Last July, a married couple came to us seeking help with an IRS audit of their foreign earned income exclusion (FEIE) for tax year 2018. FEIE audits are one of the more difficult cases we work here at TaxAudit, as there is a large element of subjectivity involved. Proving a person’s intent to remain in a foreign country on an indefinite basis is challenging, and the IRS is looking for verifiable facts and proper context. A seasoned IRS auditor is trained to spot any weaknesses in your underlying case. Fortunately, TaxAudit has seasoned audit representatives that are also good at finding weaknesses in the IRS’s case. Through our combined efforts with our clients, TaxAudit can perform magic – like making a large $30,000 tax bill from the IRS (and the associated stress) disappear.
In this FEIE case, the husband was a civilian pilot working in support of the U.S. Armed Forces in a designated combat zone. The clients were claiming the FEIE based on having a “bona fide residence” in a foreign country. The taxpayers deemed their “tax home” to be in Iraq since their only source of earned income were the wages the husband received as a pilot. During the nearly yearlong audit engagement, the clients worked diligently and supplied me with roughly 80 separate documents to help prove their case. Their documents ranged from employment contracts and pay statements, to flight logs and foreign visas/passports.
Following the submission of a very well-organized initial response package of over 200 pages, the IRS auditor came back with a proposed bill disallowing the FEIE in full. The examiner’s main contention was that the taxpayer maintained a primary abode in the United States and only lived temporarily on the military base while performing his duties as a civilian pilot on a military contract. As such, the IRS took the position the taxpayers failed to demonstrate a realistic intent to establish a “bona fide residence” in the foreign country.
The unfavorable initial determination caused the clients to suffer heightened anxiety, adding more grief to an already difficult situation. To clarify, the husband was still recovering from the psychological aftershock of being part of the January 2020 missile strike at the U.S. airbase where he was stationed. I quickly went to work on their case, analyzing the examiner’s preliminary findings, and preparing a research log that I used to disassemble the legal analysis of the statutes and Tax Court cases cited by the IRS examiner in support of his audit position.
In this case, it was clear the IRS examiner took a position not simply based on a misinterpretation of facts, but he was also relying upon decades old court cases that were no longer applicable. As anyone in the tax profession knows, tax laws change often, and each year stands alone. The biggest weakness in the IRS’s legal position was their failure to fully consider the recent amendment to Internal Revenue Code section 911(d)(3) by the Bipartisan Budget Act. The new law greatly changed the rules for civilian contractors serving in combat zones. During my research, I found several recent Tax Court decisions, including a landmark case heard in 2017 in which the judge ruled in favor of the taxpayer on a FEIE.
I quickly shared the results of my research and overall rebuttal strategy with our clients, who had a renewed sense of optimism. I needed a little help, and the clients came through like the champions I knew they were. They prepared an awesome, and very respectful, three-page rebuttal narrative that outlined their basis for disagreeing with how the IRS examiner was interpreting their facts. Combined with the technical legal rebuttal I prepared, we were able to convince the IRS examiner his position was incorrect, and he revised his audit report to allow the FEIE in full.
The case ended up closing with a “no change letter,” meaning the IRS accepted the FEIE as originally claimed on the taxpayers’ 2018 federal tax return. Hopefully, the IRS will update their outdated procedures for working FEIE cases and spare others from having to go through this long and stressful ordeal. The moral of the story is, the IRS is just as human as anyone and mistakes will happen, but with vigorous audit representation and a determined mindset, magical things can happen.
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