Contract Employee vs. Independent Contractor Are you an employee for Defense Base Act Insurance purposes but an Independent Contractor for Tax purposes? Expat Tax Information 2012 |
If your are receiving DBA benefits they are not taxable Were you injured prior to 2006 and lost your expat status for USTaxes? Under provision IRC 662 (a) you are exempt from the time requirement of being out of the country for the full 330 days. IRS Form 2555 (Foreign Earned Income) was revised 2006 Determination of Worker Status for purposes of Federal Employment Taxes and Income Tax WIthholding IRS Form SS-8 Combat Zone Pay Exclusion A-8 The combat zone military pay exclusion applies only to members of the U.S. Armed Forces. Neither federal civilian employees nor civilian defense contractors deployed with U.S. forces qualify for an exclusion of income earned while working in a combat zone or qualified hazardous duty area. They may, however, qualify for an extension of deadlines to file and pay taxes. Foreign Earned Income and Housing: Exclusion – Deduction You may be able to exclude up to $92,900 of your foreign earned income in 2010. Tax Guide for U.S. Citizens and Resident Aliens Abroad Employer's Tax Guide to Fringe Benefits Blackwater Dodges Taxes Tax Evasion or Fraud Combat Support Associates, CSA dodges taxes for a decade WASHINGTON (AP) — When the Pentagon announced an obscure California company had won a lucrative military contract, no one mentioned any plans for a Caribbean outpost — a tropical shell the company quickly created that allowed it to duck millions in taxes and deflect U.S. lawsuits. It's legal, at least for now. Contractors large and small have been heading offshore to shield piles of taxpayer dollars, according to an Associated Press investigation, but irate lawmakers are thundering that they'll put an end to it. Almost a decade ago, a few months after winning the deal that has totaled more than $2 billion, Combat Support Associates established its subsidiary in the Cayman Islands, a British territory and tax haven. read story here MPRI dodges taxes Shell Firms Shielded Contractor Boston Globe May 4 2008 by Farah Stockman full story here WASHINGTON - In March 2005, one of the Pentagon's most trusted contractors - Virginia-based MPRI, founded by retired senior military leaders - won a $400 million contract to train police in Iraq and other hotspots. Two months later, MPRI set up a company in Bermuda to which it subcontracted much of the work. It was not the first time that MPRI executives had used a shell company in an offshore tax haven to perform government-funded work. A year earlier, MPRI headed a joint venture that won a $1.6 billion contract to provide US peacekeeping forces in Kosovo and elsewhere. Three months later, MPRI set up a company in the Cayman Islands to do the work. Like MPRI's Bermuda subsidiary, the Cayman Islands company appears to have no phone number, website, or staff of its own there. Blackwater Dodges Taxes IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U. S. tax advice within this website is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code |
 |  |  |  |  |  |  |
Special Note:
If your company is not paying their part of your SS and Medicare Taxes then
you are not an employee, they cannot claim you as an employee when they
purchase the DBA insurance they are required to get in order to even get the
government contracts.
In the Blackwater case for instance it would seem they are either guilty of tax
evasion or have fraudulently mis represented their independent contractors as
employees so that they could acquire the mandated DBA Insurance.
The first $92,900 (for 2011) you make is said to be "tax free". There are still
the social security and medicare taxes to pay on wages up to $106,800. These
taxes will amount to 15%+ of your wages if you are classified as a contractor. If
you are classified as an employee your employer is responsible for paying for
half of these.
Merely labeling a worker as an independent contractor is not enough. They
must actually be an independent contractor.
If you do misclassify an employee as an independent contractor, you must pay
the IRS all back-taxes owed, plus interest, plus penalty (12% - 35% of the total
tax bill).
Unlike an employee who is limited to workers' compensation benefits, an
independent contractor can sue you for negligence if they're injured on the job.
DETERMINING WHETHER JOE IS AN EMPLOYEE OR AN
INDEPENDENT CONTRACTOR
Unfortunately, as far as the various government agencies are concerned, there is not one
single test that determines whether Joe is your employee or an independent contractor. Even
more difficult, it is quite possible that for the purposes of one government agency Joe is
considered to be an independent contractor while for another he is
treated as an employee.
=> The IRS/Common Law "Control" Test
The IRS follows the common law "control" test for determining whether someone is an
employee or independent contractor. This test looks at 20 factors as being indicative (and
only indicative) of whether the person is an employee or independent contractor. The test
basically involves a balancing of these factors -- which way does the scale tip?
Here are the IRS factors:
1. Whether the worker can earn a profit or suffer a loss from the activity (if so, the more likely
it is that the worker is an independent contractor).
2. Whether the worker is told where to work (indicative of employee status).
3. Whether the worker offers his or her services to the general public (indicative of
independent contractor status).
4. Whether the worker can be fired by the hiring firm.
5. Whether the worker furnishes the tools and materials needed to do the work (indicative of
independent contractor status).
6. Whether the worker is paid by the job or by the hour (independent contractors are more
likely to be paid by the job; employees by the hour).
7. Whether the worker works for more than one firm at a time (indicative of independent
contractor status).
8. Whether the worker has a continuing relationship with the hiring firm (indicative of
employee status).
9. Whether the worker invests in equipment and facilities (indicative of independent
contractor status).
10. Whether the worker pays his or her own business and traveling expenses (indicative of
independent contractor status).
11. Whether the worker has the right to quit without incurring liability (indicative of employee
status).
12. Whether the worker receives instructions from the hiring firm (indicative of employee
status).
13. Whether the worker is told how to perform the work (indicative of employee status).
14. Whether the worker receives training from the hiring firm (indicative of employee status).
15. Whether the worker performs the services personally.
16. Whether the worker hires and pays assistants (indicative of independent contractor
status).
17. Whether the worker sets his or her own working hours (indicative of independent
contractor status).
18. Whether the worker provides regular progress reports to the hiring firm.
19. Whether the worker works full-time for the hiring firm (indicative of employee status).
20. Whether the worker provides services that are an integral part of the hiring firm's
day-to-day operations (indicative of employee status).
It is important to note that none of the above factors are, of themselves, determinative. The
IRS will balance all of the factors to determine which side of the equation is favored.
Internal Revenue Service
Independent Contractors vs. Employees
Before you can determine how to treat payments you make for services, you must
first know the business relationship that exists between you and the person
performing the services. The person performing the services may be -
An independent contractor
A common-law employee
A statutory employee
A statutory nonemployee
In determining whether the person providing service is an employee or an
independent contractor, all information that provides evidence of the degree of
control and independence must be considered.
It is critical that you, the employer, correctly determine whether the individuals
providing services are employees or independent contractors. Generally, you must
withhold income taxes, withhold and pay Social Security and Medicare taxes, and
pay unemployment tax on wages paid to an employee. You do not generally have to
withhold or pay any taxes on payments to independent contractors.
Caution: If you incorrectly classify an employee as an independent
contractor, you can be held liable for employment taxes for that worker,
plus a penalty.
Who is an Independent Contractor?
A general rule is that you, the payer, have the right to control or direct only the result of the
work done by an independent contractor, and not the means and methods of accomplishing
the result.
Example: Vera Elm, an electrician, submitted a job estimate to a housing complex for
electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the
next 10 weeks. This is not considered payment by the hour. Even if she works more or less
than 400 hours to complete the work, Vera Elm will receive $6,400. She also performs
additional electrical installations under contracts with other companies, that she obtained
through advertisements. Vera is an independent contractor.
How should I report payments made to independent contractors?
You may be required to file information returns to report certain types of payments made to
independent contractors during the year. For example, you must file Form 1099-MISC,
Miscellaneous Income, to report payments of $600 or more to persons not treated as
employees (e.g. independent contractors) for services performed for your trade or business.
For details about filing Form 1099 and for information about required electronic or magnetic
media filing, refer to information returns.
Who is a Common-Law Employee (Employee)?
Under common-law rules, anyone who performs services for you is your employee if you can
control what will be done and how it will be done. This is so even when you give the
employee freedom of action. What matters is that you have the right to control the details of
how the services are performed.
To determine whether an individual is an employee or independent contractor under the
common law, the relationship of the worker and the business must be examined. All
evidence of control and independence must be considered. In an employee-independent
contractor determination, all information that provides evidence of the degree of control and
degree of independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three
categories: behavioral control, financial control, and the type of relationship of the parties.
Refer to Publication 15-A, Employer's Supplemental Tax Guide for additional information.
Who is an Employee?
A general rule is that anyone who performs services for you is your employee if you can
control what will be done and how it will be done.
Example: Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto
dealer. She works 6 days a week, and is on duty in Bob's showroom on certain assigned
days and times. She appraises trade-ins, but her appraisals are subject to the sales
manager's approval. Lists of prospective customers belong to the dealer. She has to
develop leads and report results to the sales manager. Because of her experience, she
requires only minimal assistance in closing and financing sales and in other phases of her
work. She is paid a commission and is eligible for prizes and bonuses offered by Bob. Bob
also pays the cost of health insurance and group-term life insurance for Donna. Donna is an
employee of Bob Blue.
Statutory Employees
If workers are independent contractors under the common law rules, such workers may
nevertheless be treated as employees by statute ( statutory employees ) for certain
employment tax purposes if they fall within any one of the following four categories and meet
the three conditions described under Social security and Medicare taxes , below.
A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery
products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is
paid on commission.
A full-time life insurance sales agent whose principal business activity is selling life insurance
or annuity contracts, or both, primarily for one life insurance company.
An individual who works at home on materials or goods that you supply and that must be
returned to you or to a person you name, if you also furnish specifications for the work to be
done.
A full-time traveling or city salesperson who works on your behalf and turns in orders to you
from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar
establishments. The goods sold must be merchandise for resale or supplies for use in the
buyer s business operation. The work performed for you must be the salesperson s principal
business activity. Refer to the Salesperson section located in Publication 15-A, Employer s
Supplemental Tax Guide for additional information.
Statutory Nonemployees
There are two categories of statutory nonemployees: direct sellers and licensed real estate
agents. They are treated as self-employed for all Federal tax purposes, including income
and employment taxes, if:
Substantially all payments for their services as direct sellers or real estate agents are directly
related to sales or other output, rather than to the number of hours worked and
Their services are performed under a written contract providing that they will not be treated
as employees for Federal tax purposes.
Refer to information on Direct Sellers located in Publication 15-A, Employer s Supplemental
Tax Guide for additional information.
Misclassification of Employees
Consequences of treating an employee as an independent contractor. If you classify an
employee as an independent contractor and you have no reasonable basis for doing so, you
may be held liable for employment taxes for that worker. See Internal Revenue Code section
3509 for additional information.
References/Related Topics
Tax Topic 762 Basic Information
To determine whether a worker is an independent contractor or an employee, you must
examine the relationship between the worker and the business. All evidence of control and
independence in this relationship should be considered. The facts that provide this evidence
fall into three categories Behavioral Control, Financial Control, and the Type of Relationship
itself.
If your company is not paying their part of your SS and Medicare Taxes then
you are not an employee, they cannot claim you as an employee when they
purchase the DBA insurance they are required to get in order to even get the
government contracts.
In the Blackwater case for instance it would seem they are either guilty of tax
evasion or have fraudulently mis represented their independent contractors as
employees so that they could acquire the mandated DBA Insurance.
The first $92,900 (for 2011) you make is said to be "tax free". There are still
the social security and medicare taxes to pay on wages up to $106,800. These
taxes will amount to 15%+ of your wages if you are classified as a contractor. If
you are classified as an employee your employer is responsible for paying for
half of these.
Merely labeling a worker as an independent contractor is not enough. They
must actually be an independent contractor.
If you do misclassify an employee as an independent contractor, you must pay
the IRS all back-taxes owed, plus interest, plus penalty (12% - 35% of the total
tax bill).
Unlike an employee who is limited to workers' compensation benefits, an
independent contractor can sue you for negligence if they're injured on the job.
DETERMINING WHETHER JOE IS AN EMPLOYEE OR AN
INDEPENDENT CONTRACTOR
Unfortunately, as far as the various government agencies are concerned, there is not one
single test that determines whether Joe is your employee or an independent contractor. Even
more difficult, it is quite possible that for the purposes of one government agency Joe is
considered to be an independent contractor while for another he is
treated as an employee.
=> The IRS/Common Law "Control" Test
The IRS follows the common law "control" test for determining whether someone is an
employee or independent contractor. This test looks at 20 factors as being indicative (and
only indicative) of whether the person is an employee or independent contractor. The test
basically involves a balancing of these factors -- which way does the scale tip?
Here are the IRS factors:
1. Whether the worker can earn a profit or suffer a loss from the activity (if so, the more likely
it is that the worker is an independent contractor).
2. Whether the worker is told where to work (indicative of employee status).
3. Whether the worker offers his or her services to the general public (indicative of
independent contractor status).
4. Whether the worker can be fired by the hiring firm.
5. Whether the worker furnishes the tools and materials needed to do the work (indicative of
independent contractor status).
6. Whether the worker is paid by the job or by the hour (independent contractors are more
likely to be paid by the job; employees by the hour).
7. Whether the worker works for more than one firm at a time (indicative of independent
contractor status).
8. Whether the worker has a continuing relationship with the hiring firm (indicative of
employee status).
9. Whether the worker invests in equipment and facilities (indicative of independent
contractor status).
10. Whether the worker pays his or her own business and traveling expenses (indicative of
independent contractor status).
11. Whether the worker has the right to quit without incurring liability (indicative of employee
status).
12. Whether the worker receives instructions from the hiring firm (indicative of employee
status).
13. Whether the worker is told how to perform the work (indicative of employee status).
14. Whether the worker receives training from the hiring firm (indicative of employee status).
15. Whether the worker performs the services personally.
16. Whether the worker hires and pays assistants (indicative of independent contractor
status).
17. Whether the worker sets his or her own working hours (indicative of independent
contractor status).
18. Whether the worker provides regular progress reports to the hiring firm.
19. Whether the worker works full-time for the hiring firm (indicative of employee status).
20. Whether the worker provides services that are an integral part of the hiring firm's
day-to-day operations (indicative of employee status).
It is important to note that none of the above factors are, of themselves, determinative. The
IRS will balance all of the factors to determine which side of the equation is favored.
Internal Revenue Service
Independent Contractors vs. Employees
Before you can determine how to treat payments you make for services, you must
first know the business relationship that exists between you and the person
performing the services. The person performing the services may be -
An independent contractor
A common-law employee
A statutory employee
A statutory nonemployee
In determining whether the person providing service is an employee or an
independent contractor, all information that provides evidence of the degree of
control and independence must be considered.
It is critical that you, the employer, correctly determine whether the individuals
providing services are employees or independent contractors. Generally, you must
withhold income taxes, withhold and pay Social Security and Medicare taxes, and
pay unemployment tax on wages paid to an employee. You do not generally have to
withhold or pay any taxes on payments to independent contractors.
Caution: If you incorrectly classify an employee as an independent
contractor, you can be held liable for employment taxes for that worker,
plus a penalty.
Who is an Independent Contractor?
A general rule is that you, the payer, have the right to control or direct only the result of the
work done by an independent contractor, and not the means and methods of accomplishing
the result.
Example: Vera Elm, an electrician, submitted a job estimate to a housing complex for
electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the
next 10 weeks. This is not considered payment by the hour. Even if she works more or less
than 400 hours to complete the work, Vera Elm will receive $6,400. She also performs
additional electrical installations under contracts with other companies, that she obtained
through advertisements. Vera is an independent contractor.
How should I report payments made to independent contractors?
You may be required to file information returns to report certain types of payments made to
independent contractors during the year. For example, you must file Form 1099-MISC,
Miscellaneous Income, to report payments of $600 or more to persons not treated as
employees (e.g. independent contractors) for services performed for your trade or business.
For details about filing Form 1099 and for information about required electronic or magnetic
media filing, refer to information returns.
Who is a Common-Law Employee (Employee)?
Under common-law rules, anyone who performs services for you is your employee if you can
control what will be done and how it will be done. This is so even when you give the
employee freedom of action. What matters is that you have the right to control the details of
how the services are performed.
To determine whether an individual is an employee or independent contractor under the
common law, the relationship of the worker and the business must be examined. All
evidence of control and independence must be considered. In an employee-independent
contractor determination, all information that provides evidence of the degree of control and
degree of independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three
categories: behavioral control, financial control, and the type of relationship of the parties.
Refer to Publication 15-A, Employer's Supplemental Tax Guide for additional information.
Who is an Employee?
A general rule is that anyone who performs services for you is your employee if you can
control what will be done and how it will be done.
Example: Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto
dealer. She works 6 days a week, and is on duty in Bob's showroom on certain assigned
days and times. She appraises trade-ins, but her appraisals are subject to the sales
manager's approval. Lists of prospective customers belong to the dealer. She has to
develop leads and report results to the sales manager. Because of her experience, she
requires only minimal assistance in closing and financing sales and in other phases of her
work. She is paid a commission and is eligible for prizes and bonuses offered by Bob. Bob
also pays the cost of health insurance and group-term life insurance for Donna. Donna is an
employee of Bob Blue.
Statutory Employees
If workers are independent contractors under the common law rules, such workers may
nevertheless be treated as employees by statute ( statutory employees ) for certain
employment tax purposes if they fall within any one of the following four categories and meet
the three conditions described under Social security and Medicare taxes , below.
A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery
products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is
paid on commission.
A full-time life insurance sales agent whose principal business activity is selling life insurance
or annuity contracts, or both, primarily for one life insurance company.
An individual who works at home on materials or goods that you supply and that must be
returned to you or to a person you name, if you also furnish specifications for the work to be
done.
A full-time traveling or city salesperson who works on your behalf and turns in orders to you
from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar
establishments. The goods sold must be merchandise for resale or supplies for use in the
buyer s business operation. The work performed for you must be the salesperson s principal
business activity. Refer to the Salesperson section located in Publication 15-A, Employer s
Supplemental Tax Guide for additional information.
Statutory Nonemployees
There are two categories of statutory nonemployees: direct sellers and licensed real estate
agents. They are treated as self-employed for all Federal tax purposes, including income
and employment taxes, if:
Substantially all payments for their services as direct sellers or real estate agents are directly
related to sales or other output, rather than to the number of hours worked and
Their services are performed under a written contract providing that they will not be treated
as employees for Federal tax purposes.
Refer to information on Direct Sellers located in Publication 15-A, Employer s Supplemental
Tax Guide for additional information.
Misclassification of Employees
Consequences of treating an employee as an independent contractor. If you classify an
employee as an independent contractor and you have no reasonable basis for doing so, you
may be held liable for employment taxes for that worker. See Internal Revenue Code section
3509 for additional information.
References/Related Topics
Tax Topic 762 Basic Information
To determine whether a worker is an independent contractor or an employee, you must
examine the relationship between the worker and the business. All evidence of control and
independence in this relationship should be considered. The facts that provide this evidence
fall into three categories Behavioral Control, Financial Control, and the Type of Relationship
itself.
| Civilian Contractors in Iraq and Afghanistan Defense Base Act Comp Blog Civilian Contractor News and Views South African Justice for Injured Contractors MsSparky.com Taxes for Expats |
Combat Zone Pay
Exclusion Applies Only to
Members of the US Armed
Forces
by Tax Prof Blog
The Tax Court yesterday held
that a Florida man who earned
$98,400 in 2005 working for
Blackwater (since renamed Xe)
providing security services to
the U.S. Army in Iraq could not
exclude the compensation from
income under § 112 as “combat
zone compensation of members
of the Armed Forces.
Holmes v. Commissioner,
T.C. Memo. 2011-26 (Jan.
31, 2011)
The Tax Court concluded that
the taxpayer did not serve in the
Armed Forces of the United
States but instead was a private
citizen hired by and paid by a
private company (Blackwater).
The Tax Court refused to
impose a penalty because the
taxpayer relied on an IRS
memorandum wrongly stating
that civilian personnel in direct
support of combat zone military
operations qualified for the §
112 exclusion. (Hat Tip: Bob
Kamman.)
Exclusion Applies Only to
Members of the US Armed
Forces
by Tax Prof Blog
The Tax Court yesterday held
that a Florida man who earned
$98,400 in 2005 working for
Blackwater (since renamed Xe)
providing security services to
the U.S. Army in Iraq could not
exclude the compensation from
income under § 112 as “combat
zone compensation of members
of the Armed Forces.
Holmes v. Commissioner,
T.C. Memo. 2011-26 (Jan.
31, 2011)
The Tax Court concluded that
the taxpayer did not serve in the
Armed Forces of the United
States but instead was a private
citizen hired by and paid by a
private company (Blackwater).
The Tax Court refused to
impose a penalty because the
taxpayer relied on an IRS
memorandum wrongly stating
that civilian personnel in direct
support of combat zone military
operations qualified for the §
112 exclusion. (Hat Tip: Bob
Kamman.)
| Class Action Tax Misrepresentation Filed Against Xe/Blackwater Scott Bloch blasts Blackwater on behalf of thousands of former employees who were mistreated and denied employee benefits, unemployment and other withholding based on a fraudulent misclassification as independent contractors |
| Special note: The IRS has been targeting civilian contractors as a result of the improprieties of Blackwater, Ronco Consulting, and others. Pursuant to an IRS internal memo Memorandum Number: AM2009-0003 Also note that the IRS page to which you link has an important note regarding the definition of a foreign tax home (which is necessary to claim the Sec 911 benefit). The IRS has been using this in somewhat of a distorted way to deny the FEIE to contractors working in Iraq and Afghanistan,, not only those who have families in the U.S., but also single people who left home, joined the military and then were hired as contractors. If they did not plan in advance and take all the steps necessary to show that their abode was in a foreign country and not in the U.S. they are disallowing the exclusion. Many have had inexperienced tax preparers or did their own tax return and the case dragged on so long that they lost their administrative appeals rights and facing a substantial tax bill plus penalties cannot afford a good tax attorney to take it to Tax Court. As a result, the IRS is using their muscle to claim that these workers were living on a base and had no contact with the local community and therefore their “abode-which is not clearly defined anywhere) was in the U.S. This is the quote from the IRS page: Tax Home Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. Having a “tax home” in a given location does not necessarily mean that the given location is your residence or domicile for tax purposes. If you do not have a regular or main place of business because of the nature of your work, your tax home may be the place where you regularly live. If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and your tax home is wherever you work. You are not considered to have a tax home in a foreign country for any period in which your abode is in the United States . However, your abode is not necessarily in the United States while you are temporarily in the United States . Your abode is also not necessarily in the United States merely because you maintain a dwelling in the United States , whether or not your spouse or dependents use the dwelling. “Abode” has been variously defined as one's home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. “Abode” has a domestic rather than a vocational meaning and does not mean the same as “tax home.” The location of your abode often will depend on where you maintain your economic, family, and personal ties. Example 1. You are employed on an offshore oil rig in the territorial waters of a foreign country and work a 28-day on/28-day off schedule. You return to your family residence in the United States during your off periods. You are considered to have an abode in the United States and do not satisfy the tax home test in the foreign country. You cannot claim either of the exclusions or the housing deduction. Example 2. For several years, you were a marketing executive with a producer of machine tools in Toledo , Ohio . In November of last year, your employer transferred you to London , England , for a minimum of 18 months to set up a sales operation for Europe . Before you left, you distributed business cards showing your business and home addresses in London . You kept ownership of your home in Toledo but rented it to another family. You placed your car in storage. In November of last year, you moved your spouse, children, furniture, and family pets to a home your employer rented for you in London . Shortly after moving, you leased a car and you and your spouse got British driving licenses. Your entire family got library cards for the local public library. You and your spouse opened bank accounts with a London bank and secured consumer credit. You joined a local business league and both you and your spouse became active in the neighborhood civic association and worked with a local charity. Your abode is in London for the time you live there. You satisfy the tax home test in the foreign country. Note that the IRS agents examining these returns are not seasoned international agents and their internal directive is to disallow the exclusion regardless of the taxpayer’s defenses and force it to go to Tax Court. I have seen many contractors who came to me for help but by that time it was just too late to help as they needed a tax attorney that they could not afford. |
| U.S. Expatriate Tax & Business Solutions by Powers & Company 40 years specializing in dealing with US expatriate taxes |
Defense Base Act Benefits are not taxable
Increasing Audits When Claiming Foreign Income Exclusion
By I.J. Zemelman, EA, Taxes for Expats Jan-2-2013
IRS audits on those who claim the Foreign Earned Income Exclusion (FEIE) are becoming
more frequent. If you receive a letter or phone call stating an intention to conduct an
audit, refrain from engaging with the auditor directly and contact Taxes for Expats right
away.
Just as any competent lawyer will advise you to not talk to the police - we will advise you to not
directly talk to the IRS. Just as you would rely on us to prepare your US expat tax return you should
also rely on us to handle an audit on your behalf. By entrusting your audit to a professional who
can competently discuss your tax return with the IRS you are essentially guaranteeing a smoother
audit with better results.
Why You Should Work With a Professional
Why is it best to have a professional tax adviser conduct an audit on your behalf? The most
compelling answer is that certain situations are open to interpretation by the auditor and can lead
to poor results if not presented from a logical and legal standpoint.
For example, if you were stationed in Iraq or Afghanistan and claimed the FEIE as a bona fide
resident, the IRS may argue that you failed to meet certain qualifications for the bona fide
residence test such as a permanent long-term residence. If such a determination is made, your
claim for the FEIE will be disallowed and you will be forced to re-file – paying taxes on your entire
worldwide income. We wrote an whole article that explains this - How to not get caught off-guard by
the IRS when claiming the Bona Fide Residence Test.
You may have a considerable amount of people telling you that they claimed FEIE annually as a
bona fide resident without any negative consequences and that may be true. What you have to
consider, however, is that your circumstances may be different (since you are being audited - that
is already established). More likely - they may not actually qualify as a bona fide resident and have
just been getting lucky. After all - the IRS doesn’t have to catch everybody - they will be happy to
catch only some and make an example. Either way, you should have a professional representative
on your side who speaks the same language as the IRS auditor.
Claiming FEIE Under Physical Presence Test
If you claim the FEIE under the physical presence test, be aware that certain IRS locations require
your primary residence to be outside of the United States to qualify. This can pose a problem for
individuals who have been working and living overseas for at least 330 days who should be able to
claim the FEIE under the physical presence test.
Unfortunately, the definition of a qualifying ‘abode’ is ambiguously defined in the US tax code and
the IRS is relying on an outdated court ruling to determine that your home is where your social and
economic ties are maintained. If your family and the rest of your life are in the United States and
you are working in a foreign country, you may be at risk of having your FEIE disallowed because of
this loophole. As a US Expat claiming the FEIE under the physical presence test, your tax return
has a 5-10% chance of being selected for an audit.
It’s important to understand that all audits are handled differently and each auditor has his or her
own set of rules in regard to what will be allowed and what will not be allowed on a US expat tax
return. This is another reason why it’s important to have a seasoned professional on your side
that has experience dealing with variable auditors.
Based on historical and trending IRS auditing procedures, we will outline below some of the most
important aspects of the tax code and take a look at how it affects you as a US Expat.
Form 673
We will first take a look at Form 673. Many taxpayers believe that Form 673 is required to claim
the FEIE or that filing Form 673 qualifies you for this deduction. Both of these beliefs are false;
Form 673 has nothing to do with the FEIE. Form 673 simply exempts you from tax withholding.
The problem with filing Form 673 to avoid having taxes withheld, however, is that many employers
tend to add the cost of various travel, meal, or cost of living reimbursements to your total taxable
income, in turn causing you to be taxed on income you never received.
Use Form W-4 Instead
Rather than filing Form 673, the most effective method of having fewer taxes withheld from your
regular pay is to file Form W-4 with your employer and claim a large number of dependents on this
form on line 5. If you select between 9 and 15 dependents, there will probably be a sufficient
withholding to cover the taxes you owe at the end of the year. If you believe you will wind up owing
no taxes at all on your US expat tax return, you may claim up to 99 dependents or write ‘exempt’ as
a means of dropping the amount withheld from your payroll to close to zero.
Track Your Deductions
Be sure to maintain records of all work-related expenses, as these are all valid deductions which
may be itemized and claimed on your US expat tax return. Expenses such as food and lodging,
travel, uniforms and protective armor, automobile, telephone, computer, postage, medical and a
variety of others may be itemized and claimed as a US deduction. Rather than saving and
depending on receipts to calculate your deduction at the end of the year, get in the habit of
keeping a detailed spreadsheet to track your deductible expenses.
Pick Your Battles (States) Wisely
If you maintain a residence in the United States, it’s best to keep a residence in a tax-free state (if
possible) such as AK, FL, NV, SD, TN, TX, WA, and WY. If you have a residence in AL, CA, HI, or
PA you will have a hard time escaping state tax liability. Furthermore, if you live in one of these 4
states, you will not be able to use the FEIE to decrease your taxable worldwide income. If you
maintain a residence in another state in which state taxes are imposed, see if you have the option
of claiming residency in one of the tax-free states mentioned above.
Most importantly in case of an audit, make sure to keep all tax related documentation that you
receive. Items such as W-2s, 1099s, and any other documents you receive which have information
about tax relevant items such as property taxes, mortgage interest payments, investment income
and other types of income and deductible expenditures.
Remember that the best way to stay off the radar with the IRS is to file on time. Generally speaking
as a US Expat returning to the United States from a combat zone, you have 180 days upon
returning to file missing tax returns with no penalty. If you are living and working in another country
and are not under the constant threat of war, you are required to file an annual US expat tax return
from your place of residence before the established deadline. If you have failed to file or you are
facing an audit for a previously filed tax return, make sure to contact Taxes for Expats before you
do anything else.
| I.J. Zemelman, EA, Founder Taxes for Expats |