Foreign Nationals & Expats
Houston Tax Attorney
Foreign Earned Income Exclusion – Late Elections
Can the foreign earned income exclusion be elected on a late-filed return? Redfield v. Comm’r, T.C. Memo 2017-71 (T.C. April 26, 2017) answers this question.
Below are the facts in the case:
- Taxpayer worked in a civilian position at Kandahar Air Field in Kandahar Province, Afghanistan in 2010
- Taxpayer received an extension of time until October 15, 2011, to file his 2010 Federal income tax return
- Since taxpayer did not file his 2010 tax return, in 2014 the IRS prepared a substitute for return (SFR)
- Subsequently, the taxpayer submitted to the IRS a delinquent return for 2010 on which he included with this return Form 2555, Foreign Earned Income Exclusion to exclude his foreign income
- The IRS disallowed petitioner’s claim for a foreign earned income exclusion (FEIE) because he had not elected to exclude foreign earned income on a prior Federal income tax return and had failed to make a valid election for 2010.
Foreign earned income exclusion – timely filing requirement
In addition to satisfying the tests for foreign earned income exclusion the taxpayer must also make a timely “election” to exclude foreign earned income.
Treasury Reg. 1.911-7(a)(2), establishes the timing requirements under which a valid election can be made.
In general, an election to claim foreign earned income exclusion must be made on an income tax return that is timely filed (including any extensions of time to file). The IRS allows a grace period – the exclusion may be claimed on an income tax return that is filed within one year after the due date of the return.
For taxpayers that are claiming the exclusion on a tax return that is more than 1 year late, the foreign earned exclusion may be elected if:
- The taxpayer owes no federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached either before or after the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion; or
- The taxpayer owes federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached before the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion.
A taxpayer filing an income tax return pursuant to either of these sections must type or legibly print the following statement at the top of the first page of the Form 1040: “Filed Pursuant to Section 1.911-7(a)(2)(i)(D).”
In Redfield, taxpayer conceded that the foreign earned income was not timely elected. The issue was whether the taxpayer qualified under one of the alternative timing methods. Since taxpayer did owe taxes after the foreign earned income exclusion, the question was whether taxpayer filed the Form 1040 with Form 2555 before the IRS discovered that the taxpayer filed to elect the exclusion.
The court reasons that because the IRS filed a substitute return, it effectively discovered the taxpayer’s failure to make a timely election. Therefore no relief is available under the alternative timing methods, and taxpayer is not allowed to now claim the foreign earned income exclusion.
By preparing for petitioner on May 27, 2014, an SFR that treated all of his wages for 2010 as gross income, the IRS evidenced its “discovery” that he had failed to elect the FEIE for that year by filing a Form 1040 accompanied by a properly completed Form 2555. Petitioner did not file his delinquent 2010 return accompanied by a Form 2555 until October 7, 2014, more than four months later.
As to whether a taxpayer who does qualify for the exclusion under one of the alternative timing methods but fails to type or legibly print “Filed Pursuant to Section 1.911-7(a)(2)(i)(D)’”, the court does not decide whether that would invalidate an FEIE election. Likely it should not invalidate an election based on a technicality alone. Moreover, a taxpayer could simply file an amended return to include the language, for example, if the FEIE return is filed late but owes no taxes after the election, regardless of whether it’s filed before or after the IRS discovers the failure to make the election.