The Foreign-Earned Income Exclusion (FEIE) is asked about so frequently I write an update column every year. The most common misconception is that Americans automatically qualify if they live outside the U.S. for more than 183 days. I believe this myth is perpetuated by the fact that some other countries allow citizens to file as non-residents if they leave their country for more than six months — which leads Americans to believe the U.S. has a similar law.
While simply living outside the U.S. for 183 days will not exempt you from taxes, there is a tax code provision that allows Americans to exclude from gross income up to $120,000 (in 2023) of foreign-earned income, as well as certain employer-provided housing costs. To qualify for these exclusions and deductions, an individual’s tax home must be in a foreign country, and they must meet either a residence or physical presence test. A determination of whether a taxpayer qualifies is based on all the facts and circumstances, including but not limited to:
- The taxpayer’s intention
- Length of stay in a foreign country
- The nature and duration of employment
- Establishment of a home in the foreign country
- The nature, extent, and reasons for temporary absences from theforeign home
Most yacht crew will not qualify for the FEIE based on foreign residency. Simply living on a vessel while it is passing through or anchored in foreign jurisdiction does not make them a tax resident of that country. Normally, crew qualify for the exclusion under the “physical presence test.” This requires that the crewmember be living and working outside the U.S. for 330 out of 365 days, and time spent in international waters does not count; it’s considered the same as being in the U.S. You must be in the territorial waters of a sovereign foreign county during this time. You also must be in that country for a full 24-hour period. If you arrive in the U.S. one minute before midnight, you are considered present in the U.S. for that day.
The burden of proof is on the taxpayer to provide documentation to support the FEIE. The IRS plans to improve compliance on international issues and expects to increase the use of foreign information documents and data sharing with other federal agencies. For instance, travel dates may be verified with U.S. passport information, captain’s log, and employer affidavit. I normally recommend a crewmember keep a diary with all proper documentation supporting the claim of a foreign-earned income exclusion; normally an audit takes place several years after the tax year has ended, by then the crewmember may have already left the vessel and may not have access to all of the necessary documentation.
I recommend that taxpayers interested in more FEIE information visit irs.gov and review Publication 54.
This article was originally published in the May 2023 issue of Dockwalk.