US tax court rules against Israeli who claimed ‘911 exclusion’
Each year many US citizens and residents living overseas take advantage of the up to $100,800 a year foreign earned income exclusion (FEIE), pursuant to Section 911 of the US Internal Revenue Code. However, entitlement to FEIE is not automatic as the US Tax Court recently ruled in a case involving an Israeli citizen.
The conditions for FEIE entitlement are that the taxpayer be a bona fide resident of a foreign country, and have a tax home in a foreign country. A taxpayer’s “tax home” may be different from the taxpayer’s actual country of residence.
The first test is whether a US taxpayer is a bona fide resident of a foreign country.
If the taxpayer is a US citizen or US tax resident, then the taxpayer must be a “bona fide” resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year. Foreign residency may be established by showing the taxpayer was present in a foreign country during at least 330 days in a 12-month period.
The second test is whether the taxpayer has a foreign “tax home.” The concept of “tax home” is subjective in nature and requires an analysis of all the facts and circumstances. Generally speaking, a taxpayer’s tax home is considered to be his or her regular or principal place of business, and not necessarily where his or her personal residence is located. To identify the principal place of business, the court can look at the employer’s practices and where the employer has identified the taxpayer’s principal place of business on its records.
The Hirsch Case
In this case, Hirsch was a citizen of both Israel and the US (Michael D. Hirsch and Jane Hirsch vs. CIR, Tax Court Summary Opinion 2016-37). The court accepted that the taxpayer was a bona fide resident of Israel without discussion. However, in looking at Hirsch’s “tax home,” the court focused particularly on Hirsch’s employee records. If the person is an employee, as was the case here, the inquiry focuses on employer practices and the place the employer has identified as the taxpayer’s principal place of business.
First, Hirsch was employed full time by Merrill Lynch as an investment associate. During the tax years at issue, the employer’s offices were in the US as were most of the clients. Hirsch traveled to the US once a month to meet with clients and ended up spending about one-third of the year in the US. Merrill Lynch did not reimburse Hirsch for this travel.
Second, the court looked at Merrill Lynch’s internal policies regulating Hirsch’s activities in Israel, including what he could and could not do in Israel. Special attention was given to whether or not various Federal regulations were followed with regard to being allowed to conduct such financial activity outside the US.
In this case, Hirsch was listed in company records as being located in the company’s US office in New Jersey. His business mail was delivered to the US office, as were his W-2 forms. More importantly, employment records specifically stated that he was not authorized to work outside of his home in Israel or out of the company’s Tel Aviv office. The company did not provide him with an Israeli telephone number or office space. In fact there was nothing in company records to indicate that Hirsch worked out of anywhere else but the New Jersey office.
Finally, Hirsch, being employed in the financial sector, was subject to FINRA – the Financial Industry Regulatory Authority. Under FINRA, a US citizen cannot work in foreign countries, unless specific conditions are met, which Hirsch did not meet.
In light of all the above, the court ruled that Hirsch’s principle place of business, and thus his tax home, was the US. This occurred despite the fact that the taxpayer moved to Israel in 1993, almost 20 years before the time subject to the litigation.
The Israeli tax side:
As an Israeli resident living and working in Israel, Hirsch was presumably taxable in Israel, but Israeli income tax should be creditable against US federal tax. But that’s not all. The US employer corporation may also have a “permanent establishment” (i.e. a branch) in Israel because of Hirsch. If so, it would also be taxable in Israel on the profit generated in Israel – and VAT would be due.
To Sum Up:
US citizens and residents living in Israel and traveling regularly to the US for business must exercise care in conducting their affairs in light of the Hirsch ruling. This article does not constitute legal advice. As always, consult experienced tax advisers in each country at an early stage in specific cases.
Monte Silver is a US lawyer based in Israel specializing in US tax matters. He formerly worked for the Internal Revenue Service and the US Tax Court. Leon Harris is an Israeli certified public accountant and tax specialist at Harris Consulting & Tax Ltd.