Former Marine not entitled to exclude foreign earned income

The Tax Court held that a former U.S. Marine did not make a timely and valid foreign earned income exclusion election for 2010; thus he was not entitled to exclude from gross income his foreign earnings pursuant to Sec. 911(a)(1).

Facts: Prior to 2010, Damon Redfield left the Marine Corps as a disabled veteran suffering from memory loss and post-traumatic stress disorder. In January 2010, he began working in a civilian position at the Kandahar Airfield in Afghanistan. Due to his worsening condition, he returned to the United States before completing his one-year assignment. He did not file a 2010 return before May 27, 2014, when the IRS prepared a substitute for return that treated all of his wages for 2010 as gross income and subsequently issued a notice of deficiency.

On Oct. 7, 2014, Redfield filed a delinquent return, which included Form 2555, Foreign Earned Income, electing to exclude earnings from his work in Afghanistan. He reported a tax liability and tax due. Based on the delinquent return, the IRS issued a notice of deficiency disallowing his claim of a foreign earned income exclusion because he had failed to make a valid election for 2010.

Issue: While U.S. citizens are generally taxed on their worldwide income, Sec. 911(a)(1) allows a qualified individual to elect to exclude foreign earnings from gross income, subject to the limitations in Sec. 911(b)(2).

Regs. Sec. 1.911-7(a)(2) provides the timing requirements for a valid election. Regs. Sec. 1.911-7(a)(2)(i) provides that a Form 2555 or comparable form making the election may be attached to (1) a timely filed return (including extensions); (2) a timely amended return; or (3) an original return filed within one year after the due date of the return (without regard to extensions).

Regs. Sec. 1.911-7(a)(2)(i)(D) provides that an election made on a return after these periods will still be valid if (1) the taxpayer owes no income tax after taking into account the exclusion; or (2) tax is owed and the taxpayer files Form 1040, U.S. Individual Income Tax Return, with Form 2555 or a comparable form attached, before the IRS discovers that the taxpayer had failed to elect the exclusion; and (3) the taxpayer types or legibly prints at the top of the first page of the Form 1040: “Filed Pursuant to Section 1.911-7(a)(2)(i)(D).”

The issue decided was whether, pursuant to Regs. Sec. 1.911-7(a)(2)(i)(D)(2), Redfield made a timely and valid foreign earned income exclusion election for 2010 before the IRS discovered that he had failed to elect the exclusion. Redfield and the IRS agreed that he did not satisfy Regs. Sec. 1.911-7(a)(2)(i)(A), (B), (C), or (D)(1).

Holding: The Tax Court held that Redfield did not make a timely and valid foreign earned income exclusion election for 2010; thus, he was not entitled to exclude any of his foreign earnings from gross income pursuant to Sec. 911(a)(1). Citing McDonald, T.C. Memo. 2015-169, the court held that the IRS evidenced its discovery that Redfield failed to elect the foreign earned income exclusion for 2010 by preparing the substitute for return more than four months before Redfield filed his delinquent return.

The court noted that Redfield also did not type or print the required language on Form 1040, but it did not decide whether this omission alone would invalidate an otherwise timely election.

While the court acknowledged Redfield’s military service and that its effects may have contributed to his failure to make a timely election, it held that he was still required to have made one. However, it noted that his condition could be relevant to the penalty and additions to tax the IRS assessed, which he could contest in further proceedings.

• Redfield, T.C. Memo. 2017-71

—By Mark Aquilio, CPA, LL.M., professor of accounting and taxation, St. John’s University, Queens, N.Y.