The U.S. Tax Court has held that a commercial airline pilot stationed in South Korea failed both the “tax home” and the “bona fide residence” tests that determine whether a taxpayer qualifies for the foreign earned income exclusion.
The pilot flew airplanes for Korean Air Lines (KAL) in 2011 and 2012. KAL considered him to be stationed in Incheon, Korea, which meant that Incheon was the airport he most frequently operated from.
During the time he spent in South Korea, he played tennis and golf and participated in dinner engagements, largely with other pilots. But he spent only about one-third of each year in South Korea and more than 40% of each year in the United States. He returned to his American home frequently during those years and spent most of his days off in the United States, where his wife and house remained. The mean length of the pilot’s stays in the United States in 2011 was 7.95 days, while the mean length of his stays in South Korea that year was 2.45 days.
He stayed in South Korea only when work required it. He always stayed in the same hotel, provided at no cost by the airline, but stayed in various rooms. He also retained his U.S. citizenship, voting registration, driver’s license, bank accounts and church membership.
On their joint tax returns for 2011 and 2012, the pilot and his wife claimed an exclusion for “foreign earned income,” which the IRS disallowed.
Failing two critical tests
In order to qualify for the exclusion, a taxpayer must pass two tests:
First, his or her tax home must be in a foreign country. The general rule is that a “tax home” is located in the vicinity of a taxpayer’s regular or principal place of employment, regardless of where he or she maintains a home. The tax home is where you are permanently or indefinitely engaged to work.
If you don’t have a regular or principal place of business, your tax home may be the place where you regularly live. The tax home rule is subject to an important overriding exception — an individual isn’t considered to have a tax home in a foreign country for any period during which the individual’s “abode” is in the United States. Abode has been variously defined as a home, habitation, residence, domicile, or place of dwelling. The location of your abode often will depend on where you maintain economic, family, and personal ties.
Second, a taxpayer must pass the bona fide residence test. In this case, the court found that the taxpayer wasn’t physically present in South Korea during the “330 full days” of a 12-month period required to establish that status. The court also found that, in an eleven-factor test that it uses, eight factors weighed against a bona fide residence and just three weighed in favor.
What the factors require
The “Sochurek standard” sets out the following factors for determining whether a taxpayer is a bona fide resident of a foreign country:
- Intention of the taxpayer,
- Establishment of the taxpayer’s home temporarily in the foreign country for an indefinite period,
- Participation in the activities of the chosen community,
- Physical presence in the foreign country consistent with the taxpayer’s employment,
- Nature, extent and reasons for temporary absences from the taxpayer’s temporary foreign home,
- Assumption of economic burdens and payment of taxes to the foreign country,
- Status contrasted to that of “transient or sojourner,”
- Treatment of taxpayer’s income tax status by his or her employer,
- Marital status and residence of the taxpayer’s family,
- Nature and duration of his or her employment, and
- Good faith in making the trip abroad; for example, it shouldn’t be for purposes of evading taxes.
The court stated that intent plays perhaps the most important part in determining the establishment and maintenance of a foreign residence. It said it wasn’t convinced that the pilot intended to be anything more than a transient in South Korea. In addition, he didn’t establish a home there for any period. His actual home remained in the United States and he returned to it as frequently as practically possible.
The court also noted that the pilot’s housing abroad was a hotel — “the quintessence of transience.” He didn’t even have a particular hotel room to call his own. Even though a taxpayer may have some limited or transitory ties to a foreign country, if ties to the United States remain strong, the court has previously held that his or her abode remained in the U.S.
If your employment takes you away from home for long periods, talk with your accountant to help ensure you correctly and precisely determine your tax home. You don’t want to fail the tests that could allow you to take advantage of the foreign earned income exclusion.