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Final Regulations on Sourcing Income in U.S. Territories and Possessions

The IRS has issued final regulations providing rules for determining whether income is either (1) derived from sources within a U.S. possession or territory, or (2) effectively connected with the conduct of a trade or business within a possession or territory (territory ECI). These regulations were effective as of April 9, 2008. In general, under these regulations, the rules for sourcing income in U.S. territories and possessions and determining territory ECI are similar to those for determining whether income is from sources within the U.S. or effectively connected with a trade or business within the U.S. However, the tax consequences of classifying income as being from sources within a territory, or as being territory ECI, vary from territory to territory.

These sourcing rules are especially important to taxpayers who reside or do business in territories and possessions; the source of income will help determine to which jurisdiction the taxpayer must report his income and pay taxes. The source rules are also important to U.S. citizens and residents, and domestic corporations. Although these individuals and corporations are taxed on their worldwide income, the source rules are used to determine the foreign tax credit which alleviates double taxation.

The source rules are complex and involve the application of special rules. To further complicate the issue, the territories and possessions (American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands) have their own taxing systems, and they are not all the same.

Please call us at your earliest opportunity if you would like additional information about U.S. and territory or possession source income or assistance in properly identifying and reporting such income. Our office can analyze your situation to identify your U.S., territory, and foreign source income, and help you avoid double taxation.

IRS Circular 230 Disclosure

Pursuant to U.S. Treasury Department Regulations, information contained in this article is not intended by TOPC Potentia P.C. to constitute a covered opinion pursuant to regulation section 10.35 or to be used for the purpose of (i) avoiding tax-related penalties under Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.

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