FARRELL v. U.S

SUSAN OKI MOLLWAY, U.S. District Judge

I. INTRODUCTION.

Citing Sections 911 and 931 of the Internal Revenue Code, 26 U.S.C. § 911 and 931, Paul and Frances Farrell seek a refund of taxes they paid in 1994, 1995, and 1996. They claim that they need not pay taxes on income they earned while working and living on Johnston Island, a United States possession.

The Farrells first argue that, under Section 911, they are entitled to exclude their income earned on Johnston Island from income subject to United States taxes. In so arguing, the Farrells necessarily must argue that Johnston Island is a foreign country. However, because Johnston Island is a possession of the United States, Section 911 does not apply and income earned on Johnston Island is subject to federal tax.

The Farrells also argue that, under the applicable Federal Tax Regulation, Section 1.931-1 ("Regulation 1.931-1"), they were exempt from federal tax on income earned on Johnston Island because Johnston Island is a United States possession. Although Regulation 1.931-1 accurately defined "possession" as of 1975, Section 931, the statute underlying Regulation 1.931-1, was later amended. Under the applicable version of Section 931, Johnston Island is not a specified possession for which gross income can be excluded. Regulation 1.931-1 does not supersede the amended Section 931.

Accordingly, the United States' motion for summary judgment is granted.

II. ANALYSIS

A. Section 911.

Section 911 (1986) excludes from federal taxable income foreign income earned by a "qualified individual." 26 U.S.C. § 911 (a) (1986). A "qualified individual" is a person who, inter alia, has a tax home in a "foreign country." 26 U.S.C. § 911 d(1) (1986).

The 1986 version of Section 911 was in effect during the tax years at issue in this action.

Because the Farrells argue that they are "qualified individuals" for purposes of Section 911, they must demonstrate that Johnston Island is a "foreign country." However, Johnston Island is a possession of the United States. See, e.g., 5 U.S.C. § 5942a ("an employee of an Executive agency . . . who is assigned to a post of duty at Johnston Island, a possession of the United States in the Pacific Ocean . . .");The New Encyclopedia (15th ed. 1998) (Johnston Island is an "unincorporated territory of the U.S. in the central Pacific Ocean"); see also 48 U.S.C. § 644a ("The jurisdiction of the United States District Court for the District of Hawaii is extended to all civil and criminal cases arising on or within . . . Johnston Island . . ."). Accordingly, Johnston Island is not a foreign country" for purposes of Section 911. See 10 United States Tax Reporter ¶ 9114.03 (2000) (explanation of IRC § 911) ("For purposes of exclusion, the term "foreign country' doesn't include . . . U.S. possessions"). Summary judgment is therefore granted in favor of the United States of America and against the Farrells on their Section 911 claim.

At the hearing, the Farrells stated that they were not arguing that Johnston Island is a "foreign country." However, to qualify for the exemption in Section 911, the Farrells must show that Johnston Island, their tax home, is a "foreign country."

B. Section 931.

The Farrells claim that, under Regulation 1.931-1, Johnston Island is a United States possession for purposes of Section 931 (1986), which excludes from gross income any income derived from a "specified possession."

Regulation 1.931-1 was promulgated in 1975. It thus interprets Section 931 as it existed in 1975. In 1975, Section 931 stated that "gross income" meant gross income from sources within the United States if: (1) 80 percent or more of the gross income for the three-year period preceding the close of the taxable year was derived from sources within a possession of the United States; or (2) 50 percent or wore of the gross income was derived from the active conduct of a trade or business within a possession of the United States. 26 U.S.C. 3 931 (1972). For purposes of Section 931, "possession of the United States does not include the Virgin Islands . . . Puerto Rico[,] or Guam." 26 U.S.C. 1931(c) (1972). Regulation 1.931-1 explained that, for purposes of Section 931, "possession" included Johnston Island.

The Tax Reform Act of 1986, Pub.L. No. 99-514, completely amended Section 931. As amended in 1996, Section 931 provided that the gross income of an individual of a "specified possession' did not include income derived from sources within any specified possession. "Specified possession" was defined as Guam, American Samoa, and the Northern Mariana Islands. 26 U.S.C. 1931(c) (1986). Because these "specified possessions" had their own sets of income tax laws, Section 931 (1986) was enacted, in part, to exempt their residents from federal tax and thereby avoid the potential for double taxation. 10 United States Tax Reporter ¶ 9314 (2000) (explanation of IRC § 931).

The 1986 version of Section 931 was in effect at all relevant times in this case.

Although Section 931 was amended, Regulation 1.931-1 was not amended to reflect the changes made to Section 931. See 10 United States Tax Reporter ¶ 9312 (2000) (explanation of IRC § 931) ("Caution: The Treasury has not yet amended Reg § 1.931-1 to reflect changes made by P.L. 99-514").

To read Regulation 1.931-1 as including Johnston Island as a "specified possession" for purposes of 26 U.S.C. § 931 (1986) would be contrary to the plain intent of Congress, which is to allow income to be excluded from gross income for only Guam, American Samoa, and the Northern Mariana Islands. Accordingly, this court does not give any deference to the Treasury's outdated interpretation of "possession" in Regulation 1.931-1. See Chevron USA, Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43 (1984) ("When a court reviews an agency's construction of the statute which it administers, it as confronted with two questions, First, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress")

Moreover, Regulation 1.931-1 defines "possession," not specified possession." The exclusion in Section 931 applies only to "specified possessions."

Even if Johnston Island were a "specified possession" for purposes of Section 931, summary judgment against the Farrells would be appropriate. Section 931's exclusion applies only if there is an implementing agreement between the United States and such possession. See 26 U.S.C. § 931 (1986) Historical and Statutory Notes. Johnston Island has no implementing agreement. See 10 United States Tax Reporter ¶ 9314 (2000) (explanation of IRC § 931) (stating that American Samoa is the only "specified possession" that has entered into an implementing agreement).

At the hearing, the Farrells argued that the 1986 Amendment to Section 931 did not actually amend and supersede the earlier version because no implementing agreements have been entered into by any of the "specified possessions." This argument is wrong for two reasons. First, American Samoa has apparently entered into such an agreement. More importantly, however, the outdated Section 931 was no longer in the Internal Revenue Code in the 1994 to 1996 period. Had Congress intended that the outdated Section 931 have continuing effect, it would have stated so in the amended Section 931.

Accordingly, summary judgment is granted in favor of the United States and against the Farrells on their Section 931 claim.

III. CONCLUSION.

Neither Section 911 nor Section 931 allows the Farrells to exclude from their gross income money earned while working on Johnston Island. Accordingly, summary judgment is granted in favor of the United States and against the Farrells.

The Clerk of the Court is directed to enter judgment in favor of the United States and to terminate this action.

IT IS SO ORDERED.

DATED: Honolulu, Hawaii, February 12, 2001.

SUSAN OKI MOLLWAY UNITED STATES DISTRICT JUDGE