German Resident Isn't Eligible for Foreign Earned Income Exclusion

(Parker Tax Publishing September 2018)

The Tax Court held that a German resident who signed a personal service agreement with the U.S. State Department is considered an employee of the U.S. government for income tax purposes and, therefore, is not entitled to the Code Sec. 911 foreign earned income exclusion with respect to the wages paid to him. The court noted that, under Sec. 2669(c), individuals are employees of the federal government for purposes of any law not administered by the Office of Personnel Management and Code Sec. 911, which is administered by the Secretary of the Treasury, is not a law administered by the Office of Personnel Management. O'Kagu v. Comm'r, 151 T.C. No. 6 (2018).

During 2014 and 2015, Sidney O'Kagu, a U.S. citizen, worked for the U.S. State Department as a security equipment technician at the U.S. consulate in Frankfurt, Germany. He was hired in November 2013 as a "local hire civilian employee" pursuant to a personal services agreement (PSA). The PSA was negotiated and signed under the authority of Section 2(c) of the State Department Basic Authorities Act of 1956 (Basic Authorities Act), which was subsequently codified at 22 U.S.C. Sec. 2669(c) (2012). That provision authorizes the Secretary of State to employ individuals or organizations, by contract, for services abroad.

For 2014 and 2015, O'Kagu's wages were reported on Forms W-2, Wage and Tax Statement, issued by the U.S. State Department. O'Kagu filed Forms 1040, U.S. Individual Income Tax Return, for 2014 and 2015. He attached to his returns Forms 2555, Foreign Earned Income, on which he claimed exclusions of $67,690 and $100,800 for 2014 and 2015, respectively, pursuant to Code Sec. 911.

In 2017, the IRS issued a notice of deficiency disallowing O'Kagu's foreign earned income exclusions for 2014 and 2015. In February of 2018, while living in Germany, O'Kagu petitioned the Tax Court.

Under Code Sec. 911(a)(1), a qualified individual may elect to exclude from gross income, subject to certain limitations, his or her foreign earned income. Pursuant to Code Sec. 911(b)(1)(B)(ii), foreign earned income does not include amounts paid by the United States or an agency thereof to an employee of the United States or an agency thereof.

The IRS asserted that O'Kagu's wages were not foreign earned income for purposes of Code Sec. 911 because the U.S. State Department paid these wages to O'Kagu as its employee. O'Kagu argued that he was not a U.S. government employee during the years at issue because, under the terms of his PSA, he was excluded from certain perquisites which he said were normally afforded to U.S. government employees. He noted that, in order to apply for his position, he was required to be a resident of Germany, have a German work permit, and have a local bank account to receive his salary, which was paid in local currency. He cited a section in 22 U.S.C. Sec. 2669, which provides in relevant part: "The Secretary of State may use funds appropriated or otherwise available to the Secretary to......(c) employ individuals or organizations, by contract, for services abroad, and individuals employed by contract to perform such services shall not by virtue of such employment be considered to be employees of the United States Government for purposes of any law administered by the Office of Personnel Management ... "

The Tax Court held that, pursuant to 22 U.S.C. Sec. 2669(c) (2012), O'Kagu is considered an employee of the U.S. government for income tax purposes and, therefore, is not entitled to the Code Sec. 911 foreign earned income exclusion with respect to the wages paid to him by the U.S. State Department. The Tax Court cited the D.C. Appeals Court's decision in Miller v. Clinton, 687 F.3d 1332 (D.C. Cir. 2012), which held that a U.S. citizen working abroad for the U.S. State Department pursuant to a PSA, authorized under 22 U.S.C. Sec. 2669(c), was an employee covered by the statutory protections of the Age Discrimination in Employment Act of 1967. As the Tax Court noted, the D.C. Appeals Court's observed that this "clause (considered in isolation) confirms that Sec. 2669(c) employees are employees of the federal government for purposes of any law not administered by the Office of Personnel Management." The Tax Court also cited 48 C.F.R. Sec. 637.104-71(b) (2017) which defines a PSA as a method of employment using the statutory authority under 22 U.S.C. Sec. 2669(c).

Clearly, the Tax Court said, Code Sec. 911 is not a law administered by the Office of Personnel Management. Rather, the court said, it is part of the Internal Revenue Code, which (with certain exceptions not relevant in the instant case) is administered by or under the supervision of the Secretary of the Treasury. Accordingly, pursuant to 22 U.S.C. Sec. 2669(c), the Tax Court concluded that O'Kagu is considered an employee of the U.S. government for income tax purposes, notwithstanding his assertions about the nature of his employment perquisites and conditions. Consequently, the court said, the wages that O'Kagu received from the U.S. State Department are not considered foreign earned income within the meaning of Code Sec. 911(b)(1) and he is thus not entitled to the foreign earned income exclusion for 2014 and 2015.

For a discussion of individuals who are qualified 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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