Source of IncomeTx 8300

Learning Objectives

1. Explain why the source of income is important to both ____ and _______ persons and

2. Determine the source of income for a variety of transactions

You should be able to:

Observations about Source Rules

• Appear in §§___-___, ___

• Categorize income as U.S. or foreign

• Don’t ______ tax

• Based on _____ of income

• Treaties might ______

• Fundamental to understanding Subchapter __

Importance of Source Rules

• U.S. taxpayers claim the ______ ___ _____ for foreign income tax paid or accrued.

• However, the ___ is limited to the result of the following formula:

Importance: FTC Example

Domco earns $____ U.S. taxable income and $____ foreign taxable income. The U.S. and foreign tax rates are 35% and ___%, respectively. What is Domco’s foreign tax credit?

Importance of Source Rules

• The U.S. taxes _______ persons on two categories of income:– ___________ connected income– ____ source __________ income

United States Defined

• 50 states and ____

• ___ space

• ___ nautical miles from shores

• Continental shelf for _______ deposits

• ___________ not included

• U.S. _________ not included

General Source Rules

Interest income Depends on where ________ residence or organization

Dividend income

Personal service income

Rental income

Royalty income

Depends on _____________ organization

Depends on where person _______ service

Depends on _________ of tangible property

Depends on where the licensee ____ intangible property

General Source Rules

Real estate gain Depends on real estate’s _________

Personalty gain

Underwriting income

Transportation income

Communication income

Depends on type of _________

Depends on location of _____

Depends on ______ and destination

Depends on _________ of transmitting person

Interest Income

General ruleDepends on ________

residence or organization

For ___ or ___ meeting the ___% active foreign business test, interest either pays to:

Unrelated persons

Related persons

Interest foreign branch of ____ bank or S&L pays

Interest U.S. business of ___ pays

Prorated based on source

Interest ____-owned FC (with ≥ ___% U.S. CE&P) pays to ___% U.S. shareholder

For FTC purposes, prorate based on source of CE&P

Interest Income: Example

A corporation pays $1,000 interest to Robinet, a Tunisian national and resident. The corporation makes auto parts and derives ___% of its gross income from foreign business. Assuming the corporation conducts no U.S. business through branches, how much interest is foreign source income to Robinet?

Interest Income: Example

Domco hires Ping, a Chinese national and resident, as its sales agent in China. Since Ping will be handling Domco’s finances, the agency relationship requires Ping to post security, which Domco deposits in its account with _______ Bank. Ping receives interest from the security deposit. Assuming Domco is not an _____ company, is Ping’s interest from U.S. sources?

Dividend Income

General ruleDepends on

distributor’s place of _____________

Dividends FC pays when ≥ ___% of its gross income is ECI

Dividends FC pays from E&P accumulated as a ___

Dividends ____-owned FC (with ≥ ___% U.S. E&P) pays to ___% U.S. shareholder

Prorate based on ____ during __-year testing period

For FTC purposes, trace source on _________ basis

Dividend Income: Example

A corporation pays a $1,000 dividend to Robinet, a Tunisian national and resident. The corporation derives ___% of its gross income from foreign business. How much of the dividend is foreign source income to Robinet?

Dividend Income: Example

Ross, an NRA, owns all shares of Forco. Forco derives ___% of its E&P from Canadian business, ___% from U.S. business, and ___% from Canadian investments. What is the source of $100 dividends Ross receives from Forco?

Personal Service Income

General ruleDepends on where

person renders services

Compensation ≤ $_____ to NRA present in U.S. ≤ ___ days when services rendered for:

Foreign person not conducting U.S. business orForeign office U.S. person maintains

Compensation under covenants not to compete

U.S. Social Security benefits

Depends on where services ______ be

performed

Personal Service Income

Alimony Depends on _______ residence

Scholarships, fellowships, prizes, awards

Grants to study or research abroad and achievement awards for activities occurring abroad

Depends on ________ residence

Personal Services: Example

Brooke, a ____ citizen, worked in Sri Lanka for two weeks, making $1,000. She performed the services on behalf of a U.S. missionary board. How much of this income is foreign source income?

Personal Services: Example

Halim, an ____, receives $2,000 for a drug-free root canal he performs during a one-month vacation in the United States. How much of the $2,000 is U.S. source income?

Rent and Royalty Income

Rental or leasing income Depends on property’s ________

Royalty incomeDepends on location where intangible can

be ____

Rental Income: Example

Lemon Limousines, a ____ company, leases vehicles for use in ______. What is the source of this income for U.S. tax purposes?

Royalty Income: Example

ChemPac, a ____ partnership, licenses a secret ingredient for use in South America. What is the source of royalty income that ChemPac receives?

Gain from Selling Realty

General rule Depends on property’s location

Foreign person’s gain from selling ___ shares representing a “U.S. real property interest”

Gain from Selling Personalty

• Gain is U.S. source income to “U.S. _________” and foreign source income to “____________.”

• General rule applies only to sale of:– Intangibles where gain is ____contingent– Stockholdings (except some ___ _______)– _____ instruments– ________ investment assets– ________-use assets

U.S. Residents Under §865

• NRAs with ____ ___ homes

• Domestic corporations, trusts, and estates

• U.S. citizens and residents– Without ______ tax homes or– With ______ tax homes who pay __ ____

foreign tax on gain

So Many Exceptions

• General rule has limited application

• Exceptions for:– Inventory– __________ property– _____ of foreign affiliate– Sales via _______ business office– Sales via ____ business office

Personalty Gain: Inventory

Purchase and resell Depends on _____ transfer

Produce and resell

Purchase in U.S. possession and sell in U.S.

Harvest or extract in U.S. and sell abroad

Cut unprocessed softwood timber in U.S. and sell abroad

Depends on where ________ and _____

Partially _______ source income

Depends on export ________ FMV

____ source income

Inventory Gain: Purchase-Resell

• Involves only one ________ activity

• Depends entirely on where ____ occurs– Where do ________ of ownership and _____ of

loss transfer?– Title passage per ____ ________– Otherwise, refer to ________ terms

Presumption Per Shipping Terms

Title passes at the designated point, whether shipping or destination

Title passes at shipping point

Title passes at shipping point even when destination is designated point

Inventory Gain: Example

Domco purchases merchandise from a ____ subsidiary for $100 and sells it to a ____ customer for $180. What is the source of the $80 profit?

Inventory Gain: Example

Domco purchases merchandise from a Japanese exporter for $100 and sells it to a _______ distributor for $180. Assuming Japanese exporter passes title in _____ and Domco passes title in _______, what is the source of the $80 profit?

Inventory Gain: Example

Forco purchases auto parts from a ____ exporter for $100 and sells them to a ____ retailer for $180. What is the source of the $80 profit if Forco passes title in _______?

Inventory Gain: Produce-Sell

• Involves ___ economic activities

• Three methods– _____ method– Independent _______ price method

• Regular sales to

• _________ distributors

– Books and _______

Independent Factory Price

U.S.Manufacturer

UnrelatedDistributor

Retailer

Retailer

Inventory Gain: Example

Domco manufactures merchandise in ____ (cost $100) and sells it to a ____ customer for $180. Under the 50-50 method, how much of the $80 profit is U.S. source income?

Inventory Gain: Example

Domco manufactures merchandise in ____ (cost $100) and sells it to a ____ customer for $180, transferring title ______. Domco regularly sells to unrelated U.K. distributors for $____. Under the IFP method, what is the source of the $80 profit?

Personalty Gain: Depreciable

Portion of gain attributable to prior depreciation or amortization

Depends on prior _____________ of deductions

Excess gain for depreciable personalty

Excess gain for amortizable personalty

Depends on _____ transfer

Depends on ________ (if non-contingent) or ___ (if contingent)

Depreciable Personalty: Example

Five years ago, Domco purchased construction equipment for $75,000 that it used entirely within the U.S. Domco claimed $______ depreciation, reducing the equipment’s basis to $45,000. Then, Domco sold the equipment to a Canadian outfit for $______. If title passes in _______, what is the source of Domco’s $35,000 gain?

Gain from Selling Foreign Affiliate

• If DC– Sells stock of ___%-owned ___ and– Sale occurs where ___ derived > ___% of gross

income from active business in past 3 years,

• Gain is ___.

Foreign Affiliate: Example

Since its creation, Forco (Domco’s wholly-owned FC) has derived all its income from business activities in ________. If Domco sells all its Forco shares, how is the gain sourced?

Gain via Foreign Business Office

• If U.S. resident– Sells

• __________ assets (other than shares in foreign affiliate) or

• Intangibles (where income is ____contingent)

– Using ________ business office and– Pays ≥ ___% foreign income tax,

• Gain is ___.

Foreign Office: Example

Domco’s ________ business office sells Exxon bonds, realizing gain of $100,000. How much of the gain is foreign source income?

Gain via U.S. Office

• Notwithstanding any other rules,

• If a ___________ sells personalty through a ____ business office,

• Gain is ____ unless– Personalty is _________ used or consumed abroad

and– Nonresident’s _______ ______ materially

participates in the sale.

U.S. Office: Example

Forco’s U.S. branch sells sleepwear to U.S. retailers. Title transfers in ________. How is the profit sourced?

Assume the same facts except that Forco’s ____ office sells directly to U.S. retailers. How is the profit sourced?

Underwriting Income

Life and health insurance Depends on individuals’ _________

Property insurance

Liability insurance

Depends on property’s ________

Depends on where __________ occur

Transportation Income

• Income from ________ transportation is USSI.

• Income from transportation beginning or ending in the U.S. follows _____ rule.

• Personal services– If related to transportation between U.S. and

foreign country, it’s sourced as ________ services.– NRAs temporarily in U.S. as regular _____

members of foreign vessel earn ____.

Transportation Income: Example

A vessel loads cargo in Miami and steams to Argentina where it offloads the cargo. The vessel spends ___ days in U.S. waters, ___ days in international waters, and ___ days in Argentinean waters. If the gross income attributable to this activity is $100,000, how much is from U.S. sources?

Int’l Communication Income

U.S. persons

Foreign persons:

Generally

Controlled foreign corporationPortion of income attributable to U.S. fixed place of business

Space, Ocean, and Antarctica

U.S. persons

Foreign persons

But, to extent attributable to U.S. functions, resources, or risks:

a. Foreign persons engaged in U.S. business or

b. Controlled foreign corporations

But, to extent attributable to foreign functions, resources, or risks