Individual – Military Contractors
Generally speaking, military contractors working abroad must follow the same rules as civilian US citizens who work abroad. They must report all of their worldwide income on their US expat taxes, they will likely be eligible for an automatic extension of time to file until mid-June, and they may qualify to exclude some of their foreign earned income from US taxation. However, it’s important to realize that there are strict distinctions between military contractors and military employees/armed forces personnel. The latter qualify for numerous tax benefits for which military contractors are ineligible.
Foreign Earned Income Exclusion
One of the most important issues facing military contractors is their eligibility for the Foreign Earned Income Exclusion (FEIE). Being eligible for the FEIE allows a US taxpayer to exclude $90K of foreign earned income from their US expat taxes (adjusted annually for inflation). The FEIE is claimed by filing Form 2555 with your US expat taxes. However, to qualify you must have a “tax home” in a foreign country and meet one of following two tests:
- Physical Presence Test: You must be abroad for at least 330 days in a 365 day period. The 330 days must be full 24-hour days, and not partial days. Also, the 365-day period can be any period prior to the filing date of your tax return. This means that additional extension(s) to file your tax return can be requested in order to help you qualify for this test. As always, an extension of time to file is not an extension of time to pay and all of your US tax liability must be paid to the IRS by April 15th. If your 330-day period includes only a portion of the tax year, then your FEIE will be prorated according to a ratio of number of days in the qualifying period divided by 365.
- Bona Fide Residence Test: This test is met by establishing a permanent residence in a foreign country and maintaining it for a least a full calendar year. Your intention must be to reside in the foreign country for an indefinite period of time.
You can establish a “tax home” by having a primary place of business in a foreign country and by intending to keep that place of business for at least a year. This means that going overseas on a temporary assignment expected to last less than a year would preclude you from qualifying for the FEIE. In the event you do not qualify for FEIE, all of your income will continue to be taxable in the US.
Status of Forces Agreements (SOFAs) exist between some host and foreign countries that provide military support stationed in the host country. Some of these SOFA agreements provide visiting US citizens exclusion from taxation in the host countries. By qualifying for exclusion of host country taxation under a SOFA agreement, you are saying that you are “visiting,” thus telling the IRS that you do not have a “tax home” in the foreign country. Consequently, you cannot qualify for both an exclusion from host country taxation and the FEIE on your US expat taxes.
An income tax exemption provided in a treaty or other international agreement (i.e. SOFA) will not in itself prevent you from being a bona fide resident of a foreign country. Whether a treaty prevents you from becoming a bona fide resident of a foreign country is determined under all provisions of the treaty, including specific provisions relating to residence or privileges and immunities.
Example 1. – You are a U.S. citizen employed in the United Kingdom by a U.S. employer under contract with the U.S. Armed Forces. You are not subject to the North Atlantic Treaty Status of Forces Agreement. You may be a bona fide resident of the United Kingdom.
Example 2. – You are a U.S. citizen in the United Kingdom who qualifies as an “employee” of an armed service or as a member of a “civilian component” under the North Atlantic Treaty Status of Forces Agreement. You are not a bona fide resident of the United Kingdom.
As a taxpayer you are responsible for determining if you are covered under the SOFA or not. If you don’t already know all you need do is ask your employer if the contract you are working on is covered under the SOFA.
Here is a link to the current treaties in force – SOFA
Independent Contractor vs Employee
Whether you are self-employed (an independent contractor) or an employee of a civilian business under contract with the military, you will still be eligible to qualify for the FEIE. If you are an employee of the military, you will not be eligible for the FEIE, but your pay may be excludable under other tax rules (see Combat Zone Exclusion, below). As an independent contractor, you will receive a Form 1099 at the end of the year, and the income reflected on this statement will be subject to self-employment tax. Self-employment tax is not reduced by the FEIE. However, you will be eligible to deduct business expenses from the 1099 income.
Due Date of Tax Return
If you are working overseas on April 15th, you will be eligible for an automatic two-month extension to file your tax return. As mentioned above, this is not an extension of time to pay, only an extension of time to file. You must prepare an estimate of your tax liability and pay the balance by April 15th, even though your final return need not be completed. If you need help preparing an estimate of your US expat taxes, please contact one of our tax professionals. If you do not pay your tax liability by April 15th, you will only be liable for the interest charged on the outstanding US expat tax liability.
You can also request an additional four-month extension by filing Form 4868.
If you need an additional time to meet the Physical Presence Test or Bona Fide Residence test, you can request a special extension via Form 2350. This request is not automatic and must be approved by the IRS.
Combat / War Zone Exclusion
The IRS has regulations in place that allow enlisted military personnel to exclude income earned in a “combat zone” from US expat taxation. As mentioned above, military personnel differ from military contractors. As such, military contractors are not eligible to exclude income earned in a combat zone from their US expat taxes. The IRS lists designated combat zones on their website.
State Filing Requirements
When you work abroad as a military contractor, you might continue to have a state filing requirement depending on your individual state’s rules and whether you have retained ties to that state. If you left the US for an assignment of longer than one year and did not have any source income to a US state during the tax year, you may not have a filing requirement. However, if you have retained a home, family, or driver’s license in the state, then you may continue to have filing requirements.
If you have any questions or need any information, please contact Chuck Heyde at Chuck.Heyde@GEMMS.us or call us directly at 678-625-7641.