Elena and Frederick Weschenfelder v. Comm., TCM 2019-133

Elena Lea Morgan Weschenfelder and Frederick Burkhart Weschenfelder were employed by CACI Premier Technology, Inc. (CACI) and Sycoleman Corp. in Iraq during 2004 and 2005. They lived and worked full-time on a military base, living in Republican Guard barracks. The Weschenfelders were employed as intelligence analysts. Their jobs involved strategic and tactical intelligence, and they worked with the Iraqi interim government to help identify threats and coordinate safe passage and gatherings within the country. In 2006, they moved to Germany, where they continued to work for CACI.

Returns claiming the exclusion were delinquent. The Weschenfelders failed to file their 2004, 2005, and 2006 returns. When they failed to file US tax returns, the IRS prepared “substitute” tax returns for the Weschenfelders for the three years at issue. The Weschenfelders submitted delinquent returns on Jan. 8, 2016. Each return showed a Texas address. The return for 2004 did not include a Form 2555, although reference to such a form was made on the first page of the return. The 2005 return included separate Forms 2555 for each spouse, and the 2006 return included a Form 2555 for Mr. Weschenfelder. On line 9 of each Form 2555, the Weschenfelders reported their tax home as a Texas address established in March 2001. They claimed foreign earned income exclusions of $140,109, $103,202, and $71,929 for 2004, 2005, and 2006, respectively.

IRS disallowed foreign earned income exclusion on delinquent return. The IRS claimed that the Weschenfelders were not entitled to the foreign earned income exclusion because that exclusion is only available if a taxpayer makes an election on a timely filed income tax return, an amendment to a timely filed return, or within one year after the due date of the return (§1.911-7(a)(2)). In this case, the Weschenfelders did not file timely returns.

When is the election to exclude foreign earned income “timely filed”? The opening words of §911(a) “At the election of a qualified individual” make clear that the taxpayer must affirmatively elect to exclude the foreign earned income from his or her gross income. The regulations at §1.911-7(a)(2) provide four alternative timing methods by which a taxpayer may validly make the election. The election must be made with:

• A later return filed within the period prescribed in §6511(a) amending the foregoing timely filed income tax return,
• An original income tax return that is filed within one year after the due date of the return (determined without regard to extension of time to file),
• An income tax return filed after the period described above if the taxpayer owes no federal income tax after taking into account the exclusion and files Form 1040 with Form attached either before or after the IRS discovers that the taxpayer failed to elect the exclusion, or
• An income tax return filed after the period described above if the taxpayer owes federal income tax after taking into account the exclusion and files Form 1040 with Form attached before the IRS discovers that the taxpayer failed to elect the exclusion.

Required statement missing. Because the Weschenfelders owed tax on their delinquent 2004 and 2005 tax returns, their election was not timely filed. Although they did not owe tax on their 2006 return, the Weschenfelders’ failure to type or print the statement specified in §1.911-7(a)(2)(i)(D)(3) on the top of the return for that year (and those for 2004 and 2005) was fatal.

Tax practitioner planning. If filing a late return with the exclusion, print the following statement at the top of the first page of the Form 1040: “Filed Pursuant to §1.911-7(a)(2)(i)(D).”

Also see.

Damon Redfield v. Comm., (TCM 2017-71), where the exclusion was disallowed on Damon’s late filing because the IRS had already filed a “substitute for return” for the year in question.