rr-04-28.pdf

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Part I -1986 Code

Section 911---Citizens or Residents of the United States Living Abroad:
(Also: 6662, 6663, 6702)

Rev. Rul. 2004-28

PURPOSE

The Service is aware that some taxpayers are attempting to reduce their federal
tax liability by taking the position that their wages or other income are excluded from
gross income under section 911 of the Internal Revenue Code because the State,
Commonwealth, or Territory of the United States in which they resided or performed
services is a foreign country. The Service also is aware that promoters, including return
preparers, are advising or recommending that taxpayers take frivolous positions based
on this argument. Some promoters may be marketing a package, kit, or other materials
that claim to show taxpayers how they can avoid paying income taxes based on this
and other meritless arguments.

This revenue ruling emphasizes to taxpayers, and to promoters and return
preparers who assist taxpayers with this scheme, that there is no basis under section
911 for excluding income earned in a State, Commonwealth, or Territory of the United
States. This argument has no merit and is frivolous. Section 911 of the Internal
Revenue Code permits a taxpayer to elect to exclude income from gross income U.S.
income tax purposes only when the taxpayer earns income and resides outside the
United States under the conditions and limitations set forth in that section. For
purposes of section 911, States, Commonwealths, and Territories of the United States
are not foreign countries.

The Service is committed to identifying taxpayers who attempt to avoid their tax
obligations by taking frivolous positions, such as frivolous positions based on meritless
section 911 arguments. The Service will take vigorous enforcement action against such
taxpayers and against promoters and return preparers who assist taxpayers in taking
these frivolous positions.

Frivolous returns and other similar documents submitted to the Service are
processed through its Frivolous Return Program. As part of this program, the Service
confirms whether taxpayers who take frivolous positions have filed all of their required
tax returns, computes the correct amount of tax and interest due, and determines
whether civil and criminal penalties should apply. The Service also determines whether
civil or criminal penalties should apply to return preparers, promoters, and others who
assist taxpayers in taking frivolous positions, and recommends whether a court

injunction should be sought to halt such activities. Other information about frivolous tax
positions is available on the Service website at
www.irs.gov
.

ISSUE

Whether an individual may exclude income under section 911 by claiming that he
met the requirements of section 911 because a State, Commonwealth, or Territory of
the United States is considered to be a foreign country under section 911.

FACTS

Situation 1. A, an individual, resides in State X, a State or Commonwealth of the
United States, and performs services exclusively in State X. A was present in State X
for all of his taxable year and is therefore not eligible in that taxable year for the
exclusion from income under section 911 for citizens or residents of the United States
living abroad. Based on the advice of a person who promotes the view that section 911
excludes income earned in a State, Commonwealth, or Territory of the United States
because such State, Commonwealth or Territory is a foreign country, A files a return
including a Form 2555, Foreign Earned Income, or a Form 2555-EZ, Foreign Earned
Income. On the Form 2555 or Form 2555-EZ, A asserts that he is entitled to the
exclusion from gross income under section 911 because he earned such income by
performing services in, is a bona fide resident of, and has a tax home in, a foreign
country (
i.e.
, State X). A acknowledges on Form 2555 or Form 2555-EZ that the
services were performed in State X and that he was a bona fide resident of State X, but
contends that State X is a foreign country and not a part of the United States.

Situation 2. Same as Situation 1 except that A, a resident of State X, claims an
exclusion from gross income under section 911 based upon his physical presence in
State X. Specifically, A claims he satisfies the physical presence test of section 911
because he was physically present in a foreign country for at least 330 days during his
taxable year. A acknowledges on Form 2555 or Form 2555-EZ that he was present in
State X, but contends that State X is a foreign country and not a part of United States.

Situation 3. B, an individual, performed services in and resided on Johnston
Island, one of the islands on Johnston Atoll. The Johnston Atoll is a Territory of the
United States. B files a U.S. Federal Income Tax Return with a Form 2555 or a Form
2555-EZ in which he asserts that he is entitled to the exclusion from gross income
under section 911 because he performed services in, is a bona fide resident of, and has
a tax home in, a foreign country (
i.e.
, Johnston Atoll).

LAW AND ANALYSIS

Section 911 allows individuals that meet its requirements to elect to exclude from
gross income certain foreign earned income. To qualify for the exclusion under section
911, a U.S. citizen or resident working abroad must have a tax home in a foreign
country and satisfy either the bona fide residence test or the physical presence test.

For purposes of section 911, States, Commonwealths, and Territories of the United
States are not foreign countries. Treas. Reg. § 1.911-2(g) & (h).

In the situations described above, A and B do not meet the requirements for the
exclusion from gross income under section 911. The claim that section 911 excludes
income earned in a State, Commonwealth, or Territory of the United States because
such State, Commonwealth or Territory is a foreign country has no basis in law or fact.
Courts repeatedly have rejected similar arguments as frivolous, imposed penalties for
making arguments such as these in court, and upheld criminal tax evasion convictions
against individuals making such arguments. Courts repeatedly have rejected similar
arguments as frivolous, imposed penalties for making arguments such as these in court,
and upheld criminal tax evasion convictions against individuals making such
arguments.
See
, e.g., In re Becraft, 885 F.2d 547, 549-50 (9th Cir. 1989) (rejecting the
claim that federal law governs only the District of Columbia and U.S. territories and
sanctioning attorney for making frivolous arguments);
United States v. Ward
, 833 F.2d
1538, 1539 (11th Cir. 1987) (affirming tax evasion conviction and noting that claim that
federal law applies only the District of Columbia, federal enclaves within States and U.S.
territories is "utterly without merit").

CIVIL AND CRIMINAL PENALTIES

In determining the correct amount of tax due, the Service will include income that
taxpayers attempt to exclude based on frivolous section 911 arguments. In addition to
liability for tax due plus statutory interest, individuals who claim tax benefits on their
returns based on this and other frivolous arguments face substantial civil and criminal
penalties. Potentially applicable civil penalties include: (1) the section 6662 accuracy-
related penalty, which is equal to 20 percent of the amount of taxes the taxpayer should
have paid; (2) the section 6663 penalty for civil fraud, which is equal to 75 percent of the
amount of taxes the taxpayer should have paid; (3) a $500 penalty under section 6702
for filing a frivolous return; and (4) a penalty of up to $25,000 under section 6673 if the
taxpayer makes frivolous arguments in the United States Tax Court.

Taxpayers relying on this scheme also may face criminal prosecution for: (1)
attempting to evade or defeat tax under section 7201 for which the penalty is a fine of
up to $100,000 and imprisonment for up to 5 years; or (2) making false statements on a
return under section 7206 for which the penalty is a fine of up to $100,000 and
imprisonment for up to 3 years.

Persons who promote this scheme and those who assist taxpayers in claiming
tax benefits based on this scheme also may face penalties. Potential penalties include:
(1) a $250 penalty for each return prepared by an income tax return preparer who knew
or should have known that the taxpayer’s argument was frivolous (or $1,000 for each
return where the return preparer’s actions were willful, intentional or reckless); (2) a
$1,000 penalty under section 6701 for aiding and abetting the understatement of tax;
and (3) criminal prosecution under section 7206 for which the penalty is a fine of up to
$100,000 and imprisonment for up to 3 years for assisting or advising about the

preparation of a false return or other document under the internal revenue laws.
Promoters and others who assist taxpayers in engaging in these schemes also may be
enjoined from doing so under section 7408.

HOLDING

Any position that the exclusion from gross income under section 911 applies to a
taxpayer’s income because a State, Commonwealth, or Territory of the United States is
considered to be a foreign country is frivolous. Taxpayers attempting to reduce their
federal tax liability by taking frivolous positions based on this argument will be liable for
the actual tax due plus statutory interest. In addition, the Service will determine civil
penalties against taxpayers where appropriate, and those taxpayers also may face
criminal prosecution. The Service also will determine appropriate civil penalties against
persons who prepare frivolous returns or promote frivolous positions, and those persons
also may face criminal prosecution. Promoters and others who assist taxpayers in
engaging in these schemes also may be enjoined from doing so under section 7408.

DRAFTING INFORMATION

This revenue ruling was authored by the Office of Associate Chief Counsel
(Procedure and Administration), Administrative Provisions and Judicial Practice
Division. For further information regarding this revenue ruling, contact that office on
(202) 622-4910 (not a toll-free call).