Military contractors working in Iraq, Afghanistan and elsewhere need to keep several things in mind when doing their tax returns.
Below are several tax tips for military contractors that are working overseas:
- Military contractors often can exclude a significant portion of foreign sourced income if they qualify under the physical presence test or “bona fide residence” test.
- However, the IRS won’t accept military contractors using the bona fide residence test of what they consider “combat zones” such as Iraq and Afghanistan. Even though these combat zones are exactly where military contractors work and live, it won’t fly with the IRS and will definitely cause “red flags”. The IRS uses common sense standards to confirm qualification for the bona fide resident test.
- To qualify for the foreign earned income exclusion, as a civilian contractor you must have a foreign tax home. Your tax home may be established based on your principal place of business (in other words the location of your work). The location of your tax home for military contractors often depends on whether your assignment is temporary or indefinite. If you are temporarily absent from your tax home in the United States on business, you may be able to deduct your away-from-home expenses (for travel, meals, and lodging), but you would not qualify for the foreign earned income exclusion.If your new work assignment is for an indefinite period, your new place of employment becomes your tax home and you would not be able to deduct any of the related expenses that you have in the general area of this new work assignment. However, if your new tax home is in a foreign country and you meet the other requirements, your earnings may qualify for the foreign earned income exclusion.
- If you expect your employment away from home in a single location to last, and it does last, for 1 year or less, it is temporary unless facts and circumstances indicate otherwise. If you expect it to last for more than 1 year, it is indefinite. If you expect it to last for 1 year or less, but at some later date you expect it to last longer than 1 year, it is temporary (in the absence of facts and circumstances indicating otherwise) until your expectation changes. Once your expectation changes, it is indefinite. Thus, when accepting an overseas contract, it is important to accept one that is for more than one year (i.e. one year, plus one day).
- As a civilian you are not entitled to exclude your compensation as “combat pay”. However, you may qualify for the “combat zone extension”.
- When you are a military contractor working overseas, you may also continue to be considered a resident of the state you resided prior to starting work overseas (even though you are living and working overseas). As a result, you may have state filing requirements and your foreign earned income may be subject to taxation by the state. You can minimize your taxes by changing your residency prior to accepting your contract to states that don’t have a state income tax such as Texas, Florida, Alaska, Nevada, Washington, South Dakota, Wyoming and Tennessee. You must be able to substantively change your state residency, by obtaining a drivers license in the new state, etc.
Complying With Tax Regulations And Avoiding Common Pitfalls For Military Contractors
If you choose a tax professional who is knowledgeable and experienced with tax issues for military contractors that live and work overseas, you can have a hassle-free relationship with the IRS and save on your taxes. Avoiding the common pitfalls and complying with regulations will serve you well.
New law makes clear: Combat-zone contract workers qualify for foreign earned income exclusion
The Bipartisan Budget Act of 2018, enacted in February, changed the tax home requirement for eligible taxpayers, enabling them to claim the foreign earned income exclusion even if their “abode” is in the United States. The new law applies for tax year 2018 and subsequent years.
This means that these taxpayers, if eligible, will be able to claim the foreign earned income exclusion on their income tax return for 2018 when they file. Under the exclusion, taxpayers can choose to exclude their foreign earned income from gross income, up to a certain dollar amount. For tax year 2018, that dollar amount limit is $103,900.
The foreign earned income exclusion is not automatic. Eligible taxpayers must file a U.S. income tax return each year with either a Form 2555 or Form 2555-EZ attached.
Foreign earned income is the income a taxpayer receives for performing personal services in a foreign country or countries during a period in which he or she meets both of the following requirements:
His or her tax home is in a foreign country, and he or she meets either the bona fide residence test or the physical presence test.
Under prior law, many otherwise eligible taxpayers who lived and worked in designated combat zones failed to qualify because they had an abode in the United States. The new law makes it clear that contractors or employees of contractors providing support to U.S. Armed Forces in designated combat zones are eligible to claim the foreign earned income exclusion.
Taxpayers choosing the foreign earned income exclusion cannot take advantage of any other exclusion, deduction or credit related to the excluded income. This includes any expenses, losses or other items that would have been deductible had the exclusion not been claimed.
As in the past, the foreign earned income exclusion is not available to federal employees or members of the military. But service members in combat zones continue to qualify for the combat pay exclusion.
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Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog where all articles are written by Enrolled Agents. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. Our articles are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.
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Randall Brody is an enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.
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