Special Rules for Completing Your  
U.S. Tax Return(p19)

If you are not excluding possession income from your U.S. tax return, follow the instructions for the specific forms you file. However, you may not qualify to claim the earned income credit (EIC).

Even if you maintain a household in one of the possessions discussed in this publication that is your main home and the home of your qualifying child, you cannot claim the earned income credit on your U.S. tax return. This credit is available only if you maintain the household in the United States or you are serving on extended active duty in the U.S. Armed Forces.

U.S. military personnel stationed outside the United States on extended active duty are considered to live in the United States during that duty period for purposes of the EIC. Extended active duty means you are called or ordered to duty for an indefinite period or for a period of more than 90 days. Once you begin serving your extended active duty, you are still considered to have been on extended active duty even if you do not serve more than 90 days.

You will not be allowed to take deductions and credits that apply to the excluded income. The additional information you need follows.

Deductions that specifically apply to your excluded possession income, such as employee business expenses, are not allowable on your U.S. income tax return.

Deductions that do not specifically apply to any particular type of income must be divided between your excluded income from sources in the relevant possession and income from all other sources to find the part that you can deduct on your U.S. tax return. Examples of such deductions are alimony payments, the standard deduction, and certain itemized deductions (such as medical expenses, charitable contributions, real estate taxes, and mortgage interest on your home).

To find the part of a deduction that is allowable, multiply the deduction by the following fraction.

	Gross income subject to U.S. income tax
	Gross income from all sources (including excluded possession income)

Your adjusted gross income equals your gross income minus certain deductions (adjustments).

Generally, expenses of a move to a possession are directly attributable to wages, salaries, and other earned income from that possession. Likewise, the expenses of a move back to the United States are generally attributable to U.S. earned income.

If you are claiming expenses for a move to a relevant possession, how and where you will deduct the expenses depends on your status as a bona fide resident and if any of your possession income is excluded on your U.S. tax return. For more information, see Moving expense deduction in chapter 3 under the name of the relevant possession.

If you are claiming expenses for a move from a U.S. possession to the United States, use Form 3903 to figure your deductible expenses and enter the amount on Form 1040, line 26. For purposes of deducting moving expenses, the possessions are considered part of the United States. See Publication 521, Moving Expenses, for information about what expenses are deductible.

Generally, if you are reporting self-employment income on your U.S. return, you can deduct one-half of your self-employment tax on Form 1040, line 27. This is an income tax deduction only; it is not a deduction in figuring net earnings from self-employment (for self-employment tax).

However, if you are a bona fide resident of American Samoa or Puerto Rico and you exclude all of your self-employment income from gross income, you cannot take the deduction on Form 1040, line 27, because the deduction is related to excluded income.

If only part of your self-employment income is excluded, the part of the deduction that is based on the nonexcluded income is allowed. This would happen if, for instance, you have two businesses and only the income from one of them is excludable.

For purposes of the deduction only, figure the self-employment tax on the nonexcluded income by multiplying your total self-employment tax (from Schedule SE (Form 1040), Self-Employment Tax) by the following fraction.

	Self-employment income subject to U.S. income tax
	Total self-employment income (including excluded possession income)

The result is your self-employment tax on nonexcluded income. Deduct one-half of this amount on Form 1040, line 27.

Do not take excluded income into account when figuring your deductible IRA contribution.

The standard deduction is composed of the regular standard deduction amount and the additional standard deduction for taxpayers who are blind or age 65 or over. For 2010, you can add to these amounts certain new motor vehicle taxes and a net personal disaster loss attributable to a federally declared disaster (see the Form 1040 instructions for line 40). None of these deductions apply to any particular type of income.

To find the amount you can claim on Form 1040, line 40, first figure your full standard deduction according to the instructions for Form 1040, which may include completing Schedule L, Standard Deduction for Certain Filers. Then multiply your full standard deduction by the following fraction.

	Gross income subject to U.S. income tax
	Gross income from all sources (including excluded possession income)

In the space above line 40, enter "Standard deduction modified due to income excluded under section 931 (if American Samoa) or 933 (if Puerto Rico)." If you completed Schedule L, attach it to your return.

Most itemized deductions do not apply to a particular type of income. However, itemized deductions can be divided into three categories.

• Those that apply specifically to excluded income, such as employee business expenses, are not deductible.
• Those that apply specifically to income subject to U.S. income tax, which might also be employee business expenses, are fully allowable under the instructions for Schedule A (Form 1040), Itemized Deductions.
• Those that do not apply to specific income must be allocated between your gross income subject to U.S. income tax and your total gross income from all sources.

The example given later shows how to figure the deductible part of each type of expense that is not related to specific income.

In 2010, you and your spouse are both under 65 and U.S. citizens who are bona fide residents of Puerto Rico during the entire tax year. You file a joint income tax return. During 2010, you earned $20,000 from Puerto Rican sources (excluded from U.S. gross income) and your spouse earned $60,000 from the U.S. Government. You have $16,000 of itemized deductions that do not apply to any specific type of income. These are medical expenses of $4,000, real estate taxes of $5,000, home mortgage interest of $6,000, and charitable contributions of $1,000 (cash contributions). You determine the amount of each deduction that you can claim on your Schedule A (Form 1040), Itemized Deductions, by multiplying the deduction by the fraction shown under Figuring the deduction, earlier under Deductions if Possession Income is Excluded.

	Medical Expenses
	$60,000 $80,000	×	$4,000	=	$3,000 (enter on line 1 of Schedule A)

	Real Estate Taxes
	$60,000 $80,000	×	$5,000	=	$3,750 (enter on line 6 of Schedule A)

	Home Mortgage Interest
	$60,000 $80,000	×	$6,000	=	$4,500 (enter on line 10 or 11 of Schedule A)

	Charitable Contributions (cash contributions)
	$60,000 $80,000	×	$1,000	=	$750 (enter on line 16 of Schedule A)

Enter on Schedule A (Form 1040) only the allowable portion of each deduction.

Personal exemptions are allowed in full even if you are excluding possession income.

If you must report American Samoa or Puerto Rico source income on your U.S. tax return, you can claim a foreign tax credit for income taxes paid to the possession on that income. However, you cannot claim a foreign tax credit for taxes paid on possession income that is excluded on your U.S. tax return. The foreign tax credit is generally figured on Form 1116.

If you have income, such as U.S. Government wages, that is not excludable, and you also have possession source income that is excludable, you must figure the credit by reducing your foreign taxes paid or accrued by the taxes based on the excluded income. You make this reduction for each separate income category. To find the amount of this reduction, use the following formula for each income category.

Excluded income from possession sources less deductible expenses based on that income	x	Tax paid or accrued to the possession	=	Reduction in foreign taxes
Total income subject to possession tax less deductible expenses based on that income

Enter the amount of the reduction on Form 1116, line 12.

For more information on the foreign tax credit, see Publication 514.

Jason and Lynn Reddy are U.S. citizens who were bona fide residents of Puerto Rico during all of 2010. They file a joint tax return. The following table shows their excludable and taxable income for U.S. federal income tax purposes.

	Taxable		Excludable
Jason's wages from U.S. Government	$25,000
Lynn's wages from Puerto Rican corp.			$15,000
Dividend from Puerto Rican corp. doing business in Puerto Rico			200
Dividend from U.S. corp. doing business in U.S.*	1,000
Totals	$26,000		$15,200

* Income from sources outside Puerto Rico is taxable.

 

Jason and Lynn must file 2010 income tax returns with both Puerto Rico and the United States. They have gross income of $26,000 for U.S. tax purposes. They paid taxes to Puerto Rico of $4,000 ($3,980 on their wages and $20 on the dividend from the Puerto Rican corporation). They figure their foreign tax credit on two Forms 1116, which they must attach to their U.S. return. They fill out one Form 1116 for wages and one Form 1116 for the dividend. Jason and Lynn figure the Puerto Rican taxes on excluded income as follows.

	Wages: ($15,000 ÷ $40,000) × $3,980 = $1,493
	Dividend: ($200 ÷ $200) × $20 = $20

They enter $1,493 on Form 1116, line 12, for wages and $20 on the second Form 1116, line 12, for the dividend.