U.S. Tax Court rules against Israeli claiming Foreign Earned Income Exclusion
Each year many US citizens and residents living overseas take advantage of the up to $100,000 a year foreign earned income exclusion ("FEIE"). However, entitlement to FEIE is not automatic as the U.S. Tax Court recently ruled in a case involving an Israeli.
The conditions for FEIE entitlement are that the taxpayer (i) be a bona fide resident of a foreign country, and (ii) have a tax home in a foreign country. As detailed in the ruling, a taxpayer's "tax home" may be different from the taxpayer's actual country of residence.
The first test is whether a U.S. taxpayer is a bona fide resident of a foreign country.
If the taxpayer is a US citizen or US tax resident, then the taxpayer must be a "bona fide” resident of a foreign country or countries for an uninterrupted period which includes an
entire taxable year. Foreign residency may be established by showing the taxpayer was present in a foreign country during at least 330 days in a 12-month period.
The second test is whether the taxpayer has a foreign "tax home". The concept of "tax home" is subjective in nature (much like the “domicile” test for estate and gift tax) and requires an analysis of all the facts and circumstances. Generally speaking, a taxpayer's tax home is considered to be his or her regular or principal place of business, and not necessarily where his or her personal residence is located. To identify the principal place of business, the court can look at the employer's practices and where the employer has identified the taxpayer's principal place of business on its records.
In the present case, Hirsch was a citizen of both Israel and the U.S. The court accepted that the taxpayer was a bona fide resident of Israel without discussion. However, in looking at Hirsch’s "tax home", the court focused particularly on Hirsch’s employer's records.
First, Hirsch was employed full time by Merrill Lynch as an investment associate. During the tax years at issue, the employer’s offices were in the U.S. as were most of the clients. The taxpayer traveled to the U.S. once a month to meet with clients and ended up spending about one-third of his year in the U.S. Merrill Lynch did not reimburse Hirsch for this travel.
Second, the court looked at Merrill Lynch's internal policies regulated Hirsch’s activities in Israel, including what he could and could not do in Israel. Special attention was given to whether or not various Federal regulations were followed with regard to being allowed to conduct such financial activity outside the U.S.
In light of these factors, the court in Hirsch determined that the taxpayer had a tax home in the U.S.
Accordingly, U.S. citizens and residents living in Israel and travelling regularly to the U.S. for business must exercise care in conducting their affairs in light of the Hirsch ruling.
Monte Silver is a U.S. lawyer based in Israel specializing in U.S. tax matters. He formerly worked for the Internal Revenue Service and the U.S. Tax Court.
This article does not constitute legal advice.