Opinion
Nos. 02-9006, 02-9007.
Filed January 29, 2004.
Appeals from the United States Tax Court; (T.C. Nos. 12348-99 and 12010-99).
Kenneth W. McWade, Kailua, Hawaii, for Petitioners-Appellants.
Eileen J. O'Connor, Assistant Attorney General, David English Carmack and Kenneth W. Rosenberg, Attorneys, Tax Division, Department of Justice, Washington, D.C., for Respondent-Appellee.
Before MURPHY, HARTZ, and McCONNELL, Circuit Judges.
ORDER
Appellee's motion to publish the order and judgment dated December 11, 2003, is granted. A copy of the published opinion is attached.
After examining the briefs and appellate record, this panel has determined unanimously to grant the parties' request for a decision on the briefs without oral argument. See Fed.R.App.P. 34(f); 10th Cir.R. 34.1(G). These cases are therefore ordered submitted without oral argument.
In these appeals, we decide whether taxpayers Eric N. Umbach and Joseph D. Specking may exclude from gross income compensation earned while working on Johnston Island, a United States possession, in 1995, 1996, and 1997. Mr. Umbach and Mr. Specking sought to exclude their compensation under either 26 U.S.C. § 911, which excludes income earned in a foreign country, or 26 U.S.C. § 931, which excludes income earned in a "specified possession" of the United States. We review these narrow legal issues de novo. See Twenty Mile Joint Venture, PND, Ltd. v. Comm'r, 200 F.3d 1268, 1275 (10th Cir. 1999). In doing so, we hold, as did the Tax Court, that the compensation is not excludable under either section. Specking v. Comm'r, 117 T.C. 95, 107-11, 113-16 (2001). Accordingly, we affirm the decision of the Tax Court.
BACKGROUND
The facts in these cases were stipulated and thus are undisputed. Both Mr. Umbach and Mr. Specking worked for Raytheon Engineers and Constructors, Inc. (Raytheon) on Johnston Island in 1995, 1996, and 1997. See T.C. No. 12010-99, R., Doc. 10 at 2; T.C. No. 12348-99, R., Doc. 10 at 2. Johnston Island is located approximately 700 miles west-southwest of Honolulu, Hawaii. Appellee's Br., Addendum (United States General Accounting Office, Report to the Chairman, Committee on Resources, House of Representatives, U.S. Insular Areas, Application of the U.S. Constitution, GAO/OGC 98-5, at 51 (Nov. 1997) (Report)). It is one of four islands making up the Johnston Atoll, a United States military installation and bird refuge, which is also used as a storage and disposal site for chemical munitions and as a standby test site for atmospheric nuclear weapons testing. Id. (Report at 51-52).
For the 1995, 1996 and 1997 tax years, Mr. Umbach reported wage income from Raytheon on his tax return in the amounts of $97,492, $103,112 and $100,659, respectively. T.C. No. 12348-99, R., Doc. 10 at 2. Mr. Specking reported wage income from Raytheon for the same years in the amounts of $74,552, $85,385 and $95,246, respectively. T.C. No. 12010-99, R., Doc. 10 at 2. On their 1997 tax returns, both deducted $70,000 from their wage income. See T.C. No. 12010-99, R., Doc. 10 at 3 Ex. 3-J; T.C. No. 12348-99, R., Doc. 10 at 2 Ex. 2-J; see also Tax Reform Act of 1986, Pub.L. No. 99-514, § 1233(a), 100 Stat. 2085, 2564 (1986) (establishing $70,000 as annual foreign-earned-income exclusion for years at issue here). Also, both filed amended returns for 1995 and 1996 claiming refunds because $70,000 of their wage income was excludable from gross income under § 911 or § 931. T.C. No. 12010-99, R., Doc. 10 at 2 Ex. 4-J, 5-J; T.C. No. 12348-99, R., Doc. 10 at 2 Ex. 3-J, 4-J. In doing so, they noted on their 1995 and 1996 amended returns that under § 931 and 26 C.F.R. § 1.931-1, their earnings from Johnston Island were earned income from a foreign source excludable as foreign income. See T.C. No. 12010-99, R., Doc. 10, Ex. 4-J at 2, 5-J at 2; T.C. No. 12348-99, R., Doc. 10, Ex. 3-J at 2, 4-J at 2.
After allowing tax refunds for 1995 and 1996, the Internal Revenue Service (IRS) sent deficiency notices for tax years 1995, 1996 and 1997, disallowing the claimed $70,000 exclusions. The IRS denied the exclusions because Johnston Island is not a foreign country and therefore the earned income was not excludable under § 911, and because Mr. Umbach and Mr. Specking were not bona fide residents of a "specified possession" as defined in § 931(c) and therefore did not qualify for income exclusion under § 931. T.C. No. 12010-99, R., Doc. 10, Ex. 6-J; T.C. No. 12348-99, R., Doc. 10, Ex. 5-J, 6-J.
Mr. Umbach and Mr. Specking petitioned the Tax Court for a redetermination of the deficiencies. T.C. No. 12010-99, R., Doc. 1; T.C. No. 12348-99, R., Doc. 1. The Tax Court held in favor of the Commissioner that the compensation did not qualify for exclusion under either § 931, because Johnston Island is not one of the "specified possession[s]" listed in that section, or under § 911, because Johnston Island is a United States possession and not a foreign country. Specking, 117 T.C. at 107-11, 113-16. Mr. Umbach and Mr. Specking appeal, arguing the Tax Court erred in deciding that they were not entitled to exclude income earned on Johnston Island under § 931 or § 911.
JURISDICTION
As a preliminary matter, we consider our jurisdiction over these appeals. This court requested that the parties brief whether the notices of appeal in both appeals were timely filed. We agree with the parties that the appeals are timely. The Tax Court entered its decisions in these cases on February 1, 2002. T.C. No. 12010-99, R., Doc. 20; T.C. No. 12348-99, R., Doc. 20. Under 26 U.S.C. § 7483 and Fed.R.App.P. 13(a)(1), the ninety-day deadline to file a timely notice of appeal expired on May 2. Although the notices of appeal were filed on May 9, T.C. No. 12010-99, R., Doc. 21; T.C. No. 12348-99, R., Doc. 21, their envelopes were postmarked April 29. Pursuant to 26 U.S.C. § 7502, these postmarks establish timely filings within the ninety-day deadline. See also Fed.R.App.P. 13(b) (recognizing notice of appeal mailed to Tax Court "is considered filed on the postmark date, subject to § 7502"). Accordingly, we exercise jurisdiction over these appeals under 26 U.S.C. § 7482(a)(1).
ANALYSIS
The Internal Revenue Code broadly defines gross income as "all income from whatever source derived." 26 U.S. § 61(a). "Thus, any gain constitutes gross income unless the taxpayer demonstrates that it falls within a specific exemption." Brabson v. United States, 73 F.3d 1040, 1042 (10th Cir. 1996); see also Comm'r v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955). Unlike the broad, sweeping inclusion of § 61(a), exclusions from income are narrowly construed. See Comm'r v. Schleier, 515 U.S. 323, 327-28 (1995). They "are not to be implied; they must be unambiguously proved." United States v. Wells Fargo Bank, 485 U.S. 351, 354 (1988). Taxpayers therefore must clearly bring themselves within the terms of the statutes they point to as granting an exemption. See Jones v. Kyle, 190 F.2d 353, 353 (10th Cir. 1951). Here, Mr. Umbach and Mr. Specking must clearly prove their income earned while working on Johnston Island is excludable from gross income under § 931 or § 911.
I. Applicability of § 931
As amended by the Tax Reform Act of 1986 (TRA), § 931 provides in part:
(a) General Rule. — In the case of an individual who is a bona fide resident of a specified possession during the entire taxable year, gross income shall not include —
(1) income derived from sources within any specified possession, and
(2) income effectively connected with the conduct of a trade or business by such individual within any specified possession.
26 U.S.C. § 931(a)(1), (2). The statute defines a "specified possession" as Guam, American Samoa and the Northern Mariana Islands. Id. § 931(c). Although the statute does not set forth its effective date, the TRA established generally that § 931, as amended, took effect for tax years beginning after December 31, 1986. Tax Reform Act of 1986, Pub.L. No. 99-514, § 1277(a), 100 Stat. 2085, 2600 (1986). The special rules applying to Guam, American Samoa and the Northern Mariana Islands, however, take effect only if there is an implementing agreement in effect between the United States and the possession. Id. § 1277(b).
Section 931, as amended by the TRA, applies only to income derived from sources within the three specified possessions, Guam, American Samoa and the Northern Mariana Islands. Under the plain language of the statute and the effective date of the statute set forth in the TRA, Mr. Umbach and Mr. Specking were ineligible to exclude income earned on Johnston Island because they were not bona fide residents of Guam, American Samoa or the Northern Mariana Islands. See United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989) (holding that all inquiries about meaning of statute begin with statute itself; if statutory language is plain, courts will enforce statute according to its terms without further inquiry).
Mr. Umbach and Mr. Specking do not dispute that they do not meet the requirements of § 931 as amended. Rather, they contend that there are two sections in effect: § 931 as amended by the TRA, which is in effect if the United States and the three specified possessions have entered into the implementing agreements, and pre-TRA § 931, which is in effect if not. Mr. Umbach and Mr. Specking assert that because Guam, American Samoa and the Northern Mariana Island have not enacted the required implementing agreements, pre-TRA § 931, which permitted United States citizens to exclude income earned within various United States possessions, including Johnson Island, applies to them. They base this argument on footnote fifteen of the Tax Court's opinion, which provides, in part:
The mirror system of taxation in effect in a qualified possession the day before the effective date of TRA 1986 continues to operate until the possession amends its tax laws. S. Rept. 99-313, at 482-484, 490-491 (1986), 1986-3 C.B. (Vol. 3) 1, 482-484, 490-491. Unlike Guam and the [Northern Mariana Islands], before the enactment of the TRA 1986, American Samoa had the authority to enact its own tax system; however, with certain modifications not pertinent here, it generally adopted the U.S. Internal Revenue Code as its own. S. Rept. 99-313, at 477 (1986), 1986-3 C.B. (Vol. 3) 1, 477. Thus, had American Samoa and the United States not entered into an implementing agreement, income from sources within that possession would qualify for the exclusion provided by old section 931.
Specking, 117 T.C. at 106 n. 15. To the extent pre-TRA § 931 applies to American Samoa, Mr. Umbach and Mr. Specking argue it should apply to them.
We disagree. Before the TRA, § 931 excluded income received from sources within various United States possessions, including Johnston Island, from gross income, if certain conditions were met. See Farrell v. United States, 313 F.3d 1214, 1219 (9th Cir. 2002); Specking, 117 T.C. at 102-03. After the TRA, § 931 applies to Guam, American Samoa and the Northern Mariana Islands only if those possessions implemented the required agreements with the United States. See Tax Reform Act of 1986, Pub.L. No. 99-514, § 1277(b), 100 Stat. 2085, 2600 (1986). Because the TRA § 1277(b) does not apply to other United States possessions, such as Johnston Island, the general effective date set forth in the TRA § 1277(a) controls. Thus, we agree with the Tax Court that "income earned in any possession other than Guam, American Samoa, and the [Northern Mariana Islands] is not eligible for the exclusion provided under [§] 931 as amended by TRA . . . for the tax years beginning after December 31, 1986." Specking, 117 T.C. at 110; see also Farrell, 313 F.3d at 1219 (holding that contingency of signed agreements between United States and three specified possessions affects only taxable income derived from sources within those possessions and does not affect income derived from sources within other United States possessions). Thus, pre-TRA § 931 does not apply to the Johnston Island earnings of Mr. Umbach and Mr. Specking. Contrary to their argument, footnote 15 does not state that § 931, as amended by the TRA, applies to Johnston Island; the footnote only discusses American Samoa. See Specking, 117 T.C. at 106 n. 15; see also Jones v. Comm'r, T.C. Memo. 2003-14 (2003).
Mr. Umbach and Mr. Specking point to the Treasury Secretary's failure to amend 26 C.F.R. § 1.931-1 for more than sixteen years as evidence that pre-TRA § 931 is still valid law. It is true that § 1.931-1 was not amended after enactment of the TRA, and § 1.931-1(a)(1) therefore still lists Johnston Island as a United States possession eligible to exclude income under § 931. The TRA, however, expressly limits the § 931 exclusion to income derived from sources within Guam, American Samoa and the Northern Mariana Islands. Farrell, 313 F.3d at 1219. Thus, the statute and regulation are in conflict.
If a regulation conflicts with a statute, the regulation is invalid. Scofield v. Lewis, 251 F.2d 128, 132 (5th Cir. 1958); see also Bingler v. Johnson, 394 U.S. 741, 750 (1969) (requiring that regulation be sustained unless it is inconsistent with statute). Even a regulation valid when promulgated becomes invalid if the amended statute conflicts with the regulation. See Scofield, 251 F.2d at 132. Section 931 therefore controls, and it voids § 1.931-1. Farrell, 313 F.3d at 1219.
Mr. Umbach and Mr. Specking, however, fault the Tax Court for failing to consider 26 U.S.C. § 7805(a), which provides that the Treasury Secretary shall prescribe all needed regulations for the enforcement of the tax laws. See Bingler, 394 U.S. at 750-51. Any failure to amend a regulation shows inattention, not an official intent to make a statement that the regulation is still valid. See United Dominion Indus., Inc. v. United States, 532 U.S. 822, 836 (2001) ("The Treasury's relaxed approach to amending its regulations to track Code changes is well documented."). The Tax Court did not err in failing to discuss § 7805(a).
Mr. Umbach and Mr. Specking also argue that the Commissioner's failure to amend § 1.931-1 for more than sixteen years after the TRA should preclude any additions to tax until the regulation is amended and should entitle them to abatement of interest under 26 U.S.C. § 6404(e) for the three tax years at issue. They, however, do not cite a record reference where this issue was raised and ruled on by the Tax Court. See 10th Cir.R. 28.2(C)(2). This argument therefore is not properly before us and we will not consider it. See Lopez v. Behles (In re Am. Ready Mix, Inc.), 14 F.3d 1497, 1502 (10th Cir. 1994).
Also, the Commissioner argues that Mr. Umbach and Mr. Specking did not raise an abatement of interest issue in the Tax Court. The two have not filed a reply brief disputing this assertion. Under the circumstances of this case, we will not consider this new issue not previously raised in the Tax Court. See Walker v. Mather (In re Walker), 959 F.2d 894, 896 (10th Cir. 1992).
II. Applicability of § 911
As is relevant here, § 911 provides:
(a) Exclusion from gross income. — At the election of a qualified individual . . . there shall be excluded from the gross income of such individual, and exempt from taxation under this subtitle, for any taxable year —
(1) the foreign earned income of such individual. . . .
26 U.S.C. § 911(a)(1). "Foreign earned income" is the amount an individual receives "from sources within a foreign country . . . which constitute[s] earned income attributable to services performed by such individual" during the applicable time period described in 26 U.S.C. § 911(d)(1)(A) or (B). Id. § 911(b)(1)(A). Under § 911(d)(1)(A) or (B), to qualify for the exclusion, the individual's tax home must be in a foreign country and the individual must be a United States citizen who has been a bona fide resident of the foreign country for the entire tax year or a United States citizen or resident who has been present in the foreign country for at least 330 full days of twelve consecutive months. See also 26 C.F.R. § 1.911-2(a). The regulations define a "foreign country" as "any territory under the sovereignty of a government other than that of the United States," id. § 1.911-2(h), and "United States" to "include any territory under the sovereignty of the United States[,]" including its "possessions and territories," id. § 1.911-2(g).
Mr. Umbach and Mr. Specking do not dispute that Johnston Island is not a foreign country, but is instead a United States possession. Thus, as the Tax Court stated:
Inasmuch as Johnston Island does not fall within the definition of a foreign country, the compensation [Mr. Umbach and Mr. Specking] earned on Johnston Island does not come within the definition of "foreign earned income", nor was their "tax home" in a foreign country. Sec. 911(b)(1)(A) and (d). Consequently, [they] cannot satisfy the requirements for the exclusion from income provided by section 911.
Specking, 117 T.C. at 113; see also Farrell, 313 F.3d at 1218.
Rather, Mr. Umbach and Mr. Specking argue they are entitled to exclude $70,000 of income earned on Johnston Island for 1995, 1996, and 1997 under § 911 based on 26 C.F.R. § 1.931-1(b)(2). Section 1.931-1(b)(2) provides:
Relationship of sections 931 and 911. A citizen of the United States who cannot [qualify under] section 931 but who receives earned income from sources within a possession of the United States, is not deprived of the benefits of the provisions of section 911 (relating to the exemption of earned income from sources outside the United States), provided he meets the requirements thereof. In such a case none of the provisions of section 931 is applicable in determining the citizen's tax liability.
Contrary to Mr. Umbach's and Mr. Specking's argument, we conclude this regulation does not entitle them to exclude income under § 911. Section 1.911-2(g) and (h) were promulgated pursuant to a statutory grant of authority to the Secretary of the Treasury to prescribe regulations to carry out § 911's purposes. See 26 U.S.C. § 911(d)(9). These valid and current regulations define the relevant terms of § 911 — United States and foreign country. Because § 1.931-1(b)(2) interprets pre-TRA § 931, it is obsolete. We therefore agree with the Tax Court that the § 911 regulations take priority over regulation § 1.931-1(b)(2). Specking, 117 T.C. at 116; see also Jones, T.C. Memo. 2003-14 (rejecting similar argument).
We conclude Mr. Umbach and Mr. Specking cannot exclude from gross income their compensation earned while working on Johnston Island under either § 931 or § 911. Accordingly, we AFFIRM the Tax Court's judgments.