If you got yourself a job sweeping out the Halls of Montezuma or sailing along the shores of Tripoli and otherwise qualify you can exclude what you earn from your taxable income thanks to the foreign earned income exclusion. If your work is “on the sea”, though, maybe not so much. That is the holding in the recent Tax Court decision in the case of Wendell Wilson. Mr. Wilson is a US citizen, a resident of Mexico and a ship’s engineer in the Merchant Marine.
What’s In A Name?
And here we need to clear something up. Judge Gerber wrote:
The Marine Engineers Benefits Association (MEBA) posts jobs, and merchant marines are able to bid on them. Petitioner would bid on jobs through MEBA and, ultimately, would sign a contract with a ship’s captain for a specific voyage. Petitioner worked on five voyages during 2009 and five during 2010. Each of the contracts petitioner entered into specified an itinerary that included time in foreign ports. All 10 of the voyages began and ended in California. He did not work or earn income in Mexico during 2009 and 2010 but would generally leave his home in Mexico and travel to California where he would board a ship for a voyage to foreign ports. (Emphasis added)
According to a US Merchant Marine FAQ:
What do you call people who are in the Merchant Marine? Mariners. Seamen. Seafarers. Sailors. Never marines! Mariners is the preferred designation, just like the Seattle professional baseball team. The term Merchant Marines is incorrect. (Emphasis added)
Foreign Earned Income Exclusion
Back to the tax issues. During 2009, Mr. Wilson was on voyages for 175 days and earned $76,055.45. During 2010 he earned $113,086.15 for 146 days. That seems kind of neat. During 2009, he spent 41 days in foreign ports and the territorial waters of foreign countries and 22 such days in 2010. The rest of his voyage days were in international waters.
Mr. Wilson was audited for the years 2005-2008. He had excluded all his voyage income in those years and there were no adjustments for those years. As we used to say at Joseph Cohan and Associates – “Better to be lucky than good”.
Mr. Wilson had less luck with his 2009 and 2010 audit. In order to qualify for the foreign earned income credit, the income must be earned by a “qualified individual”. That was not an issue. The income must be “foreign earned income”. “Foreign earned income” is income “from sources within a foreign country or countries”. International waters are not a foreign country.
On the record before the Court and in accord with the statutes and caselaw, petitioner was in the territorial waters of a foreign country for 41 days during 2009 and 22 days during 2010. During 2009 petitioner worked a total of 175 days, so that 23% 3 divided by 175) of his income is exempt from U.S. taxation. During 2010 petitioner worked a total of 146 days, so that 15% (22 divided by 146) of his income is exempt from U.S. taxation. The resulting percentages, found by the Court for 2009 and 2010, are to be applied by the parties to petitioner’s maritime income earned for each year in a Rule 155 computation.
Scientists working in Antartica and at least one international flight attendant have been tripped up by this rule in the last couple of years. It stirkes me as unfair, but that is covered by Reilly’s First Law of Tax Planning.
No Penalty
As is par for the course the IRS asserted the accuracy penalty, but the Tax Court cut Mr. Wilson a break on that.
The Court is not aware of a valuation issue between the parties. Petitioner had employed his preparer for 20 years and relied upon his expertise to report that petitioner’s income was exempt under section 911(a). The preparer was informed about petitioner’s residence and the facts surrounding his income earned during international voyages on cargo ships. The reporting position had been approved for earlier years, and it was reasonable for petitioners to rely on the preparer under these circumstances. Accordingly, we hold that petitioners are not liable for accuracy-related penalties with respect to any underpayments that may result from our holding on the section 911(a) issue.
Other Coverage
Lew Taishoff covered the case with a post titled No One’s Water. Lew caught the same subtlety I did.
Here I would drop a kindly hint to Judge Gerber. Wendell is not a “merchant marine.” He is definitely not a “licensed merchant marine,”.
The merchant marine comprises all the ships of a nation that, in the words of a classic 1939 documentary, “keep our larders full, increase foreign trade, bring out supplies to naval bases and navy ships,” and carry passengers. The ships of the merchant marine are crewed by merchant mariners. And please, Judge, never confuse a merchant mariner with a Marine (I use the capital letter advisedly). If you do so to a United States Marine, I will not be answerable for the consequences.
Just for clarity, here is what a Marine, one who apparently does not want to be President, looks like.
Accounting Equations Insight was not quite as sharp. Their headline is Merchant marine couldn’t fully exclude income. There is an uncaptioned photo and I have to say that the fellows in it look more like Marines than mariners, but I’ve been fooled before.
In a Summary Opinion, the Tax Court has held that a merchant marine couldn’t use the foreign earned income exclusion to shield from U.S. tax all of his wages from voyages to foreign ports. The exclusion didn’t apply to income earned in international waters; it only applied to that portion of his wages that was allocable to income earned in the territorial waters of a foreign country.
Nicholas Patrick of Current Federal Tax Developments had a nice summary.