In order to determine where to file your return and which form(s) you need to complete, you must determine the source of each item of income you received during the tax year. Income you received from sources within, or that was effectively connected with the conduct of a trade or business within, the relevant possession must be identified separately from U.S. or foreign source income.
This chapter discusses the rules for determining if the source of your income is from:
- American Samoa,
- The Commonwealth of the Northern Mariana Islands (CNMI),
- The Commonwealth of Puerto Rico (Puerto Rico),
- Guam, or
- The U.S. Virgin Islands (USVI).
Generally, the same rules that apply for determining U.S. source income also apply for determining possession source income. However, there are some important exceptions to these rules. Both the general rules and the exceptions are discussed in this chapter.taxmap/pubs/p570-006.htm#en_us_publink1000221201
This rule states that income is not possession source income if, under the rules of Internal Revenue Code sections 861–865, it is treated as income:
- From sources within the United States, or
- Effectively connected with the conduct of a trade or business within the United States.
Table 2-1 shows the general rules for determining whether income is from sources within the United States.
Table 2-1. General Rules for Determining U.S. Source of Income
|Item of Income||Factor Determining Source|
|Salaries, wages, and other compensation for labor or personal services||Where labor or services performed|
|Pensions||Contributions: Where services were performed that earned the pension|
Investment earnings: Where pension trust is located
|Interest||Residence of payer|
|Dividends||Where corporation created or organized|
|Rents||Location of property|
| Natural resources||Location of property|
| Patents, copyrights, etc.||Where property is used|
|Sale of business inventory—purchased||Where sold|
|Sale of business inventory—produced||Allocation if produced and sold in different locations|
|Sale of real property||Location of property|
|Sale of personal property||Seller's tax home (but see Special Rules for Gains From Dispositions of Certain Property for exceptions)|
|Sale of natural resources||Allocation based on fair market value of product at export terminal. For more information, see Regulations section 1.863-1(b).|
This section looks at the most common types of income received by individuals, and the rules for determining the source of the income. Generally, the same rules shown in Table 2-1 are used to determine if you have possession source income.taxmap/pubs/p570-006.htm#en_us_publink1000221205
Income from labor or personal services includes wages, salaries, commissions, fees, per diem allowances, employee allowances and bonuses, and fringe benefits. It also includes income earned by sole proprietors and general partners from providing personal services in the course of their trade or business.taxmap/pubs/p570-006.htm#en_us_publink1000221206
Generally, all pay you receive for services performed in a relevant possession is considered to be from sources within that possession. However, there is an exception for income earned as a member of the U.S. Armed Forces.taxmap/pubs/p570-006.htm#en_us_publink1000221207
If you are a bona fide resident of a relevant possession, your military service pay will be sourced in that possession even if you perform the services in the United States or another possession. However, if you are not a bona fide resident of a possession, your military service pay will be income from the United States even if you perform services in a possession.taxmap/pubs/p570-006.htm#en_us_publink1000221208
If you are an employee and receive compensation for labor or personal services performed both inside and outside the relevant possession, special rules apply in determining the source of the compensation. Compensation (other than certain fringe benefits) is sourced on a time basis. Certain fringe benefits (such as housing and education) are sourced on a geographical basis.
Or, you may be permitted to use an alternative basis to determine the source of compensation. See Alternative basis, later.
If you are self-employed, determine the source of your income for labor or personal services from self-employment on the basis that most correctly reflects the proper source of that income under the facts and circumstances of your particular case. In many cases, the facts and circumstances will call for an apportionment on a time basis as explained next.taxmap/pubs/p570-006.htm#en_us_publink1000221209
Use a time basis to figure your compensation for labor or personal services from the relevant possession (other than the fringe benefits discussed later). Do this by multiplying your total compensation (other than the fringe benefits discussed later) by the following fraction:
| ||Number of days you performed |
services in the relevant
possession during the year
| ||Total number of days you |
performed services during the year
| || || |
You can use a unit of time less than a day in the above fraction, if appropriate. The time period for which the income is made does not have to be a year. Instead, you can use another distinct, separate, and continuous time period if you can establish to the satisfaction of the IRS that this other period is more appropriate.taxmap/pubs/p570-006.htm#en_us_publink1000221211
In 2009, you worked in your employer's office in the United States for 60 days and in the Puerto Rico office for 180 days, earning a total of $80,000 for the year. Your Puerto Rico source income is $60,000, figured as follows.
| || |
| || 180 days |
| || || || || || || |taxmap/pubs/p570-006.htm#en_us_publink1000221214
The source of multi-year compensation is generally determined on a time basis over the period to which the compensation is attributable. Multi-year compensation is compensation that is included in your income in 1 tax year but is attributable to a period that includes 2 or more tax years. You determine the period to which the income is attributable based on the facts and circumstances of your case. For more information on multi-year compensation, see Treasury Decision (T.D.) 9212 and Regulations section 1.861-4, 2005-35 I.R.B. 429, available at http://www.irs.gov/irb/2005-35_IRB/ar14.html
If you received any of the following fringe benefits as compensation for labor or services performed as an employee partly inside and partly outside a relevant possession, you must source that income on a geographical basis.
- Local transportation.
- Tax reimbursement.
- Hazardous or hardship duty pay.
- Moving expense reimbursement.
For information on determining the source of the fringe benefits listed above, see Regulations section 1.861-4.
You can determine the source of your compensation under an alternative basis if you establish to the satisfaction of the IRS that, under the facts and circumstances of your case, the alternative basis more properly determines the source of your income than the time or geographical basis. If you use an alternative basis, you must keep (and have available for inspection) records to document why the alternative basis more properly determines the source of your income. taxmap/pubs/p570-006.htm#en_us_publink1000221216
There is now an exception to the rule for determining the source of income earned in a possession. Generally, you will not have income from a possession if during a tax year you:
- Are a U.S. citizen or resident,
- Are not a bona fide resident of that possession,
- Are not engaged in a trade or business in that possession,
- Temporarily perform services in that possession for 90 days or less, and
- Earned $3,000 or less from such services.
This exception began with income earned during your 2008 tax year.
Generally, pension income has two components: contributions to the pension plan and the earnings accrued from investing those contributions. The contribution portion is sourced according to where services were performed that earned the pension. The investment earnings portion is sourced according to the location of the pension trust.taxmap/pubs/p570-006.htm#en_us_publink1000221218
You are a U.S. citizen who worked in Puerto Rico for a U.S. company. All services were performed in Puerto Rico. Upon retirement you remained in Puerto Rico and began receiving your pension from the U.S. pension trust of your employer. Distributions from the U.S. pension trust must be allocated between (1) contributions, which are Puerto Rico source income, and (2) investment earnings, which are U.S. source income. taxmap/pubs/p570-006.htm#en_us_publink1000221219
This category includes such income as interest, dividends, rents, and royalties.taxmap/pubs/p570-006.htm#en_us_publink1000221220
The source of interest income is generally determined by the residence of the payer. Interest paid by corporations created or organized in a relevant possession (possession corporation) or by individuals who are bona fide residents of a relevant possession is considered income from sources within that possession.
However, there is an exception to this rule if you are a bona fide resident of a relevant possession, receive interest from a corporation created or organized in that possession, and are a shareholder of that corporation who owns, directly or indirectly, at least 10% of the total voting stock of the corporation. See Regulations section 1.937-2(i) for more information. taxmap/pubs/p570-006.htm#en_us_publink1000221221
Generally, dividends paid by a corporation created or organized in a relevant possession will be considered income from sources within that possession. There are additional rules for bona fide residents of a relevant possession who receive dividend income from possession corporations, and who own, directly or indirectly, at least 10% of the voting stock of the corporation. For more information, see Regulations section 1.937-2(g). taxmap/pubs/p570-006.htm#en_us_publink1000221222
Rents from property located in a relevant possession are treated as income from sources within that possession. taxmap/pubs/p570-006.htm#en_us_publink1000221223
Royalties from natural resources located in a relevant possession are considered income from sources within that possession.
Also considered possession source income are royalties received for the use of, or for the privilege of using, in a relevant possession, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property. taxmap/pubs/p570-006.htm#en_us_publink1000221224
The source rules for sales or other dispositions of property are varied. The most common situations are discussed below.taxmap/pubs/p570-006.htm#en_us_publink1000221225
Real property includes land and buildings, and generally anything built on, growing on, or attached to land. The location of the property generally determines the source of income from the sale. For example, if you are a bona fide resident of Guam and sell your home that is located in Guam, the gain on the sale is sourced in Guam. If, however, the home you sold was located in the United States, the gain is U.S. source income.taxmap/pubs/p570-006.htm#en_us_publink1000221226
The term "personal property" refers to property (such as machinery, equipment, or furniture) that is not real property. Generally, gain or loss from the sale or other disposition is sourced according to the seller's tax home. If personal property is sold by a bona fide resident of a relevant possession, the gain or loss from the sale is treated as sourced within that possession.
This rule does not apply to the sale of inventory, intangible property, depreciable personal property, or property sold through a foreign office or fixed place of business. The rules applying to sales of inventory are discussed below. For information on sales of the other types of property mentioned, see Internal Revenue Code section 865.taxmap/pubs/p570-006.htm#en_us_publink1000221227
Your inventory is personal property that is stock in trade or that is held primarily for sale to customers in the ordinary course of your trade or business. The source of income from the sale of inventory depends on whether the inventory was purchased or produced.taxmap/pubs/p570-006.htm#en_us_publink1000221228
Income from the sale of inventory that you purchased is sourced where you sell the property. Generally, this is where title to the property passes to the buyer. taxmap/pubs/p570-006.htm#en_us_publink1000221229
Income from the sale of inventory that you produced in a relevant possession and sold outside that possession (or vice versa) is sourced based on an allocation. For information on making the allocation, see Regulations section 1.863-3(f). taxmap/pubs/p570-006.htm#en_us_publink1000221230
There are special rules for gains from dispositions of certain investment property (for example, stocks, bonds, debt instruments, diamonds, and gold) owned by a U.S. citizen or resident alien prior to becoming a bona fide resident of a possession. You are subject to these special rules if you meet both of the following conditions.
- For the tax year for which the source of the gain must be determined, you are a bona fide resident of the relevant possession.
- For any of the 10 years preceding that year, you were a citizen or resident alien of the United States (other than a bona fide resident of the relevant possession).
If you meet these conditions, gains from the disposition of this property will not be treated as income from sources within the relevant possession for purposes of the Internal Revenue Code. Accordingly, bona fide residents of American Samoa and Puerto Rico, for example, may not exclude the gain on their U.S. tax return. (See chapter 3 for additional filing information.) With respect to the CNMI, Guam, and the USVI, the gain from the disposition of this property will not meet the requirements for certain tax rules that may allow bona fide residents of those possessions to reduce or obtain a rebate of taxes on income from sources within the relevant possessions.
These rules apply to dispositions after April 11, 2005. For details, see Regulations section 1.937-2(f)(1) and Examples 1 and 2 of section 1.937-2(k).taxmap/pubs/p570-006.htm#en_us_publink1000221231
In 2003, Cheryl Jones, a U.S. citizen, lived in the United States and paid $1,000 for 100 shares of stock in the Rose Corporation, a U.S. corporation listed on the New York Stock Exchange. On March 1, 2006, she moved to Puerto Rico and changed her tax home to Puerto Rico on the same date. Cheryl satisfied the presence test in 2006 and, under the year-of-move exception, she was considered a bona fide resident of Puerto Rico for the rest of 2006. On March 1, 2006, the closing value of Cheryl's stock in the Rose Corporation was $2,000. On January 5, 2009, while still a bona fide resident of Puerto Rico, Cheryl sold all her Rose Corporation stock for $7,000. Under the earlier rules, none of Cheryl's $6,000 gain will be treated as income from sources within Puerto Rico.
The source rules discussed in the preceding paragraphs supplement, and may apply in conjunction with, an existing special rule. This existing special rule applies if you are a U.S. citizen or resident alien who becomes a bona fide resident of American Samoa, the CNMI, or Guam, and who has gain from the disposition of certain U.S. assets during the 10-year period beginning when you became a bona fide resident. The gain is U.S. source income that generally is subject to U.S. tax if the property is either (1) located in the United States; (2) stock issued by a U.S. corporation or a debt obligation of a U.S. person or of the United States, a state (or political subdivision), or the District of Columbia; or (3) property that has a basis in whole or in part by reference to property described in (1) or (2). See chapter 3 for filing information.
For dispositions after April 11, 2005, you can choose to treat the part of gain (or loss) attributable to the time you held the property while a bona fide resident of the relevant possession (the possession holding period) as gain (or loss) from sources within that possession. Make the election by reporting the gain attributable to the possession holding period on your income tax return for the year of disposition. This election overrides both of the special rules discussed earlier.
There are two methods for figuring the gain for the possession holding period, one for marketable securities and another for other types of investment property.taxmap/pubs/p570-006.htm#en_us_publink1000221234
Marketable securities are those actively traded on an established financial market, such as stock in a publicly held corporation. Under the special election, allocate the gain (or loss) by figuring the appreciation separately for your possession and U.S. holding periods.
Your possession holding period begins on the first day you do not have a tax home outside the relevant possession. The gain (or loss) attributable to the possession holding period is the difference in fair market value of the security at the close of the market on the first and last days of this holding period. This is your gain or loss that is treated as being from sources within the relevant possession. If you were a bona fide resident of the relevant possession for more than one continuous period, combine the gains (or losses) from each possession holding period.taxmap/pubs/p570-006.htm#en_us_publink1000221235
Assume the same facts as in Example 1, except that Cheryl makes the special election to allocate the gain between her U.S. and possession holding periods. Cheryl's possession holding period began March 1, 2006, the date her tax home changed to Puerto Rico. Therefore, the portion of gain attributable to her possession holding period is $5,000 ($7,000 sale price – $2,000 closing value on first day of the possession holding period). By reporting $5,000 of her $6,000 gain as Puerto Rico source income on her 2009 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income.taxmap/pubs/p570-006.htm#en_us_publink1000221236
For personal property other than marketable securities, use a time-based allocation. Figure the gain (or loss) attributable to the possession holding period by multiplying your total gain (or loss) by the following fraction.
| ||Number of days in the |
possession holding period
| ||Total number of days |
in your holding period
| || || |
The result is your gain or loss that is treated as being from sources within the relevant possession.
In addition to the stock in Rose Corporation, Cheryl acquired a 5% interest in the Alder Partnership on January 1, 2005. On March 1, 2006, when she established bona fide residency in Puerto Rico, her partnership interest was not considered a marketable security. On September 15, 2009, while still a bona fide resident of Puerto Rico, Cheryl sold her interest in Alder Partnership for a $100,000 gain. She had owned the interest for a total of 1,719 days. Cheryl's possession holding period (from March 1, 2006, through September 15, 2009) is 1,295 days. The portion of her gain attributable to Puerto Rico is $75,334 ($100,000 x (1,295 Puerto Rico days ÷ 1,719 total days)). By reporting $75,334 of her $100,000 gain as Puerto Rico source income on her 2009 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income.
The source of these types of income is generally the residence of the payer, regardless of who actually disburses the funds. Therefore, in order to be possession source income, the payer must be a resident of the relevant possession, such as an individual who is a bona fide resident or a corporation created or organized in that possession.
These rules do not apply to amounts paid as salary or other compensation for services. See Compensation for Labor or Personal Services, earlier in this chapter, for the source rules that apply.