U.S. Contractor Living in Saudi Arabia Qualified for Foreign Earned Income Exclusion

(Parker Tax Publishing July 2022)

The Tax Court held that a U.S. citizen, who lived in Saudi Arabia and worked there as a government contractor, was entitled to exclude his Saudi Arabia wages from gross income as foreign earned income under Code Sec. 911(a). The court found that, even though the taxpayer owned a home in the United States, his tax home was in Saudi Arabia and he satisfied the physical presence test under Code Sec. 911(d)(1). Morgan v. Comm'r, T.C. Summary 2022-10.

Background

Alfred Morgan is a U.S. citizen. After retiring from the U.S. Army in 2008, Morgan purchased a home in Fairburn, Georgia. Morgan's daughter lived with him in the home and continued living there after he took a job outside the United States in 2013. Morgan opted against renting out the house, in part to maintain a place for his daughter to live until she found a place of her own. He has not owned or rented any other property in the United States.

In 2013, Morgan took a job with Vinnell Arabia to work as a quality control manager in Saudi Arabia under a U.S. government contract. Morgan's job involves training the Saudi Arabia National Guard in rotary aviation. He is primarily responsible for mission assurance and quality safety. In a September 2020 letter, Vinnell representatives described Morgan as "highly valued," his performance as "excellent," and his role as "essential."

In 2016, the year at issue, Morgan worked full time for Vinnell. He lived in an employer-provided housing compound more similar in appearance to a military compound than to an apartment complex. The compound has a swimming pool, a recreational facility, an exercise gym, and a convenience store. Since 2015, he has lived in the same villa within the compound, which he shares with two other contractors. In his free time, Morgan served as the president of a social club in Saudi Arabia called the Worldwide Fraternity of Turtles, which is a charitable fraternity that organizes food and clothing drives and donates collected items to shelters and orphanages. He also spent much of his free time using the amenities at the compound where he lived and visiting local grocery stores and restaurants. On the weekends, he typically traveled with other contractors to places like South Africa, Bahrain, and Dubai to partake in recreational activities that are otherwise forbidden in Saudi Arabia. In 2016, Morgan used his paid time off to travel back to the United States to spend time with his daughter and mother. He spent about two weeks visiting his daughter at the home he owned in Georgia, and about one week visiting his mother at her home in Chattanooga, Tennessee.

Morgan continues to work in Saudi Arabia for Vinnell and is currently engaged to a woman who works as a manager of a local beauty salon in Saudi Arabia. He has not sought work in any other country outside of Saudi Arabia and earned wage income in 2016 only from his employment with Vinnell. He does not pay tax to Saudi Arabia on his wage income because it is excepted from Saudi Arabia's value added tax (VAT). As a requirement (or consequence) of his employment with Vinnell, Morgan has obtained Saudi Arabian proof of residence, Saudi Arabian medical insurance, and a Saudi Arabian driver's license.

Morgan failed to file a federal income tax return for 2016. In 2019, the IRS prepared a substitute for return and issued a notice of deficiency determining that Morgan received unreported wage income and an unreported pension distribution. The IRS further determined that Morgan was not entitled to the foreign earned income exclusion under Code Sec. 911(a) for 2016 and that he was liable for additions to tax under Code Sec. 6651(a)(1) and (2) for failing to file a return and pay the taxes due. Morgan challenged the notice in the Tax Court.

Under 911(a)(1), a "qualified individual" may exclude from gross income his or her foreign earned income subject to the limitations in Code Sec. 911(b)(2). To be a qualified individual, a taxpayer must satisfy two requirements set forth in Code Sec. 911(d)(1): (1) the taxpayer must either be (a) physically present in a foreign country or countries during at least 330 full days in a 12-month period, or (b) be a "bona fide resident" of one or more foreign countries for an uninterrupted period which includes an entire tax year; and (2) the taxpayer must be an individual whose "tax home" is in a foreign country.

The term "tax home" is defined in Code Sec. 911(d)(3) as an individual's home for purposes of Code Sec. 162(a)(2), which is generally the vicinity of the taxpayer's principal place of employment and not where his or her personal residence is located. However, an individual is not treated as having a tax home in a foreign country for any period for which his or her "abode" is within the United States. In contrast to the term "tax home," the term "abode" generally has a domestic rather than vocational meaning. To determine a taxpayer's abode, the Tax Court compares the taxpayer's domestic ties to the United States with his or her ties to the foreign country in which he or she claims a tax home. Considerations for determining the taxpayer's abode include property ownership, community involvement, banking activity, recreational activities, the amount of time the taxpayer spent in each location, and the residence of the taxpayer's family.

Morgan argued that he was a qualified individual because (1) he spent less than 35 days in the United States during 2016, and (2) his tax home was in Saudi Arabia. The IRS cast doubt on Morgan's reported time spent in the United States in 2016 because his testimony did not exactly correspond to the information provided on his Form 2555, Foreign Earned Income. The IRS also argued that Morgan's abode was in the United States in 2016 given that he maintained a U.S. driver's license and a U.S. bank account, retained his U.S. citizenship, lived in employer-provided housing and owned no property in Saudi Arabia, had medical insurance with a U.S. provider, and did not pay tax to Saudi Arabia.

Analysis

The Tax Court held that Morgan was entitled to exclude his foreign earned income for 2016 up to the limitations set for in Code Sec. 911(b)(2). The court found that Morgan met the physical presence requirement because he was present in a foreign country or countries for at least 330 full days in 2016 and thus the court did not need to consider whether he was also a bona fide resident. The discrepancy between Morgan's testimony and his Form 2555, in the court's view, was an honest mistake.

On the issue of Morgan's tax home, the court determined that Morgan had stronger domestic ties to Saudi Arabia than he did to the United States and that therefore, he did not have an abode in the United States. The court found that Morgan's community involvement and recreational activities in Saudi Arabia were relatively significant in comparison with those in the United States, and overall, most of his time had been spent in Saudi Arabia. The court noted that Morgan dedicated much of his free time in Saudi Arabia to serving as the president of a local social club and organizing charitable events to benefit the local community. He also spent his free time frequenting local grocery stores and restaurants, using the recreational amenities at the residence, and traveling with other contractors to nearby foreign countries. The court also cited the fact that Morgan obtained a Saudi Arabian resident alien card indicating proof of his legal residence, Saudi Arabian medical insurance, and a Saudi Arabian driver's license. He also did not seek work in any country outside of Saudi Arabia. Morgan's family and personal ties to the United States were limited, in the court's view, considering that he only visited his daughter for two weeks over the summer and his mother for one week during the winter holidays during 2016.

Some of the facts the IRS pointed to as adverse to Morgan appeared neutral to the court. The court found that Morgan: (1) had a Saudi driver's license and presumably used it far more frequently than his U.S. license; (2) was required by his employer to keep a U.S. bank account, which was the sole medium to receive his salary payments; (3) obtained a resident alien card, which was proof of his legal residence and desire to stay in Saudi Arabia; (4) stayed in employer-provided housing because he was used to the type of housing since it was similar to the housing he used for most of his military career and it was a bargained-for part of his employment contract; (5) had medical insurance with a U.S. provider that supports retired military members, but also obtained medical insurance in Saudi Arabia; and (6) did not pay tax in Saudi Arabia because earned income is generally excepted from Saudi Arabia's VAT.

Further, although each year stands by itself and must be separately considered, the court added that three additional facts supported its conclusion that Morgan's domestic ties in Saudi Arabia continued to be stronger than those in the United States: (1) he continues to be employed in Saudi Arabia; (2) his employer recently described him as "highly valued," his performance as "excellent," and his role as "essential"; and (3) he has a fiancin Saudi Arabia, who has been in Saudi Arabia for 30 years and manages a local beauty salon.

However, the court upheld the imposition of additions to tax for Morgan's failure to file a return and failure to pay the taxes due (computed consistently with the court's ruling) after finding that Morgan did not have a meaningful defense to the imposition of those penalties.

For a discussion of the rules for qualifying for the foreign earned income exclusion, see Parker Tax ¶78,610.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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