Rev. Rul. 80-78

ISSUE

Is a taxpayer, a U.S. citizen and contract employee of the Government of the Trust Territory of the Pacific Islands (GTTPI), entitled to exclude from gross income under section 911(a) of the Internal Revenue Code the salary paid by the GTTPI?

LAW AND ANALYSIS

Section 911 of the Code provides, in part, for the exclusion from gross income of earned income from sources without the United States (except amounts paid by the United States or any agency thereof) in the case of a United States citizen who is a bona fide resident of a foreign country for an uninterrupted period that includes an entire taxable year, or is physically present in a foreign country or countries during at least 510 full days of a period of 18 consecutive months.

For taxable years beginning after December 31, 1977 (or December 31, 1978, if a timely election is filed), the section 911 exclusion is further limited by section 202 of the Foreign Earned Income Act of 1978, Pub. L. 95-615, 1978-2 C.B. 415, to individuals who, because of their employment, reside in a camp located in a hardship area. A new section 913, added by section 203 of that Act and effective for taxable years beginning after December 31, 1977, provides a deduction for certain expenses of an individual living abroad, but not in excess of the individual's earned income. Section 913(j) provides that the term "earned income" does not include amounts paid by the United States or any agency thereof.

Rev. Rul. 68-608, 1968-2 C.B. 309, holds that in view of the control exercised by the Secretary of the Interior, or the Secretary's representatives over the GTTPI, United States citizens employed by that government are "paid by the United States or any agency thereof" for purposes of section 911 of the Code, and thus are not entitled to exclude from gross income under section 911 of the salary paid by the GTTPI whether they are United States Civil Service employees or contract employees who are outside the Civil Service system. Accord Groves v. United States, 533 F.2d 1376 (5th Cir. 1976), aff'g, Civil No. 74-15 (N.D. Fla., Nov. 21, 1974), cert denied, 429 U.S. 1000 (1977), which reaches a similar nonexcludable result for salary paid to contract employees of GTTPI.

In McComish v. Commissioner, 580 F.2d 1323 (9th Cir. 1978), rev'g, 64 T.C. 909 (1975), the Ninth Circuit considered the same issue for tax year 1968. In that decision, however, the court held that a U.S. citizen who was a contract employee of the GTTPI could exclude from gross income under section 911(a) of the Code the salary paid by the GTTPI because of the "severely limited" United States control over GTTPI, and the fact that the taxpayer was neither a U.S. government employee nor a person receiving the benefits accorded such an employee.

The Internal Revenue Service will follow McComish only to the extent of its holding that contract employees of the GTTPI are not paid by an agency of the United States. It remains the position of the Service that the exception in section 911(a) applies to any U.S. citizen, regardless of whether such citizen is a Civil Service or contract employee, who is paid by the United States or any agency thereof. See, Erlandson v. Commissioner, 277 F.2d 70 (9th Cir. 1960), in which the court stated at page 72 that "amounts paid by the United States or an agency thereof are excepted from the benefits of section 911(a)(2) whether or not the recipient is an employee of the United States"; and Donaldson v. Commissioner, 51 T.C. 830 (1969), in which the court examined the degree of control exercised by the United States over the operations of the paying entity in determining that it was an agency of the United States.

HOLDING

On the basis of the result reached under section 911 of the Code by the Ninth Circuit in McComish, taxpayer, a U.S. citizen and contract employee of the GTTPI, may exclude from gross income under section 911(a) of the Code the salary paid by the GTTPI for all open tax years. Section 911 as amended by Pub. L. 95-615, and section 913 as added by that Act, will be similarly interpreted.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 68-608, 1968-2 C.B. 309, is modified with respect to U.S. citizens who are contract employees of the GTTPI. This modification is not applicable to U.S. citizens, employed by the GTTPI, who are U.S. Civil Service employees.