily lives of the people, and, in general, assimilation into the foreign environment;
  4. physical presence in the foreign country consistent with her employment;
  5. nature, extent, and reasons for temporary absences from her temporary foreign home;
  6. assumption of economic burdens and payment of taxes to the foreign country;
  7. status of resident contrasted to that of transient or sojourner;
  8. income tax treatment accorded by her employer;
  9. marital status and residence of her family;
  10. nature and duration of her employment and whether assignment abroad could be completed more expeditiously; and
  11. whether residence abroad reflects good faith (as opposed to a tax evasion purpose).

The “uninterrupted period” that includes an entire taxable year may be established even if “temporary visits” to the United States or other locations are made during that time. Treas. Reg. § 1.911-2(c). While all of the factors listed above may not be present in every case, the applicable factors should be considered and weighed. Sochurek, 300 F.2d at 38.

Several of these factors weigh strongly in petitioner’s favor. The U.S. Court of Appeals for the Fifth Circuit has observed that “intent plays perhaps the most important part in determining the establishment and maintenance of a foreign residence.” Jones v. Commissioner, 927 F.2d 849, 854 (5th Cir. 1991), rev’g T.C. Memo. 1989-616. The petitioner testified that she intends to work as a contractor in Afghanistan for as long as such jobs remain available to her. The Tax Court found that testimony “entirely credible.”

The petitioner has not worked in the United States since 2011. Including her military service, she has spent most of her adult life working in the Middle East, uniformly in war zones. When these cases were tried, she was still working as a defense contractor in Afghanistan, and she delivered her testimony from Kandahar Airfield. This is not the track record of a “transient or sojourner” abroad. Sochurek, 300 F.2d at 38.

The nature and duration of petitioner’s employment also support her foreign residency. She worked a demanding schedule that necessitated her physical presence on the base. Although she had a series of one-year contracts, those contracts were reliably renewed for five years. See Linde v. Commissioner, T.C. Memo. 2017-180 (finding that a contractor in Iraq expected one-year contracts to be extended indefinitely). How her employer treated her income tax status is another factor in her favor: AC First advised that she was eligible for the FEI exclusion and explained how she could elect to have no U.S. tax withheld from her wages. Judge Lauber, was not having the IRS’s arguments. He next stated that “[n]eedless to say, her presence in Afghanistan reflected nothing but ‘good faith.’” Sochurek, 300 F.2d at 38.

Wood Marines DancingThat she couldn’t “participate in the activities of her chosen community” was understandable, as she was a western woman in an Afghan warzone. However, she did fully assimilate into the only community she had available to her: the 50,000 people who lived and worked at Kandahar Airfield. Likewise, although the petitioner lived in employer-provided housing and did not acquire her own space, she had no other housing option available to her. She did not learn the local languages or participate in activities with the local Afghan community. But assimilation of this sort was a practical impossibility, as she was forbidden to leave the base, and most Afghans with whom she interacted had little interest in conversing with her. She could not stay in Afghanistan legally without employment, and her employment was structured as a series of one-year contracts. But those contracts were renewed regularly for five years.

The Tax Court’s analysis differs for 2016. Each tax year stands by itself and “must be separately considered.” Pekar v. Commissioner, 113 T.C. 158, 166 (1999). In April 2016 petitioner lost her job because of a reduction in force. She returned to Texas and lived there until December 24, 2016, when she departed for her new job in Afghanistan. While between jobs, she lived at her house in Pflugerville and collected Texas unemployment compensation. She also registered her car and used it while in Texas. She voted in 2016 even though she had not voted while living in Afghanistan.

The petitioner cannot be a bona fide foreign resident on a part-year basis. See Dawson v. Commissioner, 59 T.C. 264, 270-271 (1972). IRC § 911(d)(1)(A) provides that an individual seeking to meet this bona fide resident test must do so “for an uninterrupted period which includes an entire taxable year.” Because the balance of factors weighs against the petitioner for 2016, the Tax Court found that she was not a bona fide resident of Afghanistan in that year. During the 12-month period beginning April 20, 2015, petitioner was present in the United States for only 17 days, between June 7 and June 23. She was thus “present in a foreign country or countries during at least 330 full days in such period.” IRC § 911(d)(1)(B). However, because the applicable period used for the physical presence test does not correspond with the petitioner’s calendar taxable year, a pro rata adjustment to her FEI exclusion for 2016 will need to be made under Treas. Reg. § 1.911-3(d). See Struck, T.C. Memo. 2007-42.

Foreign Tax Home

In order to be a “qualified individual” as defined by IRC § 911(d)(1), a taxpayer must satisfy not only the “bona fide residency” or physical presence test. She must also show that her “tax home is in a foreign country.” IRC § 911(d)(1) (flush language). IRC § 911(d)(3) defines the term “tax home” to mean, in the case of an individual, “such individual’s home for purposes of IRC § 162(a)(2).” Under IRC § 162(a)(2), a person’s home is generally considered to be the location of her regular or principal place of business. See Mitchell v. Commissioner, 74 T.C. 578, 581 (1980). For the petitioner, this is Afghanistan.

Wood HomeHowever, IRC § 911(d)(3) goes on to provide that an individual shall not be treated as having a tax home in a foreign country for any period for which her abode is within the United States. Thus, if the petitioner’s “abode” during 2012-16 was in the United States, she cannot establish that her tax home was in Afghanistan. See Jones, 927 F.2d at 856; Harrington v. Commissioner, 93 T.C. 297, 303 (1989). The “foreign tax home” requirement is evaluated using the same applicable period used for the bona fide residence or the physical presence requirement.” See Treas. Reg. § 1.911-2(a).

The term “abode” has been “variously defined as one’s home, habitation, residence, domicile, or place of dwelling,” and it “has a domestic rather than [a] vocational meaning.” Bujol v. Commissioner, T.C. Memo. 1987-230, aff’d without published opinion, 842 F.2d 328 (5th Cir. 1988). To determine a taxpayer’s “abode” for a particular period under IRC § 911(d)(3), the Tax Court compares and contrasts the taxpayer’s domestic ties to the United States with his ties to the foreign country in which she claims a tax home. Haskins v. Commissioner, 820 F. App’x 994, 995 (11th Cir. 2020) (quoting Harrington, 93 T.C. at 307-308), aff’g T.C. Memo. 2019-87. Although any taxpayer working in a foreign country will “invariably have some connections” with that country, if her ties to the United States are stronger, the Tax Court has held that her “abode” remains in the United States. Evans v. Commissioner, T.C. Memo. 2015-12.

Considerations for determining the taxpayer’s “abode” include the amount of time spent in each country, the residence of close family members, community involvement, banking activity, property ownership, and recreational activities. See Wentworth v. Commissioner, T.C. Memo. 2018-194. “Maintenance of a dwelling in the United States by an individual, whether or not that dwelling is used by the individual’s spouse and dependents, does not necessarily mean that the individual’s abode is in the United States.” Treas. Reg. § 1.911-2(b); see, e.g., Harrington, 93 T.C. at 309 (finding a U.S. abode where the taxpayer spent almost half his time in the United States with his family, maintained bank accounts in the United States, attended church in the United States, and owned vehicles in the United States); Acone, T.C. Memo. 2017-162 (finding a U.S. abode where the taxpayer spent so much time at his family’s home in New Hampshire that he “continue[d] to be the one who mowed the grass there”); Daly v. Commissioner, T.C. Memo. 2013-147 (finding a U.S. abode where the taxpayer worked abroad for fewer than 110 days annually and derived less than half his income from work overseas).

The Tax Court considered the petitioner’s ties to Afghanistan in the light of the “nature of the region” and the “unique circumstances” of her work. See Wentworth, T.C. Memo. 2018-194. The petitioner had a Texas driver’s license, but it was a condition of her employment that she be licensed to drive in the country that issued her passport. She had a U.S. bank account, but that was necessary to enable her employer to make direct deposit of her paychecks. Opening a local bank account or buying property in Afghanistan would have been impracticable if not impossible, given the requirements of her security clearance and the ban on leaving the base. The petitioner worked 12 hours a day in Afghanistan, with a half-day off every 14 days. Despite the strenuous demands of her work, she managed to have a full social life, including visiting restaurants and shops on the boardwalk, cooking with friends, and pursuing her weightlifting hobby.

The petitioner had limited family and personal ties to the United States. She was unmarried and had no children; although she visited her parents in Boston occasionally, she spent a significant amount of her vacation time traveling to other foreign countries. Cf. Cobb v. Commissioner, T.C. Memo. 1991-376 (discounting the significance of occasional U.S. family visits that were “limited by convenience”). Her house in Texas remained unoccupied, so she did not have to manage any tenants. She often let her car registration lapse and thus rented a car when visiting Texas. She spent fewer than 43 days in the United States in 2012, 2013, and 2015, and zero days in 2014. The only wages she earned during these years were derived from her job in Afghanistan.

Most of petitioner’s close friends were other contractors who also lived and worked in Afghanistan. At one point she dated another contractor working overseas. She planned to work as a contractor in the Middle East for as long as such jobs remained open to her. Cf. Haskins, T.C. Memo. 2019-87 (noting that a contractor in Afghanistan described herself as “miserable” and asked how soon she could return to the United States “without getting in trouble with the IRS”).

This Court has previously found that civilian defense contractors working overseas can have “abodes” outside the United States, so long as they have stronger ties to the foreign country than to the United States. See Wentworth, T.C. Memo. 2018-194 (finding that taxpayer’s tax home was in Iraq). We find that petitioner’s ties to the United States during the relevant period were much weaker than her ties to her community in Afghanistan. We thus find that her tax home was in Afghanistan from the start of 2012 until she left Afghanistan in April 2016. See Struck, T.C. Memo. 2007-42 (observing that the foreign tax home requirement is to be evaluated during the same applicable period used by a taxpayer for the bona fide residence or the physical presence requirement).

Late Filing Penalties for 2015

IRC § 6651(a)(1) provides for an addition to tax of 5% of the tax required to be shown on the return for each month or fraction thereof for which there is a failure to file the return, not to exceed 25% in toto. As in effect during 2016, however, IRC § 7508 allowed an extension of time to file to taxpayers who were serving in support of the U.S. Armed Forces in an area designated by the President as a combat zone. The parties agree that the petitioner was serving in support of the Armed Forces and that Afghanistan was a combat zone during 2016.

The normal deadline for individual taxpayers to file returns for 2015 was April 18, 2016.5 Under IRC § 7508(a)(1)(A), the petitioner’s “period of service” in the combat zone before the deadline “and the next 180 days thereafter” are disregarded in determining whether her 2015 return was timely filed. Petitioner was in a combat zone from January 1 through April 19, 2016, the date of her departure from Kandahar Airfield. In determining her filing deadline, therefore, 289 days are disregarded—those 109 days plus 180 days. See Rev. Rul. 76-425; IRS Publication 3, Armed Forces’ Tax Guide 25 (2015).

The petitioner’s extended filing deadline was therefore 289 days after April 19, 2016, or February 2, 2017. She did not file her 2015 tax return until October 26, 2017. However, she returned to Afghanistan, which remained a combat zone, on December 24, 2016, before her 2015 return was due. IRC § 7508(a), therefore, entitled her to another extension of time to file while she remained in that combat zone. She remained in Afghanistan continuously through October 26, 2017 (and thereafter). Her 2015 return was thus timely filed, so she is liable for no addition to tax under IRC § 6651(a)(1) for that year.

(T.C. Memo. 2021-103) Wood v. Commissioner


Footnote:

[1] Sochurek v. Commissioner, 300 F.2d 34, 38 (7th Cir. 1962), rev’g and remanding 36 T.C. 131 (1961); Schoneberger, 74 T.C. at 1023.

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