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U.S. Service Members at NATO Can't Exclude Pay From Taxes

By Jim Garamone
American Forces Press Service

WASHINGTON, Aug. 5, 1999 – U.S. service members assigned to NATO are employees of the United States and cannot use the foreign earned income exclusion to escape taxes on their military pay.

The Internal Revenue Service announced its decision in a letter to DoD July 23.

Foreign earned income includes pay received for services performed as an employee in a foreign country, but does not include amounts paid by the United States to its employees, said Air Force Lt. Col. Tom Emswiler, executive director of the Armed Forces Tax Council in the Pentagon.

There had been some confusion in the IRS about this matter -- IRS specialists erroneously told some military members working at NATO activities that they could use the foreign earned income exclusion.

The confusion comes from a Tax Court decision in the 1995 case of Adair vs. the Commissioner of Internal Revenue. William Adair was a U.S. Army civilian employee who transferred to NATO. The court allowed Adair to use the foreign earned income exclusion. "Even though the United States paid his salary, the Tax Court said Adair's transfer to NATO caused him to become an employee of NATO and no longer one of the United States.

Emswiler said certain unique facts apply to Adair's case that do not apply to U.S. uniformed personnel. Adair transferred under a special program that allows a U.S. civilian employee to become an employee of an international organization. Under the terms of his employment, Adair swore an oath of complete loyalty to NATO and NATO could fire him. If he were fired, he would be out of a job. None of these things is true for uniformed service members.

Still, since 1995 some uniformed personnel have claimed the foreign earned income exclusion. In a cursory look at its records, the IRS found 30 returns that erroneously used this provision. "I expect there to be more," Emswiler said. He said the confusion has not been limited to NATO headquarters in Belgium, but in Naples, Turkey or any base where U.S. service members serve with NATO.

The ruling only affects military pay. Service members can still exclude pay earned from a second job, for example. It also does not affect provisions for excluding pay for service in a combat or hazardous duty zone.

Uniformed members assigned to NATO sites who relied on the Adair case to support the exclusion of their military pay from taxes should talk to a legal assistance attorney about filing an amended tax return, Emswiler said. IRS officials are considering waiving interest and penalties in these cases and hope to reach a decision in the next two weeks.

Affected members may want to wait until the revenue service makes this decision before mailing their amended returns, Emswiler suggested. Legal assistance attorneys will be notified of the IRS decision as soon as possible.

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