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Discussion:Dumb Question about Foreign Earned Income Exlusion

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Discussion Forum Index --> Basic Tax Questions --> Dumb Question about Foreign Earned Income Exlusion

Discussion Forum Index --> Tax Questions --> Dumb Question about Foreign Earned Income Exlusion

CrowJD (talk|edits) said:

30 December 2007

I have noticed that "working abroad" is sometimes touted as an income tax savings idea. But if a U.S. citizen is working in a foreign country, is not her income subject to the tax of the host country? I mean, what's the real savings of this (limited) exclusion if you are paying perhaps a higher tax in the foreign country? Are those taxes nulled by an applicable treaty with that nation? I must be missing something basic here.

TonyM (talk|edits) said:

30 December 2007
A lot of countries want US workers, believe it or not, and will grant favorable tax treatment. BTW California still wants to tax your foreign earned income.

Death&Taxes (talk|edits) said:

30 December 2007
As would any other state where domicile is.

KatieJ (talk|edits) said:

31 December 2007
Actually, California is one of the most LIBERAL states in granting nonresident status to expatriate domiciliaries. I never understand why California gets such a bad rap on this.

Many US states treat ALL domiciliaries as tax residents, no matter how long or for what reason they are absent from the state. A person who moves to another US state for employment purposes may change domicile at the same time, depending on the facts. But a US citizen working in a foreign country generally does not establish a new domicile there. Until a new domicile is established, the old one continues (with some exceptions -- some generous case law in Maryland, for example). Some states (NY, NJ, for example) have special rules under which a domiciliary who is absent in a foreign country for a specified period of time is treated as a nonresident; but many states do not have such provisions. You're a resident for tax purposes until you establish a new domicile somewhere else, i.e., move there with the intention of remaining permanently.

Under California law, a domiciliary who is absent from the state for a purpose that is not temporary or transitory is a nonresident. Indefinite employment in a foreign country, coupled with a severing of ties to California at the time of departure, has frequently been held to create nonresidence even though the domicile remained in California. There are a lot of State Board of Equalization decisions on this. Of course, if the taxpayer maintained his or her place of abode in California so as to be able to walk right back into it, and left other ties in California suggesting that the purpose of the absence was temporary, the taxpayer would lose. These cases were extremely fact-driven and when you read the decisions, which necessarily summarize the facts, sometimes it is hard to tell the difference between a taxpayer who wins and one who loses.

In 1993 this problem was fixed by legislation in California. Cal. Rev. & Tax Code Sec. 17014(d) provides a "safe harbor" for domiciliaries who are absent under an employment-related contract for a period of at least 18 months. As long as such a person does not spend more than 45 days of any taxable year in California, he or she is treated as a nonresident for California tax purposes.

So don't say California wants to tax your foreign earned income. No they don't; not if you meet the safe harbor to be treated as a nonresident, even though your domicile remains in California. Of course, if you do not meet the terms of the safe harbor, and you cannot show by facts and circumstances that your absence was not for a temporary or transitory purpose, all of your income will be subject to California tax.

But many other states are MUCH more aggressive than California in taxing foreign income of domiciliaries. Some of those states, however, do conform to the IRC Sec. 911 exclusion.

Riley2 (talk|edits) said:

1 January 2008
KatieJ, under the safe-harbor rule, if an employment contract is for one-year, but contains a one-year renewal clause, do you think Sec. 17014(d) applies? If so, should the client wait until the 546-day requirement is satisified before claiming the safe-harbor exclusion?

KatieJ (talk|edits) said:

2 January 2008
Riley, we don't have any case law on this yet, probably because the State Board of Equalization has virtually quit issuing published decisions. It's a real pain. Does the contract have to be in writing? Who knows? The only authority we have so far, as far as I know, is a Chief Counsel Ruling from 2000 allowing that 17014(d) would protect an independent contractor as well as an employee.

In the situation you describe, I think I would explain the situation and go by the client's wishes. In other words, how aggressive does the client want to be? If the client clearly intended and expected to be absent for at least 546 days, regardless of the original term of the contract, I'd file as a nonresident (or part-year resident) for the first year, but I'd also advise the client to behave otherwise as if he or she intended to be absent for a long time -- e.g., giving up the place of abode, closing bank accounts, etc., etc., so as to enhance the likelihood of passing the facts-and-circumstances test if for some reason the 546-day requirement is not met. I'd also warn the client that if it turns out the safe harbor is not met, there is a risk of additional tax liability, especially if ties to California are not severed. On the other hand, if the client is uncertain, or wants to take the conservative position and file a claim for refund when the contract is extended, I'd go along with that. Just be sure the client understands the ramifications either way.

Wonder Woman USA (talk|edits) said:

23 March 2010
Sorry to drag up this old business, KatieJ, but I wonder about proving ex-pat status for someone who lives overseas but is an employee of a California company that withholds both Federal and State taxes.

He is a German citizen and lives there permanently, with annual visits to the US to see relatives. He also does free-lance work, over the internet, and has no workplace in California.

Guya (talk|edits) said:

23 March 2010
You may well be concerned that he is a PE of the California entity for German corporate taxes. From a US perspective he files a 2555 and/or 1116.

No clue why he is having US withholding - doubtless this is contrary to German law so he needs urgent advice in Germany.

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