Expatriates Who Claim the Foreign Earned Income Exclusion on the Basis of Foreign Residence Alone Can Face Tax Penalties

Expatriates Who Claim the Foreign Earned Income Exclusion on the Basis of Foreign Residence Alone Can Face Tax Penalties

One of the most common complaints regarding U.S. taxes that is leveled by expats and others with a U.S. tax obligation is the potential for double taxation. The United States is the only developed nation in the world that taxes on the basis of citizenship. All other developed nations tax on the basis of physical presence and economic nexuses. When these different methods of taxation intersect, U.S. taxpayers can face additional, double taxation on the income they earn abroad.  

Thankfully, many U.S. taxpayers living abroad are often able to leverage certain tax treaties and tax agreements the United States has with foreign nations. These agreements frequently allow the taxpayer to eliminate all or a significant portion of the double-taxation he or she would otherwise face. However, taxpayers should ensure that they qualify for tax exclusions and tax credits before claiming them. Taxpayers who improperly claim tax exclusions like the Foreign Earned Income Tax Exclusion (FEIE) can face fines, penalties, and interest on any unpaid tax.

Ted Kleinman of U.S. Tax Help has helped expats minimize double-taxation while maintaining all aspects of tax compliance for more than 20 years. Whether you are living at home or abroad in China, Brazil, India, Israel, or any other nation call U.S. Tax Help today to work with a trusted CPA.

When Can a Taxpayer Claim FEIE on His or Her Tax Return?

Minimizing the effects of double-taxation is often one of the foremost concerns in an expatriate taxpayer’s mind. Unfortunately, in some instance, these concerns can overwhelm a taxpayer’s better judgment and he or she may make claims for tax credits and exclusions without the ability to support the claims. The IRS is well aware that taxpayers often attempt to utilize FEIE improperly and therefore engages in targeted enforcement in this area.

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Essentially, there are two main prongs of the test to determine whether a taxpayer can qualify for the FEIE. The first prong of the test involves determining whether the taxpayer is considered a bona fide resident of a foreign nation. Depending on one’s citizenship and tax stats, bona fide resident status can be proven through one of two methods. These methods are:

  • A U.S. citizen or resident alien from a taxation with a tax treaty with the United States  is considered a bona fide resident of a nation when he or she spends the uninterrupted duration of one tax year in a foreign nation.
  • Certain U.S. citizens and residents can also qualify as bona fide residents of a foreign nation through the physical presence test.  The test typically requires the taxpayer to spend at least 330 full days of the last year in a foreign country.

Aside from satisfying the bona fide resident prong, a taxpayer must also be able to demonstrate that his or her “tax home” is located outside of the United States. The IRS typically defines a taxpayer’s tax home as the nation of their principle place of business. That is, it takes more than merely living in a foreign nation to establish a foreign tax home. Unless the taxpayer has also taken steps to establish a tax home in a foreign nation, he or she is unlikely to qualify for FEIE.

U.S. Taxpayer Living in Israel Discovered that Residence Alone Does Not Entitle One to FEIE Claim

In Hirsch v. Commissioner, T.C. Summ. Op. 2016-37 a taxpayer living in Israel but working in the New York metro area claimed the FEIE. The taxpayer’s argument to the tax court boiled down to he should be entitled to FEIE because of his permanent residence in Israel.

While the court could have probably raised concerns regarding the bona fide resident prong, the tax court declined to do so and accepted that the taxpayer was a resident of Israel. Therefore, the taxpayer merely needed to prove a foreign tax home in Israel to qualify for the FEIE. However, the taxpayer presented the following facts:

  • He was authorized to seek clients and perform business only in the United States.
  • He was in the United States for approximately 1/3 of the year to conduct these business activities.
  • The taxpayer had opened a U.S. mailbox where he received his W-2 and other tax documents.
  • The taxpayer traveled to the United States at least once a month.

Taken as a whole, the facts showed that the taxpayer had not established a new tax home in Israel. While he was indeed a bona fide resident of a foreign nation, that alone was not enough to qualify for FEIE.

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Work with an Experienced U.S. Tax Accountant to Reduce Double-Taxation for Expats

For more than 20 years, CPA Ted Kleinman of U.S. Tax Help has assisted expats with tax concerns including minimizing double taxation and ensuring that all foreign account disclosure obligations are met. To schedule an offshore and foreign tax consultation with Ted if you are seeking international tax services for Americans, please call U.S. Tax Help at (541) 923-0903 today.