These newsletters come out about this time every year and they are a wealth of information. Probably the big one here is Luke’s suggestion of setting up a S Corp. Especially with the increased scrutiny by the IRS on those who have been claiming the foreign income exclusion.
Check it out below and definitely email him and his team if you have questions or are looking for a CPA. As you can see, he is a busy guy and Luke has partnered with another CPA to keep up. I also put his newsletter in the blue bar up top under Taxes For Contractors if you need to find it again. –Matt
Greetings!
For all you ex-teams, ex-pats, ex special forces, security contractors and operators out there I hope this letter finds you well. In an attempt to keep you current with your tax filings I am sending out this letter as a year end reminder that 2011 is almost over. There are some important new tax law changes this year such as the foreign tax being withheld in Afghanistan and increased IRS scrutiny of the foreign income exclusion and on Schedule C filers which I will address below. Feel free to pass this email on to anyone in your situation who could use the help or anyone that I missed on this email. As always, I will do my best to minimize your tax bill and provide relevant advice for your situation.
Important Updates for 2011:
1) Audits on the foreign income exclusion have greatly increased. Those of you filing a Schedule C as an IC seem to be of particular interest. This is due to the IRS opening a new office specifically dealing with this type of tax return. In a typical audit, you are asked to provide some or all of the following:
a. A letter from your employer stating your work location and job duties for the year.
b. Letter of Authorization from the DOD stating your qualification to work overseas.
c. Copy of your passport to include any visa stamps.
d. A schedule of days outside the US for the period in question.
e. A copy of receipts for expenses claimed as deductions.
f. A copy of your work contract.
g. If claiming bona fide residency, they want to know where you lived, for how long and if it was your intention to remain overseas for a certain period.
2) Based on these audits, I strongly recommend starting an S Corporation for anyone who is an IC getting a 1099. This appears to greatly reduce audit risk. Additionally, if you do not think you could provide the above information or prove your qualification think twice about claiming it as you will most likely incur a 10 – 20% penalty on the additional tax due.
3) Audit results have varied and can depend on who the auditor is. I have had excellent (100%) success in proving the foreign income exclusion but have had issues with claiming a per diem deduction. In particular, the IRS appears to be most interested in contractors working for Blackwater or US Training Center. This may relate to an IRS enquiry into the pay structure at BW and USTC which has led to an audit of some of you, unfortunately.
4) As a result of the above, I will be more cautious claiming any per diem deductions this year. Therefore, if you’ve claimed a per diem deduction in prior years, you may notice a significant increase in your tax liability if the per diem deduction is decreased in the current year.
5) Afghanistan Tax. Afghanistan is withholding a 20% tax on income earned in the country by foreign personnel. This is definitely happening if you are an employee and most of you were paid more to cover this tax but that amount is then subject to US tax as well. I am not sure if it is happening to ICs. This brings up some new issues:
a. Tax paid to a foreign country can be claimed as a credit on your US tax return (Form 1116).
b. The credit can be combined with the foreign income exclusion if you qualify but the foreign tax credit is partially reduced when both are used, making this a complex calculation.
c. In general, claiming the tax credit on foreign tax paid is a better tax break than the foreign income exclusion alone meaning that if you are nervous about claiming the foreign income exclusion, you can skip it and still get about 85% of the tax break you would have received by claiming both.Based on the most common questions I was asked last year, let me briefly cover the points most relevant to your situation. The following is a rundown of how your tax situation differs from someone working in the states.
1) Generally you will receive the first $92,900 (for 2011) of your income earned in a foreign country tax free provided that:
a. You were physically present in a country other than the U.S. for at least 330 days out of a 365 day period. This does not have to have been in the 2011 calendar year as a prorated partial exclusion can be obtained by extending your tax return until the 330 day period is up. You will still only file using the 2011 calendar year income but your test period for the physical presence test may run from June 2011 – June 2012 or any other dates spanning 365 days.
b. You were a bona fide resident of a country other than the U.S. during 2011. Many of you have received residency Visas from Iraq this year. This is good proof that could be presented to the IRS if needed but alone does not guarantee that you qualify under this method. Filing under this method requires that you are a foreign resident for the full year starting Jan 1. No partial year exclusion is available.
2) Filing Form 673… all that filing this form will do is exempt you from tax withholding; contrary to rumor it is NOT required to claim NOR does it qualify you to claim the foreign income exclusion. Additionally, some companies now add the cost of travel, incidentals, meals, reimbursements, etc to the taxable income of employees filing Form 673. This causes you to be taxed on income that you never received. The best alternative to regulate tax withholdings is to file a Form W4 with your payroll department and claim a large number of allowances on line 5. Generally between 9 and 15 allowances will have enough withheld to cover your tax bill but you can also write in “exempt” or claim up to 99 allowances to drop withholding to close to zero if you do not expect to owe any tax.
3) Keep a list of job related expenses – these are deductions for you. This can include travel, meals, weapons, supplies, body armor, computer, auto, telephone, postage, etc. A simple spreadsheet with yearly totals is the best way to provide this to me. Please do not send receipts when possible; I can provide a very simple spreadsheet template for you to record your eligible expenses. See #4 below for a caution if you are an employee.
4) Expenses…many of you may have changed from working as an IC to an IE or vice versa. There is a vast difference in what can be deducted. As an IC (you receive a 1099), all expenses related to your work are deductible. As an IE (you receive a W2), only expenses required by your employer but not reimbursed are allowed as deductions and under audit the IRS will require a letter from your company detailing this. Needless to say, this is impossible to obtain from many of the companies. You can continue to deduct work related expenses as an IE but be aware that deducting too much can quickly put you on the radar.
5) You are generally eligible for an additional extension of time to file and pay your taxes. You have 180 days from the time you return to the states to file any missing tax returns without penalty if you were in a combat zone. That being said, file on time if you can; it keeps you off of the IRS radar.
6) If possible, get an address in a tax free state and use this as your U.S. address. This may save you some money on your state taxes. Tax free states are TX, FL, AK, NV, WA, and TN. This will not work if you have a house and family in another state. CA and HI are the worst as they do not allow the foreign income exclusion; pay attention if you live here but have the option to claim residency in another state.
7) I am getting a lot of questions about starting S-corps and LLCs for those of you working as ICs. This is a good move in most cases as properly structured it allows you to save about 50% of what you pay in self-employment tax. This is usually about a $7k savings on income of $100k.
8 ) Lastly, what will I need from you? Every situation varies but in general I will need W-2s, 1099s, amount added to income due to the 673, list of work related expenses, foreign address and city you worked out of and any other tax documents you receive relating to home mortgages, property taxes, investments and other income.Now for Xe (XPG), MVM, US Training Center and other ICs working for companies paying you as an independent contractor (1099): Do not forget that the IRS will take 15% right off the top of your net income as self-employment tax. You will also pay regular income tax on the earnings. In addition, the foreign income exclusion of $92,900 does not apply to the self employment tax calculation even though you will get the exclusion in the calculation of income tax. This can result in a very large, very surprising tax bill. Be aware of this and plan accordingly when saving for taxes.
* For 2011, I am continuing to bill through ACH Withdrawal. I will ask you to provide me with your bank account number and routing number (which many of you do already for refund purposes). Once you approve the invoice, I will have the bank auto draft your account for the fee. This has greatly simplified invoicing for me and hopefully you as well. More importantly it gives me more time to focus on tax issues rather than tracking collections. Of course if you would still like to pay by check or Paypal, just let me know as that is fine as well.
** Thank you all for the countless referrals each and every year. It allows me to keep my prices low for you. It can be difficult to get correct tax advice and tax preparation when working overseas as there is a lot of misinformation, confusion and lack of knowledge concerning your situation. Referrals let me know I am doing a good job for you. Due to work overload, I have been forced to pass some new referrals to Chris Hughes, who is a partner CPA in my office with the same knowledge concerning your situation that I have. I would love to continue working with all new referrals but it will take away from the service level I want to provide to current clients. Working with Chris will be virtually the same as working directly with me. Continue to refer anyone needing help directly to me and I will redirect them as needed based on my workload.
Happy New Year! I look forward to hearing from each of you. Stay safe.
Luke M. Fairfield
Certified Public Accountant
Luke@FairfieldCPAs.com