Tax Tips Military Contractors/Employees Abroad
I prepare returns for many military contractor employees abroad, many in Iraq and Afghanistan but also in Europe, Asia and the Mid-East.
So this posting is intended to address the special issues such individuals have in preparing and filing tax returns. I have also provided a few tips of things to do and not do and to clear up some often misunderstood areas.
If anything is unclear or questions remain, feel free to contact me. This is intended as general information only, not as tax advice nor is this intended to cover every situation
So this posting is intended to address the special issues such individuals have in preparing and filing tax returns. I have also provided a few tips of things to do and not do and to clear up some often misunderstood areas.
If anything is unclear or questions remain, feel free to contact me. This is intended as general information only, not as tax advice nor is this intended to cover every situation
Foreign Earned Income Exclusion (FEIE) Form 2555: Be Careful of the "Tax Home" Test
Almost everyone I talk to is aware of the FEIE.
The FEIE is the tax provision that allows an exclusion of up to $91,500 (2010 amount) for someone receiving foreign earned income.
Also almost everyone is aware of the "physical presence" test to qualify for the FEIE. This test requires you to be out of the US for 330 days in a 12 month period.
What you may not be aware of is that there is an additional test called the "tax home" test. This is in addition to the physical presence or "330 day" test.
To meet this test you must have a "tax home" overseas. The date your tax home was established must be shown on Form 2555. If you don't meet the tax home test, you don't qualify for the FEIE even if you meet the "330 day" test.
To meet the tax home test you can not have a temporary assignment overseas…the assignment must be either "permanent" or "indefinite" in IRS lingo. To meet the test your work assignment overseas must be "expected to last" at least one year. In addition you must actually stay and work there for one year. So both matter: expected length of assignment when you start and actual length of assignment.
If you start out, for example, on a 9-month assignment and then extend it, you don't get to go back to the beginning and count the time. You have to start counting the one-year period as of the date the assignment changes.
To sum this up, you need to start out with a minimum one-year assignment and you should have written documentation stating when your assignment begins and how long it it expected to last. If there is no expected end point, your documentation should say the assignment is indefinite.
The FEIE is the tax provision that allows an exclusion of up to $91,500 (2010 amount) for someone receiving foreign earned income.
Also almost everyone is aware of the "physical presence" test to qualify for the FEIE. This test requires you to be out of the US for 330 days in a 12 month period.
What you may not be aware of is that there is an additional test called the "tax home" test. This is in addition to the physical presence or "330 day" test.
To meet this test you must have a "tax home" overseas. The date your tax home was established must be shown on Form 2555. If you don't meet the tax home test, you don't qualify for the FEIE even if you meet the "330 day" test.
To meet the tax home test you can not have a temporary assignment overseas…the assignment must be either "permanent" or "indefinite" in IRS lingo. To meet the test your work assignment overseas must be "expected to last" at least one year. In addition you must actually stay and work there for one year. So both matter: expected length of assignment when you start and actual length of assignment.
If you start out, for example, on a 9-month assignment and then extend it, you don't get to go back to the beginning and count the time. You have to start counting the one-year period as of the date the assignment changes.
To sum this up, you need to start out with a minimum one-year assignment and you should have written documentation stating when your assignment begins and how long it it expected to last. If there is no expected end point, your documentation should say the assignment is indefinite.
1099s vs W-2
Most people working overseas as defense contractors are W-2 employees. But you also qualify for the FEIE if you are a 1099 contractor.
If you receive a 1099, you must pay self employment (S/E) tax, the equivalent of Social Security and Medicare taxes for self-employed people. S/E tax is not offset by the FEIE. As a self employed person, you may deduct business expenses from your 1099 income.
If you receive a W-2, you will still have to pay social security taxes assuming you work for a US based employer.
In certain circumstances you will have to pay Social Security and Medicare taxes even if you work for a foreign employer. This is not the majority of cases and applies if the work performed is considered employment under Section 223 of the Social Security Act.
If you receive a 1099, you must pay self employment (S/E) tax, the equivalent of Social Security and Medicare taxes for self-employed people. S/E tax is not offset by the FEIE. As a self employed person, you may deduct business expenses from your 1099 income.
If you receive a W-2, you will still have to pay social security taxes assuming you work for a US based employer.
In certain circumstances you will have to pay Social Security and Medicare taxes even if you work for a foreign employer. This is not the majority of cases and applies if the work performed is considered employment under Section 223 of the Social Security Act.
US Government Employees
If you are a US government employee, you can not claim the FEIE, including "agencies and instrumentalities of the United States"
Counting the 330 Days
There are two important points about counting the days outside the US:
If your passport is lost or stolen (along with all your passport stamps which can't be re-created), make sure you report the loss or theft. Then keep documentation that you made the report. This is another case where the back up documentation such as boarding passes is essential.
- Don't cut it too close. Only full days abroad count. So the first day you count has to be 24 hours in a foreign country starting at mid-night. You don't have to start working that day as time spent abroad for any reason will count for purposes of the physical presence test.
- Keep documentation of your travel dates. Most people don't get audited. But if you do, you have a lot to lose as the FEIE can easily amount to $20,000 in tax savings in a year. To prove your time abroad, the IRS will likely ask for a full color copy of your entire passport. This is to prove when you arrive at the foreign destination and also that your didn't spend too much time in the US during your qualifying 12 month period. If you aren't offered a passport stamp, ask for one. Also keep your boarding passes or airline tickets as a back up plan. Don't count on going back to the airline's web site later and printing this information as the data is often purged after 6 months or so. If you are challenged by the IRS, it could be 2-3 years after you file.
If your passport is lost or stolen (along with all your passport stamps which can't be re-created), make sure you report the loss or theft. Then keep documentation that you made the report. This is another case where the back up documentation such as boarding passes is essential.
State Income Taxes
Each state has its own requirements regarding who is considered a resident. Chances are if you left a state with an income tax, still have a home, family or other connections to a state, you will have to continue paying state income taxes. But the circumstances of each case need to be considered.
If you re-locate to a state with no income tax before leaving for overseas, then generally speaking a state income tax return would not be required.
A state income tax return would still be required if you earned income from that state for the part of the year before moving.
If you re-locate to a state with no income tax before leaving for overseas, then generally speaking a state income tax return would not be required.
A state income tax return would still be required if you earned income from that state for the part of the year before moving.
Filing date and extensions
You may need an extension to file in order to meet the Physical Presence Test (330 day requirement). Form 2350 is used for this purpose. This is different from the form which is normally used to request an extension.
You still have to pay all of the tax due by April 15 even if you qualify for an extension of time to file. Your tax filing deadline will be 30 days after you meet the physical.
You still have to pay all of the tax due by April 15 even if you qualify for an extension of time to file. Your tax filing deadline will be 30 days after you meet the physical.
Allowances
Many people received allowances in addition to their pay. These items may be called things like hazardous duty pay, relocation assistance, overseas differential, per diem, etc.
Generally speaking these items are taxable even if your employer isn't reporting them on your W-2.
Meal and lodging payments may not be taxable if you are on temporary assignment, that is you are traveling away from home. But the key here is "temporary assignment". If the assignment is temporary, you may get travel and meal reimbursements tax free…but you lose the FEIE.
Generally speaking these items are taxable even if your employer isn't reporting them on your W-2.
Meal and lodging payments may not be taxable if you are on temporary assignment, that is you are traveling away from home. But the key here is "temporary assignment". If the assignment is temporary, you may get travel and meal reimbursements tax free…but you lose the FEIE.
Withholding
If you are planning to claim the FEIE, you will need to complete IRS Form 673, Statement for Claiming Exemption From Withholding on Foreign Earned Income Eligible for Exclusion(s) Provided by Section 911. This lets your employer know you will be claiming the FEIE and that tax should not be withheld on that portion of your wages.
The really important thing not to do is have withholding stopped and then fail to meet the FEIE requirements. You will have to make up all the tax due at filing time.
The really important thing not to do is have withholding stopped and then fail to meet the FEIE requirements. You will have to make up all the tax due at filing time.
First Year, Last Year, Partial Year
If your overseas stay begins or ends in mid-year, you don't get the full $91,500. The amount is prorated for the time during the year you are outside the US.
There are also some funny rules about this so you can't just count up the number of days and divide. But the basic idea is that the longer you are out of the country, the more FEIE you can claim
There are also some funny rules about this so you can't just count up the number of days and divide. But the basic idea is that the longer you are out of the country, the more FEIE you can claim
I hope this has helped clear up a few of the more confusing points. But if you have questions remaining, please feel free to let me know and I will be glad to help.
All information presented should be considered general in nature and not advice as to a specific situation.