This post was originally published on Forbes April 27th, 2015
Every once in a while, there is a case where I think the taxpayers are getting a really raw deal. The DC Circuit appeals decision in the case of Yen-Ling Rogers is one of those situations. It was about the foreign earned income exclusion. The United States is unusual in taxing its citizens on their worldwide income. The foreign income exclusion mitigates this somewhat. The maximum amount is adjusted for inflation and just broke one hundred grand for 2015. Without getting into the fine points, you basically have to be living in a foreign country and working in a foreign country in order to qualify for the exclusion.
It seemed like Yen-Ling Rogers should have had no problem. She lived and was based in Hong Kong. She was a flight attendant for United Airlines. That is where it got sticky.
Under her contract she was paid based on flight time, which commences when the plane pushes back from the terminal and ends when it arrives at the destination. She was required to arrive an hour and forty-five minutes before take-off and had about half of an hour cleanup work after landing, but that was not paid. Since she was doing trans-Pacific flights, you could see that she was actually doing a little bit of work in the United States, but it seems it would be kind of petty to make an issue out of that.
Only it is worse, a lot worse. You see the definition of foreign income for the foreign earned income exclusion is not “not in the United States”. It is “within a foreign country”. I remember one of the best things my father ever bought for me was a globe. It was endlessly fascinating. Something that you will note when you look at a globe is that most of the earth’s surface is neither within the United States nor within a foreign country – particularly on the Pacific side. So all of the flight time over international waters was not “in a foreign country” meaning that very little of Ms. Roger’s pay was subject to the foreign earned income exclusion. The unfairness of this result is pretty obvious, since, if she had been on the Hong Kong to Moscow run (assuming for the sake of argument that there is one), most, if not all, of her pay would have been subject to the exclusion.
The Fourth Circuit cut Ms. Rogers no slack.
Earned income is from sources within a foreign country if it is attributable to services performed by an individual in a foreign country or countries. The place of receipt of earned income is immaterial in determining whether earned income is attributable to services performed in a foreign country or countries.
While this regulation does not speak directly to the treatment of income earned over international waters, a separate regulation defines the term “foreign country” to mean “any territory under the sovereignty of a government other than that of the United States,” including, among other things, “the territorial waters of the foreign country” and “the air space over the foreign country.”
The regulation thus makes explicit that income earned over waters not subject to any foreign country’s jurisdiction would not be income earned “in a foreign country or countries” for purposes of Section 1.911-3(a). In sum, it is clear that Appellants’ position in this case is completely at odds with IRS’s regulations.
An agency’s regulation implementing its authorizing statute “is binding in the courts unless procedurally defective, arbitrary or capricious in substance, or manifestly contrary to the statute.”
I suppose that I should just write this off to another application of
Reilly’s First Law of Tax Planning – It is what it is, deal with it. I think though that the IRS could have reasonably taken a different tack in the regulations and allowed the exclusion to people in Ms. Rogers’s situation, which would have been a simpler rule to implement.
Tony Nitti had a
pretty humorous piece about this case, when it came out. He must have had an easier end of March than I did.
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