CONTRACTOR EMPLOYEE - Defense Technical …

1 Q~jQpOFfor Urnenthvs J)dIstribution Cf i in4 DEPARTMENT OF THE AIR FORCEAM UNIVERSIY (ATC)B AIR FORCE INSTITUTE OF TECHNOLOGYp Wright-Patterson Air Force Sase, OhioDEFENSE CONTRACTOR EMPLOYEEOVERSEAS COMPENSATION AND THEFOREIGN EARNED INCOME ACT OF 1978 James D. Mayer, GS-12 David F. Whealdon, GS-13 LSSR 10-80ojThe contents of the document are technically accurate, andno sensitive items, detrimental ideas, or deleteriousinformation are contained therein. Furthermore, the viewsexpressed in the document arm those of the author (s) and donot necessarily reflect the views of the School of Systemsand Logistics, the Air University, the Air Training Command,the United States Air Force, or the Department of 44 USAF SLN 7S-20B AFIT Control Number LSSR 10-80 AFIT RESEARCH ASS4 ESThe purpose of this questionnaire is to detemine the potential for currentand future applications of AFIT thesis research. Please return completedquestionnaires to: .4 Frr/ LSH (Thesis Feedack), Wright-Patterson AFB,Ohio Did this reseah contribute to a current Air Force project?

2 A. Yes b. No2. Do you believe this research topic is significant enough that it wouldhave been researched (or cntracted) by your organization or another agencyif AFIT had not researched it?a. Yes b. No3. The benefits of AFIT research can often be expressed by the equivalentvalue that your agency received by virtue of AFIT perfoning the you estimate what this research would have cost if it had beenaccatplished under contract or if it had been done in-house in tems of man-power and/or dollars?a. Man-years $ (Ctract) Mau-years $ Un-house).4. Often it is not possible to attach equivalent dollar values to research,although the results of the research may, in fact, be important. Whether ornot you wre able to establish an equivalent value for this research (3 above),what is your estimate of its significance?a. Highly b. Significant c. Slightly d. Of NoSignificant Significant SignificanceS. 0=1111=:Nie and Grade PositionOrgij zation THIP0IN*Y "N1 PMVATI USE.

3 J UNTO STATI-SBUSINESS REPLY MAIL "FOT? MAS POM E& ?3S ONISIUS&tSPWSAOU WOLL NI PA60 IV ADOUS _____AnT/LSH (Tahe ifeedback)We ghc-Paccersa AFl OH 43433 ILASSI=SECURITY CLASSIFICATION OF THIS PAGE (When DatoaEnteted)REPORT DOCUMENTATtON PAGE READ BEFORE COMPLETING FORMG2. GOVT ACCESSION NO. 3. RECIPIENT'S CATALOG NUMBER*SgP C ~U5~ ~I~ S--. TYPE OF REPORT & PERIOO 0 EFENSE PNTRACTOR JMPLOYEE gVERSEAS 7 q AND T&E FOREIGN -EARNED Master's jhesis)INCOME ACT OF 1978. ,6. jP .. W-G. R3 AoTurE"7, 0-. CONTRACT OR GRANT NUMBER( )James Mayer) GS-12 David GS-13S. PERFORMING ORGANIZATION NAME AND ADDRESS 10. PROGRAM ELEMENT, PROJECT. TASKG raduate Education Division / AREA & WORK UNIT NUMBERSS chool of Systems and Logistics vAir Force Institute of Technology,WPAFB OHII. CONTROLLING OFFICE NAME AND AOORESS WV,,' .A-TEDepartment of Communication andHumanities WPAFB OH 4543314. MONITORING AGE CV NAME & ADDRESS(Il different from Contollind O11c*) IS. SECURITY CLASS.

4 (of this twport)/~ .ID~ .~UNCLASSIFIED-. ISM. OECLASSIFICATION/OOWNGRAOINGSCHEDULEI. DISTRIOUTION STATEMENT (of this Report)Approved for public release; distribution unlimitedI?. DISTRIBUTION STATEMENT (of the abetrect entered in Block 20. It ditleent from Report)A ED F BLIC RE EASE AFR 190, c. T n N r. USAF19. KEY WORDS (C6110m1 On nen ree side It noceeowe and identity by block number)FOREIGN EARNED INCOME (ACT OF 1978)TAX ALLOWANCE OVERSEAS CONTRACTOR EMPLOYEE INCOMEINCOME TAXES CETS CONTRACTS TAX ALLOWANCETAX REFORM20. ABSTRACT (Ctinue an repere aide If neceeoar and iduntily by block numbee)See Chairman: Jeffrey C. Daneman, GS-12DO I 1473 EDITION OF I NOV 6S IS OBSOLETE UNCLASSIFIEDSECURITY CLASSIFICATION OF THIS PAGE (Who a E ,.. CLASSIFICATION OF THIS PAGE(WhaI Data ntatedj-The objective of this research was to develop a definitive DODpricing instruction for tax allowance compensation. The instruc-tion applies to service contracts for personnel involved in AFand FMS contracts overseas.))

5 The information provided to theindividual taxpayer by the IRS was consolidated into a formatusable by the AF contract negotiator to set the AF objective fortax allowance. Tax allowance compensation is necessary becauseof the adverse impact of the Foreign Earned Income Act of 1978on contract employees going overseas. Basic models were developedto aid the calculation of the tax allowance for a representativecontractor CLASSIFICATIOR OF r-" PAGE(W en ate nteredc'\AaLSSR 10-80 Defense CONTRACTOR EMPLOYEE OVERSEAS COMPENSATIONAND THE FOREIGN EARNED INCOME ACT OF 1978A ThesisPresented to the Faculty of the School of Systems and Logisticsof the Air Force Institute of TechnologyAir UniversityIn Partial Fulfillment of the Requirements for theDegree of Master of Science in Logistics ManagementByJames D. Mayer, BA David F. Whealdon, MBAGS-12 GS-13 June 1980 Approved for public release;distribution unlimitedThis thesis, written byMr. James D. MayerandMr. David F.)

6 Whealdonhas been accepted by the undersigned on behalf of thefaculty of the School of Systems and Logistics in partialfulfillment of the requirements for the degree ofMASTER OF SCIENCE IN LOGISTICS MANAGEMENT(CONTRACTING AND ACQUISITION MANAGEMENT MAJOR)DATE: 9 June 1980rl 11 MITTEE CHAIRMANiiTABLE OF CONTENTSPageLIST OF TABLES ..viLIST OF FIGURES ..viiChapterI. INTRODUCTION ..1 Overview ..1 Cost-of-Living Differential..6 Housing Expenses ..8 Problem Statement ..10 Justification for Research 11 IResearch Objective..12 Research Questions.. METHODOLOGY ..14 Data Sources and Data Collection Plan .. 14 Contract Data ..14 IRS Publications..1 Data Analyuis Plan..15 III. DOD CONTRACTOR EMPLOYEE TAXABLE INCOME .. 17 Introduction..17 Taxable Income..18 Base Salary ..18 Overtime Pay..19 ILChapter PageShift Differential..20 Domestic Assignment Pay ..22 Overseas Assignment Pay ..26 Domestic Subsistence and Lodging ..28 Overseas Cost of Living andHousing Allowance.

7 29 Hardship Pay..31 Hazardous Duty Pay..32 Auto Allowance..33 Completion Bonus..34 Home Leave ..34 Schooling Expenses..35 Moving Expenses ..36 Household Goods Storage ..37 Miscellaneous Compensation..37 Other Taxable Incomes, Deductionsand Credits ..38IV. THE ALLOWANCE COMPUTATIONS (DOD)..42 Hypothetical Domestic Tax Computation .. 42 Personal Exemptions ..43 Itemized Deductions ..46 State Income Tax Avoidance..46 Hypothetical Domestic TaxComputation Model ..48 Overseas Tax Computation..51 Overseas Tax Computation Model..52ivChapter PageTax Allowance .. 56V. GROSSING-UP TAX ALLOWANCE .. 58 General Grossing-up Formula--The TPCD .. 63 Tax Bracket Formulae ..67 Recommended Grossing-up Method .. 68VI. CONCLUSIONS AND RECOMMENDATIONS .. 77 Conclusions .. 77 Research Objectives .. 77 Research Questions .. 79 Grossing-up .. 80 Recommendations .. 80 DOD Actions .. 80AF Action .. 81 AFLC Action .. 822750th ABW Action .. 82 Future Study .. 83 APPENDICES .. 86A. A LIST OF THE COST-OF-LIVING DIFFERENTIALSFOR 20 MAJOR FOREIGN CITIES CALCULATEDON THREE DIFFERENT BASIS.

8 87B. A CALCULATION OF THE DEDUCTION FOR FOREIGNHOUSING EXPENSES USING THE IRS FORM 2555 ..90C. 1979 TAX RATE SCHEDULES .. 94D. TAX RATE SCHEDULE Y--$20,000 TO $60,000--IN $100 INCREMENTS .. 97 SELECTED BIBLIOGRAPHY .. 105 REFERENCES CITED .. IVLIST OF TABLEST able PageI-1. Proposed Salaries and Initial TaxAllowances ..11111-1. An Example of Mean Domestic AssignmentPay Calculation ..24111-2. Domestic Assignment Pay Computations ..25111-3. Summary of Taxable Income ..39IV-l. Impact of Increased Personal Exemptionson Taxable Income ..45viLIST OF FIGURESF igure PageIV-l. Hypothetical Domestic Tax Computation(Married) ..49IV-2. Hypothetical Domestic Tax Computation(Bobby Buckeye) .. 50IV-3. Overseas Tax Computation (Married) .. 53IV-4. Overseas Tax Computation (Mr. Buckeye) ..55V-I. Effective Tax Rates ..69V-2. Tax Gross-up Worksheet (Married) ..73V-3. Tax Gross-up Worksheet (Mr. Buckeye) ..74viiCHAPTER IINTRODUCTIONO verviewThe United States is the only industrial tradingnation that taxes the worldwide income of its citizens(21:75).

9 The amount of income necessary for an Americanto live abroad is generally higher than his incomebecause of the higher cost of living in many foreign coun-tries. Prior to the passage of the Tax Reform Act of 1976,the Air Force (AF) was not asked for compensation by con-tractors to offset higher personal income taxes on theiremployees' higher income earned abroad. Before the TaxReform Act of 1976, employees who earned income abroad weregranted a $20,000 or $25,000 exclusion off the top of theirincome before taxes were computed (9:1). Employees coulduse the deduction to offset the allowances they were givenfor higher living costs abroad. Employees in low costareas overseas whose total compensation was less than the$20,000 or $25,000 exclusion could offset their entireincome and pay no income tax at , prior to the passage of the Tax Reform Act of1976, the AF negotiator did not need a working knowledge ofthe income tax law. However, the Tax Reform Act of 1976reduced the exclusion to $15,000 and changed the method of1applying the exclusion in the computation of the tax.

10 Thismeant a substantial increase in the amount of tax owed bytaxpayers working abroad (9:2). CONTRACTOR employees, whowere enjoying a "windfall" before the passage of the TaxReform Act of 1976, were now demanding that their employersreimburse them the amount they would have to pay in foreignearned income taxes in excess of their domestic income the result of pressure from business, Congress delayedthe implementation of the Tax Reform Act of 1976 andordered a study of the impact of the new tax law. In aReport to the Congress (21:V), the Comptroller General ofthe found in a survey of 183 companies employingAmericans abroad that:1. Americans living in the oil-producing countriesof the Middle East and Africa will have the largesttax increases, averaging $4,700 per working in these'countries generallyreceive a large taxable In certain extreme cases in extraordinarily high-cost countries, some individuals who receive largecash allowances may have tax liabilities nearlyequal to their basic cash salaries (21:V].)