by: Tom Andrews, CPA
Every year I meet with clients who say to me “I heard if I am living outside the United States for 183 days I am not required to pay taxes…” I believe this is one of the most common tax related myths in the yachting industry. This myth is so often repeated because many nonresident crewmembers are not required to pay taxes when they are living outside of their home country for more than 183 days (although this is changing). Since many crewmembers compare notes many are under the impression that tax law is universal and mistakenly feel they might also be exempt from paying tax.. it also doesn’t help that many yacht payroll companies are not properly withholding tax from the American crewmember salary.
While it is true that simply living outside the United States for 183 will not exempt you from taxes there is a provision of the tax code that allows Americans to exclude from gross income up to $102,100 (in 2017) of foreign earned income. In order to qualify for these exclusions, an individual’s tax home must be in a foreign country and he must meet either a residence or physical presence test. A determination of whether a taxpayer qualifies is based on all the facts and circumstances including but not limited to the following:
- The taxpayer’s intention of returning to the United States
- The length of stay in a foreign country,
- The nature and duration of employment,
- The establishment of a home in the foreign country, and
- The nature, extent and reasons for temporary absences from the foreign home.
Most yacht crewmembers will not qualify for the foreign earned income exclusion based on foreign residency simply living on a vessel while it is passing through a foreign jurisdiction does not make the crewmember a resident of that country. Normally crewmembers are qualifying for the exclusion under the “physical presence test”. The physical presence test requires that the crewmember be living and working outside the United States for 330 out of 365 days, time spent in international water does not count and you must be in the territorial waters of a foreign county during this time.
The burden of proof is on the taxpayer to substantiate eligibility for the foreign earned income exclusion a taxpayer must have adequate documentation. The IRS plans to improve compliance on international issues and expects to increase the use of foreign information documents and data sharing with other federal agencies. For instance, travel dates may be verified with U.S. passport information, vessel log book, and affidavit from employer. I normally recommend a crewmember keep a diary with all proper documentation that supports the claim of a foreign earned income exclusion, normally an audit takes place several years after the tax year has ended, by then the crewmember may have already left the vessel and may not have access to all of the necessary documentation needed to support their claim for the foreign earned income exclusion.
It should also be noted that the exclusion may cross between years, if the crewmember was out of the country from June 30th of 2016 through July 1st of 2017 they still might qualify for a partial exclusion for each year as the look back period is 330 out of the 365 days.