Source of Income for International Tax Strategies

Source of Income for international tax strategies is used by international tax accountants in foreign tax planning.

The sourcing rules can create a wall between a foreign corporation and the IRS.  Of course, the foreign corporation wants to be on the side of the wall that is outside of the United States.

Most foreign source income is not subject to U.S. income taxes.  However, there is a small exception involving the sale of inventory property. 

Here is a chart of the sources of income for international tax strategies.

Item of subject to source ruleGeneral rules of source of income  for international tax strategies
Salaries, wages,Where services performed
Business income—personal servicesWhere services performed
Sale of inventory—purchasedWhere sold
Sale of inventory—producedAllocation of a variety of factors
Sale of personal propertyWhere title passes, with exceptions
InterestResidence of obligor-payor
DividendsDomestic if domestic corporation & foreign if foreign corporation
RentsLocation of property
Royalty—patents, copyrights, etc.Where patent or copyright is used; laws are vague
Sale of real estateLocation of property
Personal service, consulting, training,Where serviced performed
PensionWhere services were performed that earned the pension

Source of Income for International Tax Strategies for the service business.

For example: Ian is a member of a U.K. law firm.  The law firm has an office in Florida.  This office promotes the law firm’s Cayman Island’s office.  Ian manages the Florida office along with two other partners and two secretaries. 

In Florida, Ian and his partners meet with clients, potential clients, manage the operation and accounting of the Cayman office.

Often Ian and the other partners travel to the Cayman Islands to work with the attorneys in the Cayman office.

The Florida office has a local bank account.   

Under the U.S. international  tax accounting  sourcing rules, the U.K. law firm has no U.S source income.  Having an office (or what is known as a “permanent establishment”) is irrelevant when the income is from a service.   The U.K. law firm does not need to file an U.S. tax return.  

However, a protective filing of a U.S. tax return should be considered.

Foreign source income for international tax strategies.

The partnership income is foreign source for U.S. international tax accounting purposes. 

American tax law ignores the place of banking, the existence of an U.S. office or permanent establishment. 

The one factor that determines U.S. taxation is where Ian and his partners do their billable client work.    In this case, the legal work is performed in the United Kingdom and the Cayman Islands. The legal work is foreign source income. 

 Learn why Ian does not pay income tax in the U.S. on his income on this link. 

Looking for help with your understanding the source income for international tax strategies and planning?  Then, please contact me, Brian Dooley, CPA, MBT via email (at [email protected] ). 

By the way, here is a method to generate more foreign tax credits.

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