Revenue Ruling 82-23: Sourcing Government Employee Income
Learn how Rev. Rul. 82-23 determines that pay from the U.S. government is U.S. source income, even when earned abroad, affecting tax filing for expats.
Revenue Ruling 82-23 is an Internal Revenue Service (IRS) clarification for United States citizens employed by the U.S. government while working in foreign countries. Its purpose is to establish the source of income earned by these individuals, which determines how that income is taxed. The ruling provides a framework for government employees, distinguishing their compensation from that of other Americans working abroad for private companies.
Scope of the Ruling
The guidance in Revenue Ruling 82-23 applies to taxpayers defined by two conditions. The first is that the individual must be a U.S. citizen. The second is that the individual must be a direct employee of the United States government or one of its agencies.
This means the ruling affects personnel across numerous government bodies, including those working for the Department of State, Department of Defense, and the United States Agency for International Development (USAID). It also covers staff at U.S. embassies, consulates, and military bases located in foreign countries.
A distinction is made between direct government employees and independent contractors who perform services for the U.S. government. The ruling’s provisions do not extend to contractors. Contractors are subject to different income sourcing rules that often depend on where their work is physically performed.
Sourcing of Income and Tax Implications
The source of income—whether it is U.S. or foreign source—is a basic principle of U.S. taxation. This classification dictates eligibility for certain tax exclusions for citizens abroad, as the source is often determined by where services are performed.
Revenue Ruling 82-23 establishes a definitive rule for federal employees: all compensation paid by the U.S. government for services performed abroad is considered U.S. source income. An employee of the State Department working in a foreign embassy, for example, earns U.S. source income despite never setting foot in the United States during the tax year.
The main tax implication of this rule relates to the Foreign Earned Income Exclusion (FEIE), a tax benefit available under Internal Revenue Code Section 911. The FEIE allows eligible taxpayers to exclude a portion of their foreign-source income from U.S. taxation. Because Revenue Ruling 82-23 classifies the salaries of federal employees as U.S. source, this income is ineligible for the FEIE.
Reporting on Your Tax Return
Government employees working overseas must report their compensation correctly. The income earned from a U.S. government agency is reported on Form W-2, Wage and Tax Statement, just as it would be for a domestic employee. This income must be reported on the appropriate line for wages on Form 1040.
This U.S. government salary must not be reported on Form 2555, Foreign Earned Income. Form 2555 is used to calculate the Foreign Earned Income Exclusion and the foreign housing exclusion. Mistakenly claiming the FEIE on U.S. government wages is a common filing error that can lead to tax adjustments, penalties, and interest.
Related Tax Considerations
With the Foreign Earned Income Exclusion unavailable for their government salary, employees should be aware of the Foreign Tax Credit (FTC). Claimed using Form 1116, the FTC is designed to reduce the burden of double taxation. It allows taxpayers to claim a credit for income taxes paid to a foreign country.
The FTC can only be used to offset U.S. tax on foreign-source income. Since a government employee’s salary is treated as U.S. source income, any foreign income taxes paid on that salary cannot be claimed as a credit. However, many U.S. government employees are exempt from local income tax in their host country due to bilateral agreements, so this limitation often has no practical effect.
The situation changes if the taxpayer has other income that is classified as foreign source. For instance, if the employee operates a small side business locally, or if their spouse earns income from a non-government foreign employer, that income is foreign source. The taxpayer can use the FTC to claim a credit for foreign taxes paid on that specific income.