Ok gang, this is important and please feel free to pass this around.  This contractor lost in this case and the one thing that saved his bacon was this little memo that came from an IRS Acting Deputy Director in 2004.  If you filed your taxes with the impression that you fell under the same ‘combat zone compensation’ that the members of the Armed Forces received back then, then this memo could be your life saver. If anyone has a copy of this thing, I will make an edit and add it to this post so everyone knows where to find it. Robert L. Hunt was the IRS Acting Deputy Director at the time.

     The other point I wanted to bring up here is this. The powers that be are certainly trying all they can to put us under military/government control or under UCMJ, but god forbid if contractors actually enjoyed the same tax benefits as the Armed Services in combat zones? –Matt

Edit: 02/06/2011 – Thanks to Chris for sending me a copy of this memo.  I put it up in my Scribd account here if you want to check it out.

Court: Blackwater Contractor in Iraq Cannot Exclude Compensation Under § 112

By The Tax Prof

February 1, 2011

The Tax Court yesterday held that a Florida man who earned $98,400 in 2005 working for Blackwater (since renamed Xe) providing security services to the U.S. Army in Iraq could not exclude the compensation from income under § 112 as “combat zone compensation of members of the Armed Forces.” Holmes v. Commissioner, T.C. Memo. 2011-26 (Jan. 31, 2011). The Tax Court concluded that the taxpayer did not serve in the Armed Forces of the United States but instead was a private citizen hired by and paid by a private company (Blackwater). The Tax Court refused to impose a penalty because the taxpayer relied on an IRS memorandum wrongly stating that civilian personnel in direct support of combat zone military operations qualified for the § 112 exclusion.

Link to TaxProf blog post here.

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From the Tax Court memo Holmes v. Commissioner, Page 9

     Petitioner admitted on brief that he did not file a return for calender year 2005.  Petitioner’s only explanation for failing to file is that in 2005 while in Iraq, he was given a memorandum that caused him to believe that the income he was receiving from Blackwater was not taxable.  This memorandum was an internal memorandum written to give the Commissioner’s employees field guidance for examination and collection activity involving taxpayers in Iraq.  The memorandum, titled “Memorandum for Acting Deputy Director, Compliance Field Operations”, was issued by the Internal Revenue Service Small Business/Self-Employment Division on June 28, 2004.  The memorandum states that civilian or military personnel who are in direct support of a combat zone military initiative and physically located in the combat area are entitled to the exclusion.  It also states that time spent in a combat zone by an individual serving in support of the Armed Forces will be disregarded with respect to “certain acts required under the Internal Revenue Code.”  It goes on to state that “This change in procedure will be reflected in the next revision of the IRM, which is in the process of being written.”

     Petitioner satisfies all the criteria found in the memorandum.  He was serving in Iraq alongside the military, provided security to Government officials, and aided in giving air support, medical aid, and emergency response assistance. Petitioner had no background in tax law and was given this memorandum written by an IRS employee while serving in Iraq.  We believe that receiving this memorandum while serving in Iraq could give someone reasonable cause to believe that his payments from Blackwater were excluded from gross income.  Therefore, petitioner is not liable for the addition to tax under section 6651(a)(1).

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From the Judicial Review

     While in Iraq, petitioner was given a memorandum issued by Robert L. Hunt, the Acting Deputy Director, Compliance Field Operations, Internal Revenue Service (IRS). This memorandum discussed the appropriate steps for civilian personnel to take when engaged in an IRS examination and collection activity involving a taxpayer deployed to a Qualified Combat Zone. Petitioner did not remember who gave the memorandum to him.