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…

5 Comments

  • physiotherapy jobs

    10/01/2011

    this post is very usefull thx!

  • Kris Rizk

    15/01/2011

    I’ve got to write about this for a class Im taking, well similar to this. This actually made it easier for me , so thanks you A LOT.Regards, Kris Rizk

  • Robert Mould

    07/04/2011

    Here’s a related question for you: I am a bona fide resident of Germany (live here full-time, own a house, have a child that was born here and is in school, etc). My wife works for a German company in Germany and I work for a US company out of our residence (telecommuting, essentially). I am paid in US dollars to a US bank account. I take money out of the account from time to time to spend here. Is my income “foreign earned” and eligible for the deduction? I do all of my work here in Germany, but travel a few times/year to the US to visit headquarters.

    Thanks for any advice on this matter!

    • admin

      31/01/2012

      Sorry about the delay…
      Source is where you earn the income. Not where or how you’re paid. If you are paid those “few times a year” you’re in the US, you’d allocate to US source. So as long as you met the physical presence test it looks good. You do need to verify what tax treaties Germany has with the US as well.

      Germany has a progressive income tax that is more aggressive than the US. You might be better off filing a return with a foreign tax credit instead…

      • Kai

        26/04/2012

        This question bacllasiy is looking to see if you should itemize your deductions or take the standard deduction.When you itemize, one of the things itemized is how much in taxes you paid to the states last year. They can figure out how much you paid from your paystub. They also want to know though, if you owed any money on your 2006 tax return that you paid then, because that counts towards “income taxes paid in 2007″ for itemized deduction purposes.So what this question is asking is:- Did you owe any income tax on last years return that you paid.- Did you pay any back income taxes on last years return.- The key is that it’s *state* income taxes. They don’t care whether you owed / paid any federal income tax last year.Nothing too sinister.

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