US seafarers can claim the Foreign Earned Income Exclusion (FEIE), which allows US citizens who live and work outside of the US to claim 100% tax relief on the first $101,300 earned in 2016. The amount of income which tax relief can be claimed on increases annually in line with inflation. However, the IRS require you to meet certain conditions in order to qualify for this exemption.
The FEIE can be claimed if your ‘tax home’ is in a foreign country. This is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. This test is normally not that difficult to meet, but if you have moved to a foreign country with no definite plans to move back, your tax home has almost certainly moved as well.
However, complications arise surrounding establishing a tax home in a foreign country when you consider this in the context of a yacht. The term ‘foreign country’ is important to FEIE but the Code does not exhaustively define it which leaves it open to interpretation through established precedents. The Regs. §1.911-2(h) provides that the term ‘foreign country’ includes:
‘Any territory under the sovereignty of a government other than that of the United States. It includes the territorial waters of the foreign country determined in accordance with the laws of the United States), the air space over the foreign country, and the seabed and subsoil of those submarine areas which are adjacent to the territorial waters of the foreign country and over which the foreign country has exclusive rights, in accordance with international law, with respect to the exploration and exploitation of natural resources.’
The reason that some yacht crew choose not to claim this tax exemption is due to the fact they do not believe that they are eligible for it. This is largely due to the uncertainty surrounding whether territorial waters constitute foreign territory. However, in Bebb (1961) the US Tax Court upheld this notion:
'It is petitioner's contention that being aboard a foreign vessel as a member of that vessel's crew is tantamount to being in the foreign country under which the vessel was registered, since petitioner was subject to the laws of that foreign nation and since he was traveling over international waters. Petitioner contends he was, therefore, present in a foreign country as required by the statute. Petitioner contends that the 510-day provision of the current statute is a modification of predecessor statutes and that Congress intended that physical absence from the United States for the required time be sufficient to bring individuals within the statute.'
Individuals wishing to claim the FEIE must also qualify under the Physical Presence Test (the PPT) and the Bona fide Residence Test (the BRT). These tests are designed to ensure that your stay outside of the U.S is sufficiently lengthy to warrant your claim for the FEIE.
PPT requires individuals to be outside of the US for at least 330 days during any 12-month period. Any day spent traveling to or from the U.S. does not count as a day of physical presence in a foreign country. If you meet the PPT, you can claim the FEIE for the parts of each tax year that fall within that 12-month period. The amount of income you can exclude with the FEIE is pro-rata based on the number of days in the tax year that you qualify.
BRT requires individuals establish a bona fide residence in a foreign country for an uninterrupted period that includes an entire taxable year. If you move on board a yacht and intend to make it your home for the foreseeable future (even if you intend to eventually return to the U.S. at some indeterminate point), then you will have established a bona fide residence and therefore meet the BRT.
Once the BRT has been met you are no longer restricted to 35 days back in the U.S. each year. You could spend several months back in the U.S. and still meet the BRT as long as you haven’t actually moved back and abandoned your residence in the foreign country. The exact guidelines are lacking here, but it would be hard to argue that you maintain a bona fide residence in a foreign country if you spend more than six months each year in the U.S.
The FEIE is open to crewmembers who spend more than 330 days out of the US, work on foreign-flagged vessels in foreign territorial waters and spend sufficient time on board their respective vessel to qualify under the BRT. If you feel that you may be eligible for this exemption, you need to act and claim this. The FEIE can also be claimed for previous years so it would be advisable to start the year by choosing to tackle that nagging problem - tax!
Any tax advice in this publication is not intended or written by Marine Accounts to be used by a client or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing or recommending to another party matters herein.
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