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Recent Tax Court decision could wreak ha

Glover v. Comm, a recent tax court decision, presents several issues to Merchant Mariners. Mr. Glover worked for Reinauer Transportation. His tugs pushed oil coastwise as far as Virginia. The tugs wou

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Recent Tax Court decision could wreak havoc on Mariners

State Taxes and Mariners

Suz asked this question So, what about if you live in one state (TN) and work as a merchant mariner in another state (HI), 45 days on/45 days off rotation? Do you pay HI state taxes, or does the payro

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State Taxes and Mariners

Mariner Tax Update January 2011

E-Filing alert! How many times have you read that mariners cannot E-File? How many websites have posted this. Year after year. And then all of a sudden preparers start proclaiming “mariners can

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Mariner Tax Update January 2011

Employee vs. Non-Employee LLC and S-Corp

I’ve been a client of yours for a few years now and I had a general tax question concerning my wife’s job status. She currently works full time for a marketing firm in “Deleted”

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Employee vs. Non-Employee LLC and S-Corp Planning for Mariners and their families

Maritime Tax Preparers and the Alternati

What they don’t want you to know… This video points out the tremendous effect of the AMT on merchant mariners. Seamen taking business deductions and offsets may very well be realizing litt

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Maritime Tax Preparers and the Alternative Minimum Tax

Foreign Earned Income

5
by on December 1, 2010 at 7:40 pm

Mariners and the Foreign Earned Income Exclusion

Let’s use an extreme example to get the point across

Joe Sailor. He lives in Singapore. His wife lives there. He owns property in Singapore. He has children in Singapore. He hasn’t been in the US for years. He works for a foreign flagged shipping company. The vessel never enters US waters. It runs from Singapore to South America. He is a US Citizen. Questions are -

  1. Is he required to file a US Income Tax return?
  2. If yes is he able to use the Foreign Earned Income Exclusion on all of his shipping income?

Non Resident Citizens

Yes he HAS to file a non-resident return. He may allocate foreign tax credits for taxes payed to Singapore, but a U.S. Citizen would be required to file a return.

U.S. citizens are generally taxed on their worldwide income unless a specific exclusion applies. Sec. 61(a) (“gross income means all income from whatever source derived”); Cook v. Tait, 265 U.S. 47, 56 (1924); Specking v. Commissioner, 117 T.C. 95, 101-102 (2001), affd. sub nom. Umbach v. Commissioner, 357 F.3d 1108 (10th Cir. 2003), affd. sub nom. Haessly v. Commissioner, 68 Fed. Appx. 44 (9th Cir. 2003).

Income Earned in International Waters – via US Tax Court

Section 911(b)(1)(A) defines an individual’s “foreign
earned income” as “the amount received by such individual from
sources within a foreign country or countries which constitute earned income attributable to services performed by such individual”.

The term “foreign country” when used in a geographical sense includes any territory under the sovereignty of a government other than that of the United States. It includes the territorial waters of the foreign country (determined in accordance with the laws of the United States), the air space over the foreign country, and the seabed and subsoil of those submarine areas which are adjacent to the territorial waters of the foreign country and over which the foreign country has exclusive rights, in accordance with international law, with respect to the exploration and exploitation of natural resources.

Under general principles of international law, international waters are not under the sovereignty of any nation. United States v. Louisiana, 394 U.S. 11, 23 (1969). Thus, international waters are not a “foreign country” for purposes of section 911, and income petitioner earned while traveling in international waters is not “foreign earned income” excludable from gross income. See Plaisance v. United States, 433 F. Supp. 936, 938-939 (E.D. La. 1977).

In Clark v. Comm the petitioner argued that Section 863(c) provides special sourcing rules for certain transportation income when that transportation begins or ends in the United States or one of its possessions. Because U.S. citizens are subject to tax on their worldwide income, sourcing rules are generally not relevant to U.S. citizens. See Great-West Life Assur. Co. v. United States, 230 Ct. Cl. 477, 678 F.2d 180, 183 (1982); sec. 1.1-1(b), Income Tax Regs.

The Court concluded that section 863(d) would require petitioner to include income earned in international waters as income from “ocean activities” sourced in the United States. See Arnett v. Commissioner, 473 F.3d 790, 797 (7th Cir. 2007), affg. 126 T.C. 89 (2006).

They expanded in saying

SEC. 863(d). Source Rules for Space and Certain Ocean Activities.–
(1) In general.–Except as provided in regulations, any income derived from a space or ocean activity–
(A) if derived by a United States person, shall be sourced in the United States ** *
*******
(2) Space or ocean activity.–For purposes of paragraph (1)–
(A) In general.–The term “space or ocean activity” means–
*******
(ii) any activity conducted on or under water not within the jurisdiction (as recognized by the United States) of a foreign country, possession of the United States, or the United States.
*******
(B) Exception for certain activities.– The term “space or ocean activity” shall not include–
(i) any activity giving rise to transportation income (as defined in section 863(c))
For purposes of the Internal Revenue Code, the definition of “United States person” includes any citizen of the United States. Sec. 7701(a)(30)(A). Although he resides in Scotland, petitioner is a U.S. citizen. His income earned in international waters is income from a “space or ocean activity” as defined in section 863(d)(2). Thus, that income is sourced in the United States. Sec. 863(d)(1)(A).

Bottom line – Income from International waters is considered sourced to the U.S

I’m sure we’ll receive a comment along the lines of “But I have a friend I ship with who lives in Singapore and he doesn’t HAVE to pay U.S. taxes… WRONG… The correct thing to say is that he DOESN’T pay U.S. taxes. It’s difficult to track foreign income. It’s difficult to examine all tax returns for invalid exclusions and deductions. This DOES NOT mean that you’re right. It means you haven’t been caught – yet… No one can know if you’ll be audited or not. But professionals need to be duly informed and provide advice and guidance within the law. Too many preparers play the statistical audit game. Assuming they will lose x percent of client because of audits annually.

Bottom line – income earned by U.S. Citizens in international waters is considered U.S. Source Income. Period…

Foreign Tax Payments

2
by on October 22, 2010 at 3:40 pm

Do Mariners write off Foreign taxes?

In these tight times we’re looking for any avenue available to rub two dimes together. I remember when I started shipping there were plenty of decent jobs available. Over the years, work has become tighter. More and more I see clients seeking employment under foreign flags, and or on foreign rigs.

Some Countries require that you pay income taxes

I’ll use Brazil as an example – Under the Brazilian tax law, foreigners working with offshore work visas only have to pay personal income tax (imposto de renda )after having physically been more than 184 days in Brazil. For employees working offshore this takes roughly 1 year, 6 months (=184 days) in Brazil and 6 months outside.

This means if you’re working offshore past that time period you owe Brazil. How does that affect you as a US taxpayer? Are you simply going to be taxes by two countries and not be able to offset either return? Let’s run a few what ifs…

You are required to pay and have paid Brazil $20,000 in income taxes

Section 901 of the Internal Revenue Code states -

(a) Allowance of credit

If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under sections 902 and 960. Such choice for any taxable year may be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year. The credit shall not be allowed against any tax treated as a tax not imposed by this chapter under section 26 (b).
You’ll probably be able to take a foreign tax credit for the taxes paid. The biggest restriction is that the credit cannot exceed how much you would have owed on the same income in the US.
Things you’ll need -
  • Proof you were working
  • Proof you owed the tax
  • Proof showing how much income was taxed (important and I have seen this overlooked)

You were required to pay and have not paid Brazil $20,000 in income taxes

This is something I am seeing quite a bit of. It isn’t that mariners aren’t paying the taxes due to the foreign country. It’s that the employer is paying the foreign taxes on behalf of the employee. There are two instances of this that appear to be most prominent.

  • Company pays foreign tax due on behalf of the mariner and requires no compensation
  • Company pays foreign tax due on behalf of the mariner and includes it as income on their W-2

What are the requirements for the credit?

The magic language in the Code is “Paid or Accrued”… The internal revenue service states that -

  1. The tax must be imposed on you
  2. You must have paid or accrued the tax
  3. The tax must be the legal and actual foreign tax liability
  4. The tax must be an income tax (or a tax in lieu of an income tax)

http://www.irs.gov/businesses/article/0,,id=183263,00.html

Generally speaking, we’re not encountering issues with parts 1, 3, and 4. It’s the paid or accrued concept… If we don’t pay the amount due personally, can we still be eligible for the foreign tax credit? If it is included as income on our W-2 can we still take the foreign tax credit?

Disclaimer!

A little CYA… Just because a tax position holds water doesn’t mean that you won’t be audited. It also doesn’t mean you will win an audit. Many tax positions, though valid, are dismissed in audit and appeals. The taxpayer is forced to litigate the issue. This can be a costly venture.

Where were we…

The courts have historically shown a strong emphasis on the “liable” portion. There have been many cases over the years where the courts have restated that the taxpayer need be “legally liable” to the tax in question to be eligible for the foreign tax credit. (Riggs v. Comm, Amoco v. Comm, Guardian v. US, Gleason Works v. Comm, Nissho Iwai American Corp v. Comm) The courts also demonstrate the requirement to document liability for the actual tax in question (Wilcox v. Comm)

It seems from the common law that it is irrelevant who pays the tax due… What is relevant is who was liable. That said, taxes paid reported as income may make the transaction seem more concrete but do not seem to be a requirement. The fact that you owed the tax and it was paid has generally been the test from the Court’s perspective….

See Disclaimer above again. There are no guarantees. This is a risky position. Not because of law. Because of the amount of possible revenues that could be collected on audit. A $20,000 credit is a sizable amount. I would assume it would not go overlooked…

Aren’t I even if it’s on my W-2 and I take the credit?

No, you’re way ahead of the game. W-2 income is taxed at your Marginal Tax Rate, say 25%. So $20,000 in income would cost $5,000 in taxes. With the credit you’re still up by $15,000.

That doesn’t seem right… Does this happen elsewhere?

Yes… If you own stocks and receive dividend statements you may have noticed foreign taxes paid as a reporting line. Some mutual funds pass on the proportionate tax payment to you as the shareholder although you never physically paid the tax due.

The most common instance is with mortgages and interest deductions. It doesn’t matter who paid the interest. It matters who is liable (who is on the deed). That is the person who gets the deduction for interest paid. Even though Auntie Sally made the payments.

Summary – plan for rain

This is a fair and valuable tax position. It should be carefully considered. You should make sure to have all necessary documentation before taking this position (especially the amount of income that the foreign taxes were paid on)…. You should try to get it on a corporate report. How many times have we left a company and needed documentation down the line, only to discover they were not very accommodating? And remember, no guarantees. If you’re audited, plan on losing. Remember attorney’s fees generally start at around $5,000 for this type of venture.