taxation law services

Personal Services Income Sourcing | International Tax Lawyer & Attorney

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This article continues our series of articles on the source of income rules. Today, I will explain the general rule for individual personal services income sourcing. I want to emphasize that, in this essay, I will focus only on individuals and provide only the general rule with two exceptions. Future articles will cover more specific situations and exceptions.

Personal Services Income Sourcing: General Rule

The main governing law concerning individual personal services income sourcing rules is found in the Internal Revenue Code (“IRC”) §861 and §862. §861 defines what income is considered to be US-source income while §862 explains when income is considered to be foreign-source income.

The general rule for the individual personal services income is that the location where the services are rendered determines whether this is US-source income or foreign-source income. If an individual performs his services in the United States, then this is US-source income. §861(a)(3). On the other hand, if this individual renders his services outside of the United States, then, this will be a foreign-source income. §862(a)(3).

In other words, the key consideration in income sourcing with respect to personal services is the location where the services are performed. Generally, the rest of the factors are irrelevant, including the residency of the employee, the place of incorporation of the employer and the place of payment.

As always in US tax law, there are exceptions to this general rule. In this article, I will cover only two statutory exceptions; in the future, I will also discuss other exceptions as well as the rule with respect to situations where the work is partially done in the United States and partially in a foreign country.

Personal Services Income Sourcing: De Minimis Exception

IRC §861(a)(3) provides a statutory exception to the general rule above specifically for nonresident aliens whose income meet the de minimis rule. The de minimis rule states that the US government will not consider the services of a nonresident alien rendered in the United States as US-source income as long as the following four requirements are met:

1. The nonresident alien is an individual;

2. He was only temporarily in the United States for a period or periods of time not exceeding a total of 90 days during the tax year;

3. He received $3,000 or less in compensation for his services in the United States; AND

4. The services were performed for either of two persons:

4a. “A nonresident alien, foreign partnership, or foreign corporation, not engaged in trade or business within the United States”. §861(a)(3)(C)(i); OR

4b. “an individual who is a citizen or resident of the United States, a domestic partnership, or a domestic corporation, if such labor or services are performed for an office or place of business maintained in a foreign country or in a possession of the United States by such individual, partnership, or corporation.” §861(a)(3)(C)(ii).

Personal Services Income Sourcing: Foreign Vessel Crew Exception

The personal services income performed by a nonresident alien individual in the United States will not be deemed as US-source income if the following requirements are satisfied:

1. The individual is temporarily present in the United States as a regular member of a crew of a foreign vessel; and

2. The foreign vessel is engaged in transported between the United States and a foreign country or a possession of the United States. See §861(a)(3).

Contact Sherayzen Law Office for Professional Help Concerning US International Tax Law, Including Personal Services Income Sourcing Rules

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2018 Individual Tax Rates | International Tax Lawyer & Attorney

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The Tax Cuts and Jobs Act of 2017 modified the tax brackets that existed in tax year 2017. In this short essay, I will discuss the new 2018 individual tax rates.

2018 Individual Tax Rates: Historical Background

Tax rates seem to change every time there is a new President. For example, when President Bush got elected in 2000, the Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 creating a new tax bracket and bringing the rest of the tax rates down; the top rate was gradually reduced to 35% from 39.6%.

Then, under the new administration of President Obama, the American Taxpayer Relief Act of 2012 increased the tax rates again with the top rate going back up to 39.6%.

2018 Individual Tax Rates: 2017 Tax Reform

Under President Trump, the Congress passed a major reform of the US tax system through the Tax Cuts and Jobs Act of 2017. The tax rates were among the most important changes with respect to domestic US tax law.

While the tax reform preserves the same seven tax brackets for individual tax payers, it introduces new 2018 individual tax rates for almost each of them. Under the previous law, the tax brackets were 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. Now, the new rates starting tax year 2018 are much lower: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

It is important to emphasize that these are not permanent changes. The new tax brackets will operate only through tax year 2025; starting January 1, 2026, the tax rates will return to those that existed in 2017.

2018 Individual Tax Rates: Income Thresholds for Tax Brackets Increase

In addition to lower tax rates, the 2017 tax reform also restructured the income thresholds that apply to most tax brackets. Generally, the income thresholds went up.

For example, in order to be subject to 39.6% tax in 2017, taxpayers filing a joint tax return must have had income in excess of $470,700. In 2018, in order to be subject to the top bracket’s tax rate of 37%, the same couple will have to have income in excess $600,000. The income of $470,700 would only trigger the 35% tax rate in 2018.

Sherayzen Law Office has long held the view that the increase in the income thresholds for tax brackets is especially important (perhaps, more so than the decrease in tax rates) to alleviate the tax burden of the middle class. However, we do note with alarm that the benefits might have been spread too widely to include the top 1% of the earners while the 10% bracket was kept essentially the same. We believe that this was one of the reasons why the Congress made the increase in income thresholds for tax brackets a temporary one despite the anticipated inflation pressures in the future.

Interest Income Sourcing | International Tax Lawyer & Attorney

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This article is a continuation of a recent series of articles on the US source of income rules. In this article, I would like to introduce the readers to the interest income sourcing rules.

Interest Income Sourcing: Definition of “Interest”

Let’s first understand what is meant by the word “interest”. It is very curious that there is no definition of this term in the Internal Revenue Code nor in the Treasury regulations. Indeed, when applied to real life situations, the tax definition of interest spreads to items which do not at first appear as interest income (the most famous example is the original issue discount); the contrary is also true – sometimes an income that appears to be interest income is not considered to be such by the IRS (for example, commitment fees).

Generally, “interest” is a payment for the use of money. In most cases, there is a relationship of indebtedness that accompanies the requirement to pay interest; however, this is not always the case. In fact, there are numerous rules and rulings that one must know in order to properly determine how the IRS will treat a certain payment.

Interest Income Sourcing: General Rule

Generally, the interest is sourced at the residence of the obligor. IRC § 861(a)(1). Thus, if the obligor resides in the United States, then the interest paid on the obligation will be considered as US-source income. This is the case even if the obligor is a foreign national who resides in the United States. On the other hand, if a US citizen resides in a foreign country, then the interest that he pays to his lender is a foreign-source income.

This rule may lead to a paradoxical situation. For example, if a US citizen resides in Spain and pays interest to a Spaniard, this interest would be considered as Spanish-source income. At the same time, if a Spaniard resides in the United States and pays interest to a US citizen who resides in Spain, then the interest would be considered as US-source income.

Generally, interest paid by domestic corporations and domestic partnerships follows the same interest income sourcing rules. There are, however, some exceptions to this rule. For example, with respect to banks, interest on deposits with a foreign branch of a domestic corporation is not considered to be US-source income. IRC § 861(a)(1)(A)(i).

I wish to emphasize that I am stating here a general rule only. There are various exceptions, especially with respect to the portfolio interest. Most of these exceptions are especially relevant to nonresident aliens who receive interest from the United States.

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H.R. 7358 & Modified Residency-Based Taxation | International Tax News

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On December 20, 2018, Congressman George Holding, a Republican from North Carolina and a member of the House Ways and Means Committee, introduced The Tax Fairness for Americans Abroad Act of 2018 (H.R. 7358). According to the analysis below, Sherayzen Law Office believes that H.R. 7358 seeks to modify it in a manner that moves it closer to something that can be described as a modified residency-based model of taxation. Yet, in no way should H.R. 7358 be viewed as an attempt to completely repeal the current citizenship-based model of taxation.

Current US Tax Law: Citizenship-Based Model of Taxation

Currently, all US citizens are obligated to report their worldwide income and pay US taxes on this income irrespective of their actual place of residence. In other words, even if a US citizen resides abroad, he is a US tax resident and must file a US tax return to report his worldwide income.

The current US tax law does allow such citizens to exclude a certain amount ($104,100 in 2018) through the operation of IRC Section 911, commonly known as the Foreign Earned Income Exclusion.

The United States and Eritrea are the only two countries in the world that tax their citizens in this manner. Everyone else taxes their citizens based only on their actual place of residence or under even more restrictive territorial model of taxation.

Lack of Residency-Based Taxation Results in Higher Tax Burden for Americans Who Live Abroad

The current law imposes an enormous burden on over nine million Americans who live abroad. Not only do they have to comply with all local tax laws, but they are also forced to comply with all US international tax laws, including the numerous US international tax reporting requirements.

Undoubtedly, the Foreign Earned Income Exclusion (“FEIE”) helps on the income side, but it only applies to earned income; US taxes must still be paid on all passive income. Moreover, the FEIE is limited to a certain threshold amount of earnings, which can easily be exceeded by the salaries normally paid to mid-level and upper echelon of corporate executives as well as small business owners.

Furthermore, the unincorporated American owners of small businesses may still be subject to US self-employment taxes (despite the income exclusion under the FEIE). Their income may also be disqualified from FEIE under the infamous 30% rule.

The Tax Fairness for Americans Abroad Act of 2018: Moving Current U.S. Tax System In the Direction of Modified Residency-Based Model of Taxation

H.R. 7358 seeks to alleviate the suffering of millions of Americans by modifying the current citizenship-based model of taxation. It proposes to move the US tax system to something that is reminiscent of a residency-based model of taxation.

If it passes, H.R. 7358 would create a new IRC Section 911A which would apply to the new category of taxpayers – qualified nonresident citizens. Such qualified nonresident citizens could exclude from their gross income the entire foreign earned income and foreign unearned income. In other words, nonresident citizens would only have to pay taxes on US-source income (with one exception concerning gains from sale of personal property).

Who would be a “qualified nonresident citizens”? Basically, in order to qualify for this designation, a citizen would have to be a nonresident citizen, not make an election under the IRC Section 911 and make an election under the IRC Section 911A.

A nonresident citizen would be a US citizen who: (a) has a “tax home” in a foreign country; (b) is in full compliance with US income tax laws for the three previous tax years; and (c) either physically resides in foreign country for at least 330 full days during the relevant tax year OR is a bona fide resident of a foreign country for the entire tax year.

Modified Residency-Based Taxation is Proposed by H.R. 7358

It is important to understand that, as it is written at this moment, H.R. 7358 proposes to modify the current tax system, not establish a true residency-based system of taxation. Even if today’s version of the bill passes, all nonresident US citizens will continue to be US tax residents while they reside in a foreign country. In other words, what is really proposed here is a major expansion of the FEIE, not a complete repudiation of the citizenship-based model of taxation.

This is a highly important legal conclusion, because it allows us to clearly see the limits of the relief offered by H.R. 7358. For example, since nonresident citizens will continue to be tax residents, they will still need to file their Forms 8938 and FBARs. Moreover, it does not appear that the bill would affect the obligation to file other international information returns, such as Forms 3520, 5471, 8865, et cetera.

Additionally, it is unclear what would happen to income recognized under the tax deferral regimes, such as Subpart F rules and the GILTI tax. If this income is excluded, H.R. 7358 will become a powerful incentive to residing outside of the United States for a certain period of time in order to implement certain tax planning strategies.

Thus, instead of eliminating citizenship-based taxation, the bill simply attempts to continue the modification of the US international tax system in a way similar to the 2017 tax reform introduced on the corporate side.

Obviously, this is just the initial version of the bill. It is possible that a more overt repudiation of the citizenship-based model of taxation will be enacted, including the elimination of FBAR and Form 8938 requirements for nonresident citizens. It is also possible, however, that this bill will not be enacted in any format at all.

Source of Income: Sale of Real Property | International Tax Law Firm

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One of the most common questions that often arises is whether a sale of real property is considered to be a foreign-source or US-source income. In this short essay, I will briefly describe the source of income rule for the sale of real property and discuss its importance.

Sale of Real Property: What is “Source of Income”

The sourcing rules within the United States Internal Revenue Code (“IRC”) determine to which part of the world a particular income item needs to be assigned. In other words, the source of income rules allow a taxpayer to determine whether his income is considered to be “domestic” or “foreign” for US tax purposes.

Sale of Real Property: the Importance of the Source of Income Rules

The importance of the source of income rules is difficult to overstate. For US tax residents, the source of income rules determine the amount of foreign tax credit that can be claimed on their US tax returns. Moreover, the source of income rules may have other important effects, especially for corporate taxpayers.

However, the significance of the source of income rules is felt the most by nonresident aliens. For these foreign persons, the determination of whether income is foreign or domestic may result in a complete escape from US taxation or, on the opposite end, the obligation to submit a US tax return (even if the nonresident alien has no other connection to the United States). Moreover, the sourcing of income has direct implications for the numerous US tax withholding obligations.

Sourcing of a Sale of Real Property

The US source of income rule with respect to sales of real property is clear: the gain from a sale of real property is sourced to the place where the property is located. In other words, if a house is located in the United States, then the gains from the sale of the house will be considered US-source income. On the other hand, if a house is located in a foreign country, then it will be considered foreign-source income (actually, sourced to the specific country where the sold property is located).

Contact Sherayzen Law Office for Professional Help With US International Tax Laws

Sherayzen Law Office is a tax law firm that specializes in US international tax law. We have developed deep expertise in US international tax law that allows us to effectively resolve our clients’ problems in this area. Procedurally, we are experienced in every stage of an international tax case: tax planning, tax preparation, offshore voluntary disclosures, IRS representation and federal litigation. We have successfully helped hundreds of taxpayers around the globe with their US international tax issues, and We can help You!

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