Flight Attendant Based in Hong Kong Could Not Exclude All Earnings As Foreign Earned Income

If a U.S. citizen is a flight attendant based out of Hong Kong, can she exclude all of her income using the foreign earned income exclusion under IRC §911?  The taxpayer in the case of Rogers v. Commissioner, Docket No. 13-1241, CA DC Circuit took that position—but neither the Tax Court nor the Court of Appeals for the DC Circuit agreed with her.

The taxpayer in question was assigned as an employee to Hong Kong by United Airlines.  Ms. Rogers flew and worked in and over foreign countries, international waters and the United States.  In the year in question she flew a total of 74 flights between destinations in Asia and the United States.

The airline provided Ms. Rogers with an apportionment of her estimated duty time based on minutes spent:

·      In and over foreign countries;

·      Over international waters; and

·      In and over the United States

The taxpayer treated all of her income as eligible for exclusion as foreign earned income.  The taxpayers argued that IRC §911 allows them to exclude all of her earnings as foreign earned income because it came from sources within a foreign country.

IRC §911(b)(1)(A) defines foreign earned income as “the amount received by such individual from sources within a foreign country or countries which constitute earned income attributable to services performed by such individual” during the applicable time period.  As her income came from her job based in Hong Kong, the taxpayer took the position that all of her income came from sources within a foreign country.

Reg. §1.911-3(a) interprets the above provision, providing “Earned income is from sources within a foreign country if it is attributable to services performed by an individual in a foreign country or countries. The place of receipt of earned income is immaterial in determining whether earned income is attributable to services performed in a foreign country or countries.”

A key question becomes—does the above regulation “go too far” in interpreting the law, or is it a reasonable interpretation of what is an ambiguous rule.  The Court of Appeals, agreeing with the Tax Court, finds that it does not go too far.  Rather, the Court notes:

The IRS's regulatory limitation of income "from sources within a foreign country" to income attributable to services performed in a foreign country accords with the language of Section 911, particularly in light of the "default rule of statutory interpretation that exclusions from income must be narrowly construed." Schleier, 515 U.S. at 328 (internal quotation marks omitted). Furthermore, the regulation harmonizes with related sections of the Internal Revenue Code, in which the phrase "income from sources within" generally limits personal services income to income earned from services "performed in" a given jurisdiction. See 26 U.S.C. § 861(a)(3) (defining income from personal services as being "from sources within the United States" if those "labor or personal services [are] performed in the United States"); id. § 862(a)(3) (defining income from personal services as being "from sources without the United States" if those "labor or personal services [are] performed without the United States"). The IRS's regulation and its application here simply mirror the use of similar "source" language in related sections of the Code, where "the source of income is the place where the services are performed." Tipton & Kalmbach, Inc. v. United States, 480 F.2d 1118, 1120 (10th Cir. 1973).

In any event, the panel notes that the taxpayers did not explicitly challenge the validity of the regulation in the case.  If it is accepted that the regulation is a reasonable interpretation of §911, the taxpayer’s exclusion is going to fail.

In this case the taxpayer could only exclude the proportion of her time that represented time in and flying over foreign countries, but not any time flying over international waters or the United States, nor time performing services on the ground in the United States.  The fact she was based in Hong Kong was not relevant.

Some may be wondering about the international waters portion that was deemed taxable—after all, that’s outside the United States?  While that is true, the exclusion is not for earned income outside the United States but that from sources in a foreign country.  And, per Reg. §1.911-2(h), a foreign country is limited to territory under the sovereignty of a government other than that of the United States, the territorial waters of such country and its airspace.  Thus the airspace over international waters is not part of a foreign country, so any amounts earned for that time is also not excludable.