Much earlier this year (2016), the Tax Court handed down Co. v. IRS TC Memo 2016-19 (Feb. 8). Foreign Service folks, particularly Overseas Building Operations (OBO) personal services contractors, should find Co important. There, Mr. Co was a mechanical engineer with two personal services contracts for projects in the Middle East and central Asia. He claimed the Foreign Earned Income Exclusion (FEIE) by filing Form 2555 with his 1040. He did so believing that he, as a contractor, was not a federal employee.
The IRS disagreed. The Tax Court affirmed the IRS’s denial of FEIE benefits to Mr. Co. It did so because the FEIE does not provide benefits to “employees’ of the US government or any agency. The Court determined he was actually an employee for tax purposes because of how personal services contracts work. A six-factor test applies to this, but the most important factor is “right of control.” “Both the control exercised by the alleged employer and the degree to which the alleged employer may intervene to impose control must be examined.”
"First, during the years at issue, OBO dictated petitioner’s duties and supervised his performance. Petitioner worked under the direct supervision of an
OBO project director and was required to maintain and complete daily and monthly reports. He was not permitted to delegate his duties to others or work for any other person or entity. OBO also dictated all terms of the PSCs, including, among other things, petitioner’s duties, the scope of petitioner’s work, the process by which petitioner would be evaluated, reimbursement policies, travel policies, and termination policies. Petitioner in fact could not negotiate the terms of the PSCs and was required to abide by all terms and conditions mandated by the PSCs.
"Furthermore, OBO dictated petitioner’s hours, pay, and leave. For instance,
OBO set petitioner’s work schedule, including the specific days on which petitioner was required to work, as well as the specific hours during which he was required to work. Additionally, OBO determined the countries to which petitioner would be sent to work as well as when he would be sent there. Moreover, petitioner was paid a fixed annual salary in biweekly increments and in accordance with the Foreign Service Scale. In addition to his salary, OBO permitted petitioner to earn and accrue, among other things, home leave, annual leave, and sick leave. If petitioner wished to take time off from work--to use either annual leave or sick leave--he had to request and obtain permission from OBO."
The Court was satisfied that this, the most important factor, and enough of the remaining factors (investment in facilities, opportunity for profit an risk of loss, right to discharge, permanency of relationship, and relationship contemplated by the parties) weighed in favor of an employee relationship to deny FEIE benefits to Mr. Co. His one victory in the case was he did not have to pay penalties for inaccurately reporting his income.
Next week, I’ll get into the Gerencser case (military who may qualify for foreign income tax credits and FEIE) and an appellate court case creating binding law on what does qualify for a Foreign Earned Income Exclusion.
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