[Federal Register Volume 65, Number 14 (Friday, January 21, 2000)]
[Proposed Rules]
[Pages 3401-3404]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-757]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-208254-90]
RIN 1545-AO72


Source of Compensation for Labor or Personal Services

AGENCY:  Internal Revenue Service (IRS), Treasury.

ACTION:  Notice of proposed rulemaking and notice of public hearing.

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SUMMARY:  This document contains a proposed Income Tax Regulation 
describing the appropriate basis for determining the source of income 
from labor or personal services performed partly within and partly 
without the United States. This proposed regulation would modify the 
existing final regulation under section 861 of the Internal Revenue 
Code (Code). This regulation would affect foreign and United States 
persons that perform services partly within and partly without the 
United States during the taxable year. This document also provides a 
notice of a public hearing on this proposed regulation.

DATES:  Written and electronic comments and outlines of topics to be 
discussed at the public hearing scheduled for April 19, 2000, must be 
received by March 29, 2000.

ADDRESSES:  Send submissions to: CC:DOM:CORP:R (REG-208254-90), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
208254-90), Courier's Desk, Internal Revenue Service, 1111 Constitution

[[Page 3402]]

Avenue, NW., Washington, DC. Alternatively, taxpayers may submit 
comments electronically via the Internet by selecting the ``Tax Reg'' 
option on the IRS Home Page, or by submitting comments directly to the 
IRS Internet site at http://www.irs.ustreas.gov/tax__regs/
regslist.html. The public hearing will be held at 10 a.m. in room 2615, 
Internal Revenue Building, 1111 Constitution Avenue, NW., Washington 
DC.

FOR FURTHER INFORMATION CONTACT:  Concerning the proposed regulation, 
David Bergkuist of the Office of Associate Chief Counsel 
(International), within the Office of Chief Counsel, (202) 622-3850; 
concerning submission of comments, the hearing, and/or to be placed on 
the building access list to attend the hearing, LaNita Van Dyke (202) 
622-7180 (not toll free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR Part 1) under section 861 of the Internal Revenue 
Code (Code). These amendments modify the application of the existing 
final regulation relating to the determination of the source of income 
from the performance of labor or personal services when such labor or 
personal services are performed partly within and partly without the 
United States.

Explanation of Provisions

    Section 861(a)(3) of the Code provides, in general, that 
compensation for the performance of labor or personal services within 
the United States is treated as gross income from sources within the 
United States. Generally, under current Sec. 1.861-4(b)(1)(i) of the 
Income Tax Regulations, if a specific amount is paid for labor or 
personal services performed in the United States, that amount shall be 
included in United States source gross income. If no accurate 
allocation or segregation of amounts paid as compensation for labor or 
personal services performed in the United States can be made, or when 
such compensation is paid for labor or personal service performed 
partly within and partly without the United States, this regulation 
provides that the amount to be included in gross income from sources 
within the United States shall be determined on the basis that most 
correctly reflects the proper source of income under the facts and 
circumstances of the particular case. In many cases, the facts and 
circumstances will be such that an apportionment on a time basis will 
be acceptable; that is, the amount to be included in gross income from 
sources within the United States will be that amount that bears the 
same relation to the total compensation as the number of days of 
performance of the labor or service within the United States bears to 
the total number of days of performance of labor or services for which 
the payment is made. In other cases, the facts and circumstances will 
be such that another method of apportionment will be acceptable.
    The IRS understands that, under the current regulations, U.S. 
individuals posted overseas and foreign individuals posted to the 
United States generally apportion compensation on a time basis. 
However, the IRS has become aware that under the facts and 
circumstances test of the current regulations, U.S. individuals are 
taking the position that certain fringe benefits associated with an 
overseas posting by their employer should be considered compensation 
for labor or personal services performed outside the United States and 
treated entirely as foreign source income even though some services are 
performed within the United States during the time of the overseas 
posting. Conversely, foreign individuals posted to the United States 
are taking the position that fringe benefits associated with their U.S. 
posting should be apportioned between compensation for labor or 
personal services performed within and without the United States based 
upon the amount of time spent in each jurisdiction and would be partly 
U.S. and partly foreign source income. In addition, under the current 
regulations, similarly situated taxpayers may be treated differently 
depending upon how their employers account for any foreign posting 
fringe benefits. Where an employer separately states the value of a 
fringe benefit, a U.S. individual posted overseas may argue that the 
fringe benefit is entirely compensation for labor or personal services 
performed outside the United States and foreign source. However, 
another employee receiving the same amount of additional compensation 
as part of a foreign posting, but where that benefit is not separately 
stated, will often be required to apportion this benefit on the basis 
of time. Finally, the current regulations may allow U.S. individuals to 
take an inconsistent position for U.S. and foreign tax purposes with 
respect to the source of fringe benefits associated with an overseas 
posting and avoid all tax on such compensation.
    Treasury and the IRS have determined that an individual who 
performs labor or personal services partly within and partly without 
the United States during a specific time period should apportion the 
services income, including any income in the nature of fringe benefits, 
between compensation for labor or personal services performed within 
and without the United States on a time basis. The amount of 
compensation paid for labor or personal services performed in the 
United States, as determined under proposed Sec. 1.861-4(b), will 
constitute United States source income unless an exception applies 
under Sec. 1.861-4(a). A time basis test for individuals will provide 
certainty as well as ease of administration for both taxpayers and the 
IRS. A time basis test will also prevent the possibility of in-bound 
taxpayers taking a time basis apportionment position to apportion a 
portion of their United States posting fringe benefits back to their 
home country while similarly situated out-bound taxpayers take a facts 
and circumstances position to allocate all of their fringe benefits to 
foreign sources. This rule will also eliminate any disparate treatment 
of similarly situated taxpayers that might occur due to their 
employer's method of wage accounting. Finally, Treasury and the IRS 
believe that this rule will limit the potential for individuals to take 
inconsistent positions for U.S. and foreign tax purposes with respect 
to the source of their fringe benefits and avoid all tax.
    Treasury and the IRS have further determined that, with respect to 
persons other than an individual, an apportionment based upon all of 
the facts and circumstances available, for example, an apportionment 
based upon payroll expenses or capital and intangibles employed, may 
better reflect the proper source of such compensation. In many 
situations, an apportionment on a time basis may be acceptable.
    The proposed regulation would delete as obsolete current 
Sec. 1.861-4(b)(2), containing rules applicable to taxable years 
beginning before January 1, 1976.

Proposed Effective Date

    These regulations are proposed to be applicable for taxable years 
beginning on or after the date they are published in the Federal 
Register as final regulations.

Special Analyses

    It has been determined that this proposed rulemaking is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. Chapter 5) does not apply to this regulation, and, because this 
regulation does not impose a collection

[[Page 3403]]

of information on small entities, the Regulatory Flexibility Act (5 
U.S.C. Chapter 6) do not apply. Pursuant to section 7805(f) of the 
Internal Revenue Code, this notice of proposed rulemaking will be 
submitted the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before this proposed regulation is adopted as a final regulation, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) and electronic comments that are submitted timely 
to the IRS. The IRS and Treasury Department request comments on the 
clarity of the proposed rule and how it may be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for April 19, 2000, beginning 
at 10 a.m. in room 2615 of the Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the 10th Street entrance, located 
between Constitution and Pennsylvania Avenues, NW. In addition, all 
visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written 
comments and an outline of the topics to be discussed and the time to 
be devoted to each topic (signed original and eight (8) copies) by 
March 29, 2000. A period of 10 minutes will be allotted to each person 
for making comments. An agenda showing the scheduling of the speakers 
will be prepared after the deadline for receiving outlines has passed. 
Copies of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of this regulation is David Bergkuist of the 
Office of Associate Chief Counsel (International), within the Office of 
Chief Counsel, Internal Revenue Service. However, other personnel from 
the IRS and Treasury Department participated in its development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAX

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805. * * *

    Par. 2. Section 1.861-4 is amended as follows:
    1. The heading for paragraph (a) is revised.
    2. A new sentence is added at the beginning of paragraph (a)(1).
    3. Paragraphs (b) and (d) are revised.
    The addition and revisions read as follows:


Sec. 1.861-4  Compensation for labor or personal services.

    (a) Compensation for labor or personal services performed within 
the United States. (1) Generally, a specific amount paid for labor or 
personal services performed in the United States is gross income from 
sources within the United States. * * *
* * * * *
    (b) Compensation for labor or personal services performed partly 
within and partly without the United States--(1) Persons other than 
individuals. If a taxpayer other than an individual receives 
compensation for a specific time period for labor or personal services 
performed partly within and partly without the United States, the 
amount of compensation for labor or personal services performed in the 
United States shall be determined on the basis that most correctly 
reflects the proper source of the income under the facts and 
circumstances of the particular case. To the extent that a 
determination is made on a time basis, the time period to which the 
compensation for services relates is presumed to be the taxable year of 
the taxpayer in which the services are performed unless the taxpayer 
establishes to the satisfaction of the Commissioner, or the 
Commissioner determines, a change in circumstances that establishes a 
distinct, separate, and continuous period of time.
    (2) Individuals. If an individual receives compensation, including 
fringe benefits, for a specific time period for labor or personal 
services that are performed partly within and partly without the United 
States, the amount of compensation for labor or personal services 
performed within the United States shall be determined on a time basis. 
An amount of compensation for labor or personal services performed in 
the United States determined on a time basis is an amount that bears 
the same relation to the total compensation as the number of days of 
performance of the labor or services within the United States bears to 
the total number of days of performance of labor or services for which 
the compensation payment is made. The time period to which the 
compensation for services relates is presumed to be the calendar year 
in which the services are performed, unless the taxpayer establishes to 
the satisfaction of the Commissioner, or the Commissioner determines, a 
change in circumstances that establishes a distinct, separate, and 
continuous period of time. For example, a transfer from a position in 
the United States to a foreign posting during the year would generally 
establish two separate time periods. However, a foreign posting that 
requires short-term returns to the United States to perform services 
for the employer would not be sufficient to establish a distinct, 
separate, and continuous time period within the foreign posting time 
period. Short-term returns to the United States during the separate 
time period of the foreign posting would be relevant to the 
apportionment of compensation relating to such time period.
    (3) Examples. The following examples illustrate the application of 
this paragraph (b):

    Example 1. Corp X, a United States corporation, receives 
compensation of $15,000 under a contract for services to be 
performed concurrently in the United States and in several foreign 
countries at differing rates of compensation by numerous Corp X 
employees during the taxable year. The employees performing services 
under this contract perform their services exclusively in one 
jurisdiction and do not work both within and without the United 
States during the taxable year. The payroll costs for employees 
performing services in the United States associated with these 
contract services is $2,000 out of a total contract payroll cost of 
$3,000. Since the employees add relatively different amounts of 
value to the product, a time basis test is not the best test under 
the facts and circumstances of this particular case. An 
apportionment of the income received under the contract based upon 
relative payroll costs would be the basis that most correctly 
reflects the proper source of the income. Thus, $10,000 of the 
compensation received under this contract will be compensation for 
labor or personal services performed in the United States ($15,000 
x  $2,000/$3,000).
    Example 2. Corp X, a United States corporation, receives 
compensation of $15,000 under a contract for services. Corp X

[[Page 3404]]

is able to perform the services necessary to fulfill its obligation 
under the contract by assigning only three of its employees, each 
with the same rate of compensation, to render services both within 
and without the United States during the taxable year. Since the 
rate of compensation is the same, it can be assumed that all 
employees are adding the same value to the product. The total number 
of employee-days necessary to complete the contract is 30 days of 
which 10 days were spent performing services within the United 
States. Under these facts and circumstances, an apportionment on a 
time basis would be the basis that most correctly reflects the 
proper source of the income. The amount of compensation for labor or 
personal services performed in the United States will be that amount 
that bears the same relation to the total compensation as the number 
of days of performance of the labor or services within the United 
States bears to the total number of days of performance of labor or 
services for which the payment is made. Thus, $5,000 will be 
compensation from labor or personal services performed in the United 
States ($15,000  x  10/30).
    Example 3. B, a nonresident alien individual, was employed by M, 
a domestic corporation, from March 1 to June 12 of the taxable year, 
a total of 104 days, for which B received compensation in the amount 
of $12,240. Under the contract, B was subject to call at all times 
by M and was in a payment status on a 7-day week basis. Pursuant to 
the contract, B performed services within the United States for 59 
days and performed services without the United States for 45 days. 
Under subparagraph (b)(2) of this section, the amount of 
compensation from labor or personal services performed in the United 
States will be determined on a time basis and equal to $6,943.85 
($12,240  x  59/104).
    Example 4. (i) A, a United States citizen, is employed by a 
domestic corporation. A earns an annual salary of $100,000. During 
the first quarter of the calendar year, A's post of duty is in the 
United States and A performs services entirely within the United 
States during this period. A is transferred to Country X for the 
remaining three-quarters of the year, and, in addition to A's annual 
salary, receives $75,000 in fringe benefits that relate to the 
foreign posting. These fringe benefits are paid separately from A's 
annual salary and are specifically stated to be a housing allowance 
and an allowance for family home leave. Under A's employment 
contract, A is required to work on a 5-day week basis, Monday 
through Friday. During the last three quarters of the year, A 
performs services 30 days in the United States and 150 days abroad.
    (ii) A has $175,000 gross income for the taxable year from the 
performance of services. A is able to clearly establish that A's 
transfer created two distinct, separate, and continuous time periods 
within the calendar year. Accordingly, $25,000 of the income 
designated as salary is attributable to the first quarter of the 
year (one quarter of $100,000). This amount is allocated entirely to 
compensation for labor or personal services performed in the United 
States. The balance of A's adjusted gross income, $150,000 (which 
includes the $75,000 in fringe benefits that relate to the foreign 
posting), is compensation allocated to services performed for the 
final three quarters of his taxable year. During the last three 
quarters of the year, A's periodic performance of services in the 
United States does not constitute distinct, separate, and continuous 
periods of time. Of this $150,000 amount, $125,000 (150/180  x  
$150,000) is apportioned to compensation for labor or personal 
services performed outside the United States, and $25,000 (30/180 
x  $150,000) is apportioned to compensation for labor or personal 
services performed in the United States.
* * * * *
    (d) Effective date. Paragraphs (a) and (c) of this section apply 
with respect to taxable years beginning after December 31, 1966, 
however, the first sentence of paragraph (a)(1) applies to taxable 
years beginning on or after final regulations are published in the 
Federal Register. Paragraph (b) of this section applies to taxable 
years beginning on or after final regulations are published in the 
Federal Register. For paragraph (b) of this section and corresponding 
rules applicable to taxable years beginning after December 31, 1966, 
and before the date final regulations are published in the Federal 
Register, see Sec. 1.861-4(b) in effect prior to the date final 
regulations are published in the Federal Register (26 CFR part 1 
revised April 1, 1999). For corresponding rules applicable to taxable 
years beginning before January 1, 1967, see Sec. 1.861-4 in effect 
prior to October 2, 1975 (26 CFR part 1 revised April 1, 1975).

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-757 Filed 1-20-00; 8:45 am]
BILLING CODE 4830-01-U