A recent Tax Court case is interesting, not because of the tax principles involved but because of its unusual subject matter.
In the case, the taxpayer worked for Blackwater Security Consulting (Blackwater), performing dangerous security work in Iraq that related to military operations. Blackwater is an organization that has garnered attention as something akin to a private army. The taxpayer sought to exclude from income his pay under Code Section 112. That provision excludes from gross income compensation received for active service as a member below the grade of commissioned officer in the Armed Forces of the United States while serving in a combat zone.
The Tax Court held that Code Section 112 did not apply since Blackwater is not part of the Armed Forces of the U.S. Prior case law had likewise held the inapplicability of Code Section 112 for a pilot employed by a private airline flying civilian aircraft under contract in support of the U.S. military in the Vietnam War, and for a merchant marine employee of a private company working on a U.S. naval ship in a combat zone.
Given the existing precedent, one would expect penalties to be applied against the taxpayer, and indeed the IRS did assess them. However, the Tax Court struck them down (other than an estimated tax underpayment penalty) since the taxpayer had reasonably relied on an IRS internal memorandum that erroneously described civilian personnel as being able to use the Code Section 112 exclusion.
Nathanial J. Holmes, TC Memo 2011-26