Larkin v. IRS, T.C. Memo 2017-54 was the strongest case of 2017 for claiming the Foreign Earned Income Exclusion. This is a factually complicated case because four years of tax partnership and individual tax returns were assessed deficiencies by the IRS. Further, the Court set out ten issues, one of which was whether the Foreign Earned Income Exclusion (IRC Section 911) allowed the taxpayers to exclude foreign earned income and housing costs of over $175,000 for four years (2003, 2004, 2005, 2006).
At trial, the IRS only contested the petitioners’ exclusion of the half their claimed Foreign Earned Income Exclusions they claimed for their housing expenses. Ultimately, the Court agreed with the IRS and affirmed the denial of Foreign Earned Income Exclusions for the housing costs (on top of the exclusion they were claiming for W-2 income). The Court’s analysis was as follows (beginning on page 41):
"The parties each frame their dispute as concerning whether petitioners may exclude any housing cost amounts for each subject year. But, as respondent [a.k.a. the IRS] argues elsewhere with respect to Mr. Larkin’s liability for self-employment taxes, Mr. Larkin was self-employed during the subject years, and consequently the only housing cost benefits to which petitioners may be entitled are deductions of those amounts pursuant to section 911(c)(3)(A). [footnote 26 citations omitted] Under that section, a self-employed individual’s housing cost amount may be deducted in computing adjusted gross income, subject to certain limitations not applicable here. [footnote 27 citations omitted]
A taxpayer’s housing cost amount comprises the “housing expenses” paid or
incurred during the taxable year for the taxpayer’s foreign housing above a “base housing amount” floor. [fn 28] Sec. 911(c)(1); sec. 1.911-4(a), (c), Income Tax Regs. For taxable years 2003 through 2005 the base housing amount floor is determined by multiplying 16% of the salary of a U.S. employee compensated at an annual rate of grade GS-14, step 1, by a fraction representing the number of days during the taxable year in which the taxpayer’s tax home is in a foreign country and the taxpayer satisfies either the bona fide residence test of section 911(d)(1)(A) or the presence test of section 911(d)(1)(B). 29 Sec. 911(c)(1)(B). For the 2006 taxable year the base housing amount floor is determined by multiplying 16% of the foreign earned income exclusion amount by that same fraction. Id.
Petitioners have offered four sets of invoices to substantiate expenses incurred in connection with their U.K. residence during the subject years: (1) mortgage interest payments, (2) local property tax payments, (3) utility payments, and (4) home repair and maintenance payments. Home mortgage interest and local property tax payments are not eligible housing expenses. See sec. 911(c)(2)(A)(ii). Although utility and maintenance expenses are eligible housing expenses, see sec. 911(c)(2)(A)(i); sec. 1.911-4(b)(1), Income Tax Regs., even if we treat the proffered invoices for those expenses as substantiating the listed amounts as paid, those expenses total only £450, £3,052, £5,453, and £903 for 2003, 2004, 2005, and 2006, respectively. In order to be deductible petitioner’s housing expenses for those years must have exceeded base housing amount floors of $11,581, $11,894, $12,191, and $13,184, respectively. [fn 30] After we converted the pound amounts listed in the invoices to dollar figures, giving petitioners the benefit of using the strongest pound to dollar exchange rate that occurred within each subject year, [fn 31] their substantiated housing costs still fall far below the foregoing base housing amount floors, as the substantiated amounts converted to dollars in the manner described would equal $801, $5,951, $10,524, and $1,788 for the subject years, respectively. Consequently, petitioners are not entitled to any housing cost amount deductions for the subject years."
The IRS’s concession in Larkin (full opinion available here: https://scholar.google.com/scholar_case?case=2513909798963178077&q=T.C.+Memo+2017-54&hl=en&as_sdt=6,47) limits its usefulness for planning purposes because the relevant facts for establishing the two elements of the Foreign Earned Income Exclusion are completely glossed over. Larkin is, however, useful for a self-employed taxpayer who hopes to take advantage of the Foreign Earned Income Exclusion to receive some benefit (a deduction) for his foreign housing cost benefits that are large enough (greater than the floor set by the IRS each year) to be deductible under the Foreign Earned Income Exclusion. Despite the strength of the taxpayers’ position in this case, the dispositive issues reduce its informativeness and planning value.
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