This year’s (2016) Tax Court cases are helpful for interpreting the IRS’s interpretation of the Foreign Earned Income Exemption (FEIE). However, none create binding case law. This generally takes a decision from an appellate-level court. In the case of tax law, the federal circuit courts. Few have weighed in on the FEIE.
Jones v. IRS 927 F.2d 849 (5th Cir. 1991) is an exception. There, the Fifth Circuit (Louisiana, Mississippi, and Texas) reversed the Tax Court to find Mr. Jones was a bona fide resident of Japan. It held, in binding case law, that the test for a taxpayer’s bona fide residence in a foreign country “is the test of alien residence established in Code Section 871.” The Court held eleven factors are used to gauge the bona fides of a taxpayer’s foreign residence:
"(1) intention of the taxpayer;
"(2) establishment of his home temporarily in the foreign country for an indefinite period;
"(3) participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment;
"(4) physical presence in the foreign country consistent with his employment;
"(5) nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time;
"(6) assumption of economic burdens and payment of taxes to the foreign country;
"(7) status of resident contrasted to that of transient or sojourner;
"(8) treatment accorded his income tax status by his employer;
"(9) marital status and residence of his family;
"(10) nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time; and
"(11) good faith in making his trip abroad; whether for purpose of tax evasion.
Those that apply to a given situation should be weighted and the taxpayer must offer “strong proof” to prevail in a way that qualifies them for the FEIE. The Fifth Circuit weighed these factors in favor of Mr. Jones:
"The tax court seemed to place particular emphasis on the fact Jones chose to live in the Hotel, rather than renting an apartment or a home in Japan, and the fact that Jones' wife chose to live in Anchorage, rather than give up her job and move to Japan with her husband. The tax court also noted that Jones had a number of ties to the United States, while he remained relatively unassimilated into the Japanese community. The tax court's analysis, however, overlooks the other Sochurek factors [the 11 listed above].
"First, the tax court failed to consider Jones intent. Jones obviously intended to become a resident of Japan and therefore he accordingly returned to the State of Alaska a dividend check which was based on Alaskan residence. A taxpayer's intent plays perhaps the most important part in determining the establishment and maintenance of a foreign residence.
"Jones established his home in Japan, presumably for the remainder of his career. Jones' job as a pilot was ongoing and both Japanese Airlines Company (JAL) and Jones intended Jones to live and work in Japan until his retirement. Therefore, Jones purpose for being in Japan was of such a nature that an extended stay was necessary. Due to his flight schedule, JAL required his physical presence in Japan and such presence was consistent with his employment.
"In addition, Jones argues that he should not be penalized because the economic realities of Japan lead him to choose to live in the Hotel, instead of renting an apartment or buying a home. The IRS and the tax court seemed bothered by the apparent temporary nature of a hotel, but it is not necessary for a taxpayer to establish a fixed, permanent place of abode in order to be a "resident" of a foreign country.
"Furthermore, Jones was apparently only away from his home in Japan when his business required it, or when he was on vacation. The fact that Jones was able to stay at his home in Anchorage during flights was merely fortuitous and should not be held against Jones. If JAL had not previously based Jones in Anchorage, Taxpayers would not have owned property there. In addition, if JAL had scheduled Jones to fly only Asian trips, as he had done when he was previously assigned to Japan, Jones would not have had occasion to layover in Anchorage. Nevertheless, business and vacation trips to the United States should not affect Jones residency.
"Jones paid resident Japanese income taxes. Jones' Japanese income tax returns were prepared at his expense by a Japanese accountant. Both JAL and International Air Service Company Ltd (IASCO) viewed Jones as a resident of Japan for Japanese income tax purposes. In fact, JAL required IASCO to withhold Japanese income taxes from Jones' payroll checks. The last factor also arguably supports Jones' claim to bona fide residency because the IRS never suggested that Jones took the job in Japan for the purposes of tax evasion.
"Both in his briefs and during oral argument, the IRS seemed to rely heavily on the fact that Jones' wife did not move to Japan during his last assignment to Tokyo. The IRS seems to argue that Taxpayers' should be punished because Mrs. Jones chose to stay in Anchorage and pursue a career, rather than move to Japan with her husband. When JAL reassigned Jones to Japan in 1980, Taxpayers' children were all away at school or married. For the first time in a number of years, Mrs. Jones was free to devote herself to a career. She would most likely not have been able to find comparable employment if she had joined her husband in Japan.
"We are besieged with cases and statistics and erudite writing about the necessity for the equalization of rights and opportunities for men and women in our society. It would be strange indeed if the Congress of the United States which has legislated frequently and ardently for the equality of the sexes, should in the field of taxation find that a woman who desires to establish herself in the field of business, and her husband who obviously encouraged her, should be penalized because she is pursuing something which the Congress thinks is in the interest of our nation and its economy. Penalizing Taxpayers for Mrs. Jones' decision in no way furthers the clearly enunciated legislative purpose behind sections 913 and 911 (the FEIE Laws) of encouraging foreign employment of United States' citizens.
"Although Jones' admittedly did not learn to speak Japanese and was relatively unassimilated into the Japanese culture, the majority of the eleven factors support Jones' contention that he was a bona fide resident of Japan during the relevant period. Jones was not a mere transient or sojourner in Japan. Even though he intended to eventually return to his domicile in the United States after he retired from JAL, his purpose for being in Japan required him to remain there for at least eight years. Although Jones may have felt a little like a sojourner in a foreign land, as Moses did after he left Egypt and fled to Midian, under the applicable modern day tax statutes we are required to classify him as a bona fide resident of Japan, and not a mere transient or sojourner.
"Sections 913 and 911 (FEIE laws) speak to the modern age; neither were quilled in antiquity. Today, husbands and wives, men and women, have the right to separate careers. With respect to Jones' tax residence, he was neither a domiciliary nor a transient. He was a resident of Japan. The Code clearly could have used the word domicile or transient; neither of these are strange to our congressional enactments and legislation. Instead, the Code speaks in terms of residence. Since we find that Jones was a bona fide resident of Japan during the relevant time period, we reverse the tax court.
So Mr. Jones prevailed on the first question – whether he was a bona fide resident of Japan. He was. But the FEIE has two prongs. As in Hirsch v. IRS, Summary Opinion 2016-37 (Aug. 8, 2016) the second is whether a taxpayer’s “tax home” is a second requirement.
Next week, I’ll explain the court’s reasoning. It concluded that Mr. Jones indeed had his tax home in Japan.
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