Lesson From The Tax Court: The 411 On Section 911

The pullout from Afghanistan has dominated the news, and many of our lives.  While it is natural to think of the war as fought by U.S. soldiers, we cannot forget the considerable number of defense contractor personnel who provided significant support.  According to this report, there were over 88,000 contractor personnel in Afghanistan nine years ago.  Many were U.S. citizens.  While the number has dropped significantly in recent years, it appears multiple thousands of non-military U.S. citizens needed to be evacuated back to the United States this year.

Today's lesson involves one such contractor and the proper application of the §911 exclusion to her.  Whatever you may think about the tax issue, I know you join me in hoping this taxpayer has made a safe return to the U.S.

Section 911 allows certain taxpayers—called “qualified individuals”—to exclude from their gross income certain amounts of income earned from outside the United States.  The case of Deborah C. Wood v. Commissioner, T.C. Memo. 2021-103 (Aug. 18, 2021) (Judge Lauber), looks at whether a civilian defense contract worker in Afghanistan could use §911 to exclude her wage income.  It teaches a short but complete lesson on what it takes to be a qualified individual for the §911 exclusion.  It is worth your time to read and think about.  Details below the fold. 

Law: Two Tests To Be A Qualified Individual
Generally, U.S. citizens must pay tax on their world-wide income.  Specking v. Commissioner, 117 T.C. 95 (2001).  Section 911, however, allows U.S. citizens who earn income from working in other countries to exclude from gross income their “foreign earned income” if they are "qualified individuals."  We don’t need to know the details of what constitutes foreign earned income for today’s lesson.

Today’s lesson involves only what it takes to be a “qualified individual.”  To be a qualified individual, a taxpayer must meet two tests: a location test and a tax home test.  Let’s look at each separately, and then compare them.

Location: The location test looks at where the taxpayer is physically located.  A taxpayer meets the test if the taxpayer can show either: (1) the taxpayer “has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year,” §911(d)(1)(A); or (2) the taxpayer “has been physically present in a foreign country or countries for at least 330 full days during any period of twelve consecutive months” ending in the relevant tax year.  §911(d)(1)(B).  In the latter situation, the individual must pro-rate the exclusion to the percentage of that time that was in the relevant tax year.  If the 12 month period is entirely within the relevant tax year then there is no need pro-ration.  See examples in Treas. Reg. 1.911-2.

As we shall see, the bona fide resident test is a mushy facts-and-circumstances test, but the physical presence test is a far more mechanical one.

Tax Home: Section 911(d)(1) says that a taxpayer must show their tax home is in a foreign country.  Section 911(d)(3) then explains that a tax home for §911 purposes is the same as “such individual’s home for purposes of section 162(a)(2).”  Oh boy.  Regular readers will recall that a “tax home” for §162 purposes is a messy concept, basically being a determination of where the taxpayer must live in order to earn their income. The shorthand is that a taxpayer’s tax home is the location of their employment.   For more details, see these prior Lessons From The Tax Court here, here, and here.

But there is one wrinkle to the §911 tax home test.  Call it the U.S. abode exception.  Section 911(d)(3) provides that "An individual shall not be treated as having a tax home in a foreign country for any period for which his abode is within the United States."

Law: The Two Tests Compared.  Both the location test and the tax home test are highly dependent on very similar facts and circumstances except, as I have noted, for the physical presence test, which is pretty mechanical.  I think, however, there are two important differences worth noting.

First, they test for different ideas.  I see the location test as being about where the taxpayer actually lives.  Is the taxpayer connected to the foreign country in a way that makes them a bona fide resident, as opposed to a traveler or sojourner or interloper?  The physical presence test hits at the same idea—and, again, more mechanically—but covers situations where a taxpayer may not be able to make the kind of connections to the foreign country that would make the taxpayer a bona fide resident.  For example, if a taxpayer is physically present in multiple foreign countries for work purposes but not enough in any one country to establish a bona fide residency, the physical presence test can still be met.   In contrast, the tax home test is about where the taxpayer ought to be considered as living for their employment needs.  That is the general idea of tax home: where does the employer need the taxpayer to be in order to work.

Admittedly the “U.S. abode” rule is a bit of a puzzler.  As the Tax Court has observed: “abode has a domestic rather than vocational meaning, and stands in contrast to 'tax home' as defined for purposes of section 162(a)(2).”  Landsdown v. Commissioner, T.C. Memo. 1994-452.  So it’s a legit question to ask just what the heck is this U.S. abode rule doing as part of the tax home test?

I read the U.S. abode rule as a second look at location.  When the taxpayer establishes they are a qualified individual under the bona fide resident test, it is hard to imagine the U.S. abode rule trumping that.  However, if a taxpayer relies upon the mechanical physical presence test to be a qualified individual, then I can see work for the U.S. abode test to perform.  Thus, a taxpayer may not be a qualified individual even when the taxpayer has physical presence and has a tax home in the foreign country.  The abode rule is a double-check to see if ties to the United States are nonetheless stronger than their ties to the foreign country.  As Judge Lauber himself explained in Evans v. Commissioner, T.C. Memo 2015-12 at 9, a "taxpayer's ‘abode’ is generally in the country in which he has the strongest economic, family, and personal ties.”)(emphasis supplied).

For an example of a taxpayer who met the location test but flunked the tax home test, see Lesson From The Tax Court: International Pilot’s Tax Home Argument Does Not Fly, TaxProf Blog (Nov. 23, 2020).  For an example of a taxpayer who met the tax home test but flunked the location test, see Lansdown, supra. 

Second, the tests impose different burdens of proof on the taxpayer.  Both the location test and the tax home test are highly dependent on the particular facts and circumstances in each case.  As usual, taxpayers bear the burden to persuade the decision-maker (whether the IRS or the courts) that they satisfy these tests.  However, courts have imposed very different burdens of proof on taxpayers for each test.  The purpose of the burden of proof is to “instruct the factfinder concerning the degree of confidence our society thinks he should have in the correctness of factual conclusions for a particular type of adjudication.” In re Winship, 397 U.S. 358, 370 (1970) (Harlan, J., concurring).

For the tax home test, taxpayers bear the usual burden: to show by a “preponderance of the evidence” that their tax home was the foreign country.  In contrast, taxpayer have a heavier burden of proof to meet the location test.  That is because §911(d)(1)(A) says that the taxpayer must “establish, to the satisfaction” of the IRS that they meet one of the location tests (bona fide residence or physical location).  The Tax Court has interpreted this “to the satisfaction” language to mean that taxpayers must give “strong proof” that they meet the location test. See Schoneberger v. Commissioner, 74 T.C. 1016 (1980).

hat the Tax Court calls “strong proof” is generally referred to by other courts as “clear and convincing.”  That is a burden of proof one level up from the preponderance standard but one level down from the strict “no reasonable doubt” standard used in criminal law. See e.g.  Jove Engineering, Inc. v. IRS, 92 F.3d 1539, 1545 (11th Cir. 1996) (clear and convincing standard “is more exacting than the preponderance of the evidence standard but, unlike criminal contempt, does not require proof beyond a reasonable doubt.”)

I think of it these three different burdens this way: the preponderance standard means the decision-maker must be 51% sure; the no-reasonable-doubt standard means the decision-maker must be 90% sure; and the clear-and-convincing standard falls somewhere in between.  Using percentages gives a false sense of precision until one realizes they are just used to illustrate the different levels and not to impose some fine-grained cutoff.

What these different burdens mean is that even if a taxpayer convinces a court that their tax home is the foreign country by preponderance of the evidence, they may still not be able to meet the stricter burden of proof for the physical location test.  That is what happened in Lansdown, supra.

That did not happen in this case!  Here the well-represented taxpayer won in a clean sweep.  Let’s take a look.

Facts
The tax years at issue were 2012-2016.  To put those years in context one needs to know that Ms. Wood had joined the U.S. Army in 2001 and eventually ended up in Iraq until 2005.  There she provided logistics support.  After leaving the Army Ms. Wood lived in Texas from 2005 to 2011.  She worked for Dell Technologies and  bought a home.  But, she testified in Court, she was pretty bored and really wanted to get back into action.  She missed the sense of mission and, oh yeah, the pay was better.  So she made a determined effort to get a job in a war zone.

In October 2011 Ms. Wood took a job with AC First, LLC, to perform transportation management services in Afghanistan.  From November 2011 until April 2016 she worked almost entirely at Kandahar Airfield in Afghanistan where, because of the war, she was confined to the Airfield.  In April 2016 that employment ended and she returned to the U.S.  But she kept trying to get back, turning down other employment until, in December 2016, she returned to Kandahar to work for DynCorp.  She was still there in February 2021 when the case was tried and she delivered her testimony from Kandahar.  Op. at 14. 

In each of the years at issue except one Ms. Wood returned to the U.S. for between three and six weeks.  Each visit included spending time at her home in Texas.  During the years at issue she exclusively used her U.S. bank accounts where all her paychecks were automatically deposited, and she used her U.S. credit cards.  She maintained her Texas driver’s license and her voter registration and voted in the 2016 elections.  During her period of unemployment in 2016 she applied for and received Texas unemployment compensation.

Until 2015, Ms. Woods filed no U.S. tax return.  The IRS noticed.  In response to a contact from an IRS Revenue Agent (RA) Ms. Woods filed her 2012-2014 returns in May 2015.   She filed her 2015 return on October 2017 and she filed her 2016 return in April 2018.   On all of the returns she claimed an exclusion under §911.

Ms. Woods was unable to satisfy the Revenue Agent that she was a qualifying individual, resulting in an NOD for about $95,000 in unpaid taxes.  Ms. Woods found good representation with the Asbury Law firm in Atlanta, and petitioned the Tax Court for review.

Lesson: The War Zone Factor
Judge Lauber found that Ms. Wood was a qualified individual for 2012-2015 because she was a bona fide resident of Afghanistan for those years.  He also found that she was a qualified individual for 2016 because she met the physical presence test for the one year period ending in April 2016 when she returned to the U.S.  While she could not get the full benefit of the §911 exclusion for that year, she could pro-rate.

Finding Ms. Wood to be a bona fide resident of Afghanistan took a bit of doing.  That is because Ms. Wood could not meet many of the factors used to evaluate residency, such as establishment of a home, assimilation and participation in local culture, establishing local economic ties and participating in the local economy such as by paying taxes, engaging in commercial relationships, etc.  That is likely what prevented the RA from being satisfied that she was a bona fide resident of Afghanistan or, if she were, that she did not still have a U.S. abode.

Judge Lauber discounted all those factors because during this period Afghanistan was a war zone.  He explained that Ms. Wood could not be expected to establish the kind of local ties and relationships when she was not allowed off base.  Most importantly, Judge Lauber found that Ms. Woods fully intended to stay in Afghanistan as long as she could get employment there.  It appears she was something of a war zone junkie.  He notes that she repeatedly turned down other, similar, job offers in other locations both within the U.S. and abroad because they were not in war zones.  “She turned that offer down because Kuwait was not in a war zone and the salary was on the low end of the spectrum.”   Op. at 4.  “Petitioner testified that she intends to work as a contractor in Afghanistan for as long as such jobs remain available to her.  We found that testimony entirely credible.”  Op. at 14.

Judge Lauber also found that Ms. Wood’s tax home was Afghanistan.  That was an easy call since that is where her employer required her to be to perform the services it hired her to perform!

Finally, Judge Lauber found that Ms. Wood did not have a U.S. abode, and again it was the War Zone factor that seems to have made the difference.   Remember, Ms. Wood’s burden of proof here was simply to show she did not have a U.S. abode by a preponderance of the evidence. The IRS argued that she had a U.S. abode because she maintained all those connections with Texas, including a home (and car), voting, and financial accounts and those were much stronger ties than she had with Afghanistan.

Again, however, the War Zone factor came into play.  Judge Lauber pointed out that “opening a local bank account or buying property in Afghanistan would have been impracticable if not impossible, given the requirements of her security clearance and the ban on leaving the base.”   Op. at 23.  Crucially, because of those War Zone restrictions, Judge Lauber held that the relevant “community” for comparison with the U.S. was not the country of Afghanistan or its people, but was the community and culture of Kandahar Airfield.  Op. at 23 (“Most of petitioner’s close friends were other contractors who also lived and worked in Afghanistan.”).

Bottom Line: The most important circumstance in this case was that Ms. Wood worked in a War Zone.  So for all of your clients coming back from Afghanistan, keep that in mind.  The War Zone factor affected the analysis of all the other factors that courts use both to determine bona fide residency and to determine abode.  Because she was so committed to her job and life in a foreign War Zone, Ms. Woods was a qualified person entitled to the §911 exclusion.

Comment:  Judge Lauber went where I would fear to tread.  It seems counter-intuitive to say that a U.S. citizen who spends all their time confined to single location in a country because the U.S. is there engaged in war can really be a bona fide resident of that country.  The intuition is that, whether viewed as an occupier or protector, they remain a stranger, an outsider.  Indeed it is the condition of war that makes them so.

To find Ms. Wood was a bona fide resident of Afghanistan stretches the meaning of that term beyond what I can recognize.  Sure, there are good reasons why she could not engage in the variety of activities that makes one a bona fide resident.  But the reason for not engaging in those activities does not change the fact that she did not engage in those activities!   The reason is not the test.  Even if it were, the opinion gives no indication that Ms. Wood made any efforts to get to know and become part of Afghanistan, to overcome the restrictions of her working in a war zone. 

As I read the intent factor, it is not the intent to be physically present in a place that counts; it’s the intent to be part of the country.  You see this in the war worker cases after WWII, where defense contractors living abroad claimed exemptions and argued there, like here, that the War Zones they worked in excused their lack of connections with the foreign countries.  The courts disagreed.  For example, in Downs v. Commissioner, 166 F.2d 504, 508 (9th Cir. 1948), the court explained that “unless the United States citizen abroad "makes his home temporarily" in the foreign country, that is, as we see it, identifies himself in some degree with its customs and lives under and within such customs, he is not a resident of the foreign country in which he is staying temporarily.”  That was the common view of courts.  The Downs court also has a nice discussion of how allowing a contractor in a War Zone to claim the exemption would be contrary to the intent of the statute, which was to promote peace-time international commerce.  I freely admit to not fully researching the history of these cases, so it may be they are no longer good law.  I welcome comments on that.  But if this were a case that would be reviewed by the 9th Circuit, I would like the government's chances on appeal.

As I see it, while Ms. Wood may have been a bona fide resident of Kandahar Airfield, that did not make her a  bona fide resident of Afghanistan.

I wonder why Judge Lauber did not rely on the physical presence test?  That would get to same bottom line on location with much less heaving and straining.  Of course, then one would need to apply the U.S. abode test, which again creates the problem of how does one balance Ms. Wood’s apparent determination to go work in war zones with her retention of ties in the U.S.  Here again I might again be more hesitant than Judge Lauber to say that the War Zone factor is relevant to the abode analysis.  For example, working in a war zone did not force her to keep her house (unrented, no less) for all those years.  So you have to wonder why she kept it.  And why did she keep returning to it, if not to maintain connections to that location, to have a U.S. place to abide between war zone jobs?

As I said at the start, regardless of whether we all agree on the proper tax treatment, I am sure we all hope that Ms. Wood is once again in her U.S. abode.

Bryan Camp is a bona fide resident of Lubbock Texas where he is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return to TaxProf Blog each week for a new Lesson From The Tax Court.