US Expat Taxes Explained: Implications for Military Contractors

US Expat Taxes for Military Contractors

If you are a military contractor, you are likely interested in finding out if your expat taxes are categorized as civilian or military. Generally speaking, military contractors working abroad must follow the same rules as civilian US citizens who work abroad. They must report all of their worldwide income on their US expat taxes, they will likely be eligible for an automatic extension of time to file until June 15th, and they may qualify to exclude some of their foreign earned income from US taxation. However, there are strict distinctions between military contractors and military employees/armed forces personnel. The latter qualify for numerous tax benefits, for which military contractors are ineligible. Below, we’ve outlined the most important considerations for expat military contractors.

Foreign Earned Income Exclusion

One of the key tax issues facing military contractors is their eligibility for the Foreign Earned Income Exclusion (FEIE). Being eligible for the FEIE allows a US taxpayer to exclude up to $107,600 of foreign earned income from their US expat taxes for the 2020 tax year ($108,700 for 2021). The FEIE is claimed by filing Form 2555 with your US expat taxes. However, to qualify you must have a “tax home” in a foreign country and meet one of the following two tests:

Physical Presence Test

You must be abroad for at least 330 days within a 365-day period. The 330 days must be full, 24-hour days, and not partial days. Also, the 365-day period can be any period prior to the filing date of your tax return. This means that additional extension(s) to file your tax return can be requested in order to help you qualify for this test.

As always, an extension of time to file is not an extension of time to pay. You need to make sure at least 90% of your taxes are paid by April 15th to avoid interest and a late payment penalty. If your 330-day period includes only a portion of the tax year, then your FEIE will be prorated according to a ratio of the number of days in the qualifying period divided by 365.

Bona Fide Residence Test

To qualify for bona fide residence, you must establish a permanent residence in a foreign country and maintain it for at least a full calendar year. Your intention must be to reside in the foreign country for an indefinite period of time.

Alternatively, you can establish a “tax home” by having a primary place of business in a foreign country and by intending to keep that place of business for at least a year. This means that going overseas on a temporary assignment expected to last less than a year would preclude you from qualifying for the FEIE. In the event you do not qualify for FEIE, all of your income will continue to be taxable in the US. Please keep in mind that if you do not qualify for the FEIE but are required to pay tax to the foreign country in which you work, you will be able to take a foreign tax credit on the income earned and taxed in the foreign country.

Independent Contractor Versus Employee

Whether you are self-employed (an independent contractor) or an employee of a civilian business under contract with the military, you will still be eligible to qualify for the FEIE. If you are an employee of the military, you will not be eligible for the FEIE, but your pay may be excludable under other tax rules (see Combat Zone Exclusion, below).

As an independent contractor, you will receive a Form 1099 at the end of the year, and the income reflected on this statement will be subject to self-employment tax. Self-employment tax is not reduced by the FEIE. However, you will be eligible to deduct business expenses from the 1099 income.

Combat Zone Exclusion

The IRS has regulations in place that allow enlisted military personnel to exclude income earned in a “combat zone” from US expat taxation using the Combat Zone Exclusion. The IRS lists designated combat zones on their website.

As mentioned above, military personnel differ from military contractors. Military contractors are not eligible for the Combat Pay Exclusion as this tax break is available only to enlisted military personnel. However, military contractors can use the FEIE if they qualify via the bona fide or physical presence tests, just like non-military expats.

Furthermore, beginning in 2018, military contractors and their employees can qualify for the Foreign Earned Income Exclusion even if they have an “abode” in the United States. Prior to this change in the tax law, many of the military contractors who lived and worked in designated combat zones failed to qualify for the FEIE because they had an abode in the US.

Due Date of Tax Return

If you are working overseas on April 15th, you will be eligible for an automatic two-month extension to file your tax return. As mentioned above, this is not an extension of time to pay, only an extension of time to file. You must prepare an estimate of your tax liability and pay the balance by the deadline, even though your final return need not be completed at that time.

If you need help preparing an estimate of your US expat taxes, please contact one of our tax professionals. However, if you do not pay your tax liability by April 15th, you will only be liable for the interest charged on the outstanding US expat tax liability. As long as you have paid at least 90% of your tax liability, you will not be charged any penalties. You can also request an additional four-month extension (for a total of six months from the April deadline) by filing Form 4868. This will extend your tax filing date to Oct. 15th.

If you need additional time to meet the Physical Presence Test, you can request a special extension via Form 2350. This request is not automatic and must be approved by the IRS.

State Filing Requirements

When you work abroad as a military contractor, you might continue to have a state filing requirement depending on your individual state’s rules and whether you have retained ties to that state. If you left the US for an assignment of longer than one year and did not have any source income to a US state during the tax year, you may not have a filing requirement. However, if you have retained a home, family, or driver’s license in the state, you may continue to have filing requirements.

Questions About Your US Expat Taxes?

With so much to consider for military contractors, you may be left with questions specific to your situation. Set up a consultation with us today and we’ll help to answer any of your questions and talk through what you’ll need to do for next steps in the expat tax filing process.