[Federal Register Volume 70, Number 68 (Monday, April 11, 2005)]
[Rules and Regulations]
[Pages 18920-18948]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-7087]



[[Page 18919]]

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Part III





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1, 301, and 602



Residence and Source Rules Involving U.S. Possessions and Other 
Conforming Changes; Final and Temporary Regulations; Notice of Proposed 
Rulemaking

  Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules 
and Regulations  

[[Page 18920]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 9194]
RIN 1545-BE22


Residence and Source Rules Involving U.S. Possessions and Other 
Conforming Changes

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that provide 
rules under section 937(a) of the Internal Revenue Code (Code) for 
determining whether an individual is a bona fide resident of the 
following U.S. possessions: American Samoa, Guam, the Northern Mariana 
Islands, Puerto Rico, and the United States Virgin Islands. The 
temporary regulations also provide rules under section 937(b) for 
determining whether income is derived from sources within a U.S. 
possession and whether income is effectively connected with the conduct 
of a trade or business within a U.S. possession. Section 937 was added 
to the Code by section 908 of the American Jobs Creation Act (2004 
Act).
    The temporary regulations also provide updated guidance under 
sections 876, 881, 884, 931, 932, 933, 934, 935, 957, and 6688 of the 
Code to reflect amendments made by the Tax Reform Act of 1986 (1986 
Act) and the 2004 Act. Conforming changes are also made to regulations 
under sections 170A, 243, 702, 861, 863, 871, 901, 1402, 6038, 6046, 
and 7701 of the Code. The text of the temporary regulations also serves 
as the text of the proposed regulations set forth in the cross-
referenced notice of proposed rulemaking on this subject in the 
Proposed Rules section in this issue of the Federal Register.

DATES: Effective Date: These regulations are effective April 11, 2005.

FOR FURTHER INFORMATION CONTACT: J. David Varley (202) 435-5165 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collection of information contained 
in these regulations has been reviewed and pending receipt and 
evaluation of public comments, approved by the Office of Management and 
Budget under control number 1545-1930. Responses to this collection of 
information are mandatory.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    For further information concerning this collection of information, 
and where to submit comments on the collection of information and the 
accuracy of the estimated burden, and suggestions for reducing this 
burden, please refer to the preamble to the cross-referencing notice of 
proposed rulemaking published in the Proposed Rules section of this 
issue of the Federal Register.
    Books and records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    The income tax laws of the United States have always contained 
special provisions concerning the income taxation of individuals 
residing in U.S. possessions and corporations created or organized in 
U.S. possessions. See e.g., sections 260 and 261 of Public Law 65-254 
(40 Stat. 1057). The current rules for residents of the Commonwealth of 
Puerto Rico (Puerto Rico) were first enacted in 1950. See sections 220 
and 221 of Public Law 81-814 (64 Stat. 906) (enacting the predecessors 
to sections 876 and 933 of the Code). Special rules for residents of 
the United States Virgin Islands (USVI) were added in 1960. See section 
4 of Public Law 86-779 (74 Stat. 998) (enacting section 934 of the 
Code). Special rules for residents of Guam were added in 1972. See 
Public Law 92-606 (86 Stat. 1494) (1972 Act) (enacting sections 935 and 
7654 of the Code). These special rules for residents of Guam were made 
applicable to residents of the Commonwealth of the Northern Mariana 
Islands (NMI) for tax years beginning after December 31, 1978. See 
section 601 of Public Law 94-241 (90 Stat. 263) and Presidential 
Proclamation 4534.
    The 1986 Act substantially revised the provisions governing the 
income taxation of individuals residing in U.S. possessions. See 
sections 1271 through 1277 of Public Law 99-514 (amending sections 876, 
931 through 935, 957(c), and 7654 of the Code). The 2004 Act restated 
and supplemented certain aspects of these provisions. See section 908 
of Public Law 108-357 (enacting section 937 of the Code). These 
regulations conform the existing regulations to the amended statutes 
and provide additional guidance on the proper application of the 
statutory provisions.
    This document contains amendments to 26 CFR parts 1, 301, and 602. 
The cross-referenced notice of proposed rulemaking is published 
elsewhere in this issue of the Federal Register.

Explanation of Provisions

I. Operative Provisions

    Many of the substantive and procedural provisions of the Code 
specifically relating to the possessions were amended by the 1986 Act. 
The 2004 Act further amended certain of these provisions. These 
regulations implement the statutory changes by modifying or replacing 
existing regulations as discussed below.

A. Puerto Rico

    Individuals who are U.S. citizens generally are subject to U.S. 
Federal income tax on their worldwide income, regardless of source, 
under section 1 of the Code. As discussed in section I.F. of this 
explanation, alien individuals who qualify as bona fide residents of 
Puerto Rico (and certain other possessions) likewise are subject to 
U.S. Federal income tax on their worldwide income under section 1.
    Under section 933, income from sources within Puerto Rico is 
excluded from gross income of bona fide residents of Puerto Rico 
(whether U.S. citizens or alien individuals) for U.S. Federal income 
tax purposes. Consequently, such individuals have a U.S. Federal income 
tax return filing obligation only if their income from sources outside 
Puerto Rico exceeds their deductions under section 151 relating to 
personal exemptions. To the extent such income constitutes income from 
sources outside the United States, such individuals generally may claim 
a foreign tax credit under section 901(b) for income taxes paid to 
foreign countries and U.S. possessions (including Puerto Rico) to 
offset their U.S. Federal income tax liability, subject to certain 
limitations.
    Deductions (other than the deduction under section 151, relating to 
personal exemptions) properly allocable to or chargeable against 
amounts excluded from gross income under section 933 generally have 
been disallowed since the statute was enacted in 1950. The 1986 Act 
amended section 933 to provide for a similar disallowance of

[[Page 18921]]

credits. These regulations amend the existing regulations under section 
933 to reflect this statutory change.

B. American Samoa, Guam, and the Northern Mariana Islands

    Section 931, as enacted in the 1986 Act, operates in a similar 
fashion to section 933. For U.S. citizens and alien individuals who are 
bona fide residents of possessions to which it applies (section 931 
possessions), income from sources within such possessions or 
effectively connected with the conduct of a trade or business in such 
possessions is excluded from gross income for U.S. Federal income tax 
purposes. Consequently, such individuals have a U.S. Federal income tax 
return filing obligation only if their income from sources outside 
section 931 possessions and not effectively connected with the conduct 
of a trade or business in such possessions exceeds their deductions 
under section 151 relating to personal exemptions. To the extent such 
income constitutes income from sources outside the United States, U.S. 
citizens who are bona fide residents of section 931 possessions 
generally may claim a foreign tax credit under section 901(b) for 
income taxes paid to foreign countries and U.S. possessions (including 
section 931 possessions) to offset their U.S. Federal income tax 
liability, subject to certain limitations. As under section 933, any 
deductions (other than the deduction under section 151, relating to 
personal exemptions) and credits properly allocable or chargeable 
against amounts excluded from gross income under section 931 are 
disallowed.
    Although section 931 by its terms applies to bona fide residents of 
American Samoa, Guam, and the NMI (collectively, the Pacific 
possessions), the statute takes effect with respect to any such 
possession only when the possession enters into an implementing 
agreement with the Internal Revenue Service as required under the 
relevant effective date provisions of the 1986 Act. See sections 
1271(b) and 1277(b) of Public Law 99-514. To date, only American Samoa 
has entered into such an agreement. Consequently, section 931 currently 
applies only to bona fide residents of American Samoa.
    Although section 935 was repealed by the 1986 Act, the effective 
date of its repeal is contingent on the entry into force of 
implementing agreements, as described above, by the possessions to 
which section 935 historically has applied (section 935 possessions), 
namely, Guam and the NMI. Given that neither has agreed to the entry 
into force of such agreements, section 935 remains in force with 
respect to bona fide residents of Guam and the NMI.
    Section 935, as in effect prior to its repeal, refers only to Guam. 
Pursuant to section 601 of the Covenant to Establish a Commonwealth of 
the Northern Mariana Islands in Political Union with the United States, 
Public Law 94-241, however, the income tax laws of the United States 
entered into force in the NMI in the same manner as those laws are in 
force in Guam, and references in the Code to Guam generally are deemed 
also to refer to the NMI. Consequently, section 935 currently applies 
to bona fide residents of Guam and of the NMI.
    These regulations amend the existing regulations under section 935 
to reflect the fact that the section currently applies not only to bona 
fide residents of Guam but also to bona fide residents of the NMI, and 
may in the future apply only to bona fide residents of one or the other 
and will not apply to bona fide residents of either possession if both 
enter into the implementing agreements contemplated in the 1986 Act. 
Similarly, these regulations set forth the post-1986 Act statutory 
framework for residents of section 931 possessions in a manner that 
reflects the potential for bona fide residents of Guam and the NMI to 
be covered by its provisions upon entry into force of such implementing 
agreements.

C. United States Virgin Islands

    Section 932, as enacted in the 1986 Act, provides two sets of 
operative rules: one for bona fide residents of the USVI, and one for 
U.S. citizens and resident alien individuals who are not bona fide 
residents of the USVI but have income from sources within the USVI or 
income effectively connected with the conduct of a trade or business in 
the USVI.
    With respect to individuals who are bona fide residents of the USVI 
(whether U.S. citizens or alien individuals), section 932(c) generally 
provides that an income tax return must be filed with the USVI tax 
authorities. If the individual properly reports on this return his or 
her income from all sources and identifies the source of each item of 
income, and pays all of the tax properly due with respect to such 
income, then such income is excluded from gross income for U.S. Federal 
income tax purposes. Consequently, such individuals have a U.S. Federal 
income tax return filing obligation only if they fail to report or 
properly identify the source of some of their income on their USVI 
income tax return, or if they fail to pay all of the tax properly due 
with respect to their income (for example, by improperly claiming the 
benefit of a tax credit or exemption provided under USVI law but 
subject to the limitations of section 934(b)).
    With respect to U.S. citizens and resident alien individuals who 
are not bona fide residents of the USVI but have income from sources 
within the USVI or income effectively connected with the conduct of a 
trade or business in the USVI, section 932(a) generally provides that 
each such individual must file his or her income tax return with both 
the IRS and with the USVI Bureau of Internal Revenue. In addition, 
under section 932(b), such an individual must pay to the USVI the 
``applicable percentage'' of the taxes imposed under Chapter 1 of the 
Code. For this purpose, the term applicable percentage means the 
percentage which the individual's Virgin Islands adjusted gross income 
bears to the individual's adjusted gross income; the term Virgin 
Islands adjusted gross income means the individual's adjusted gross 
income determined by taking into account only income derived from 
sources within the Virgin Islands and deductions properly apportioned 
or allocable thereto. On the individual's U.S. Federal income tax 
return, he or she may claim a credit for the tax required to be paid to 
the USVI, so that only the remainder is due to the United States.
    In general, the USVI administers income tax laws that are identical 
(except for the substitution of the name of the USVI for the term 
United States where appropriate) to those in force in the United States 
(commonly referred to as the mirror code). However, subject to the 
limitations of section 934(b), as amended by the 1986 Act, the USVI has 
the authority to reduce or remit tax liabilities under the mirror code 
in certain situations.
    First, under section 934(b)(1), the USVI may reduce or remit the 
tax otherwise imposed on the income of any person (other than a U.S. 
citizen or resident alien individual who is not a bona fide resident of 
the USVI) from sources within the USVI or effectively connected with 
the conduct of a trade or business in the USVI.
    Second, under section 934(b)(3), the USVI may reduce or remit the 
tax otherwise imposed on the income (other than income from sources 
within the United States or effectively connected with the conduct of a 
trade or business in the United States) of a foreign corporation, 
provided that less than ten percent of its stock (by vote and value) is 
owned by United States persons. Given that a corporation created or 
organized outside of the USVI can only have a mirror code tax liability 
with respect to income from sources within

[[Page 18922]]

the USVI or effectively connected with the conduct of a trade or 
business within the USVI (all of which is within the scope of section 
934(b)(1)), the additional waiver of the limitations of section 934(a) 
provided by section 934(b)(3) generally will have no practical effect 
for such corporations. Instead, section 934(b)(3) generally is relevant 
only to corporations created or organized in the USVI (which are 
treated as ``foreign'' corporations for U.S. Federal income tax 
purposes).
    These regulations amend the existing regulations under section 934 
and provide new regulations under section 932 to reflect this post-1986 
Act statutory framework.

D. U.S. Tax Liabilities of Certain Possessions Corporations

    Section 881(a) generally imposes a 30 percent tax on U.S.-source 
fixed or determinable annual or periodical income of foreign 
corporations. Section 884 imposes certain branch-level taxes on foreign 
corporations that are engaged in a trade or business in the United 
States. Section 881(b) provides for the reduction or elimination of the 
taxes otherwise imposed under sections 881(a) and 884 on corporations 
created or organized in U.S. possessions (possessions corporations) 
under certain circumstances.
    Section 881(b), as enacted by the 1972 Act, provides the rules 
currently in effect for corporations created or organized in section 
935 possessions. Under these rules, such corporations effectively are 
exempt from tax under section 881(a), provided that the following 
conditions are satisfied--
    (1) At all times during the taxable year, less than 25 percent in 
value of the stock of such corporation is owned (directly or 
indirectly) by foreign persons; and
    (2) At least 20 percent of the gross income of such corporation is 
shown to the satisfaction of the Secretary to have been derived from 
sources within such possession for the 3-year period ending with the 
close of the preceding taxable year of such corporation (or for such 
part of such period as the corporation has been in existence).
    Section 881(b), as enacted by the 1972 Act, also provides the rules 
currently in effect for corporations created or organized in the United 
States that otherwise might incur a tax liability to a section 935 
possession under a mirrored version of section 881(a). Under these 
rules, such corporations effectively are exempt from tax in the section 
935 possession in all cases.
    Section 881(b), as amended by the 1986 Act, provides the rules 
currently in effect for corporations created or organized in section 
931 possessions and in the USVI. Under these rules, such corporations 
effectively are exempt from tax under section 881(a) and section 884, 
provided that the following conditions (1986 conditions) are 
satisfied--
    (1) At all times during the taxable year, less than 25 percent in 
value of the stock of such corporation is beneficially owned (directly 
or indirectly) by foreign persons;
    (2) At least 65 percent of the gross income of such corporation is 
shown to the satisfaction of the Secretary to be effectively connected 
with the conduct of a trade or business in such a possession or the 
United States for the 3-year period ending with the close of the 
taxable year of such corporation (or for such part of such period as 
the corporation or any predecessor has been in existence); and
    (3) No substantial part of the income of such corporation is used 
(directly or indirectly) to satisfy obligations to persons who are not 
bona fide residents of such a possession or the United States.
    Corporations that are created or organized in section 935 
possessions and satisfy the 1986 conditions also are exempt from the 
U.S. tax imposed under section 884. Similarly, corporations that are 
created or organized in the United States and satisfy the 1986 
conditions are exempt from the tax imposed under mirrored versions of 
section 884 in section 935 possessions.
    Section 881(b), as amended by the 2004 Act, provides a special rule 
for corporations created or organized in Puerto Rico. Under this rule, 
such corporations are subject to tax under section 881(a) at a rate of 
10 percent (rather than the generally applicable rate of 30 percent) on 
their U.S.-source dividend income, provided that the 1986 conditions 
are satisfied. However, if, on or after October 22, 2004, there is an 
increase in the rate of Puerto Rico's withholding tax which is 
generally applicable to dividends paid to United States corporations 
not engaged in a trade or business in Puerto Rico to a rate greater 
than 10 percent, this special rule shall not apply to dividends 
received on or after the effective date of the increase.
    These regulations amend the existing regulations under sections 881 
and 884 to reflect this post-1986 Act and post-2004 Act statutory 
framework. These regulations also provide rules similar to the 1972 Act 
rules applicable to section 935 possessions for purposes of determining 
tax liability incurred to the USVI by corporations created or organized 
in the United States, pursuant to section 1274(c) of the 1986 Act.

E. Application of Subpart F to Bona Fide Residents of a Possession

    With respect to bona fide residents of section 935 possessions and 
the USVI (mirror code possessions), corporations created or organized 
in the possession in which they reside are treated as domestic 
corporations for mirror code tax purposes. Thus, provisions such as 
subpart F of part III of subchapter N of chapter 1 of the Code 
(relating to controlled foreign corporations) as mirrored do not apply 
with respect to their ownership of such corporations.
    With respect to bona fide residents of section 931 possessions and 
Puerto Rico, corporations created or organized in the possession in 
which they reside are treated as foreign corporations for U.S. Federal 
income tax purposes. Thus, in cases where, after the application of 
section 931 or 933 as the case may be, such individuals are required to 
file U.S. Federal income tax returns, they generally must treat such 
corporations as foreign corporations for purposes of applying 
provisions, such as subpart F, to determine their U.S. Federal income 
tax liability.
    Section 957(c), however, provides a significant exception for bona 
fide residents of section 931 possessions and Puerto Rico. In cases 
where it applies, the individual is not treated as a United States 
person for purposes of subpart F. Consequently, such individual is not 
treated as a United States shareholder under section 951(b), and 
possession corporations described in section 957(c) that are controlled 
by such individuals are not treated as controlled foreign corporations 
under section 957(a).
    In the case of a bona fide resident of Puerto Rico, section 
957(c)(1) applies with respect to a corporation organized under the 
laws of the Commonwealth of Puerto Rico if a dividend received by such 
individual during the taxable year from such corporation would, for 
purposes of section 933(1), be treated as income derived from sources 
within Puerto Rico. (As discussed in more detail below in section II.B. 
of this explanation, such would be the case if, during a three-year 
testing period ending with the taxable year, the corporation's gross 
income was derived entirely from sources within Puerto Rico or the 
corporation met certain gross income and trade or business 
requirements.)
    In the case of a bona fide resident of a section 931 possession, 
section 957(c)(2) applies with respect to a corporation organized under 
the laws of

[[Page 18923]]

such a possession if the following conditions are satisfied--
    (1) 80 percent or more of the gross income of the corporation for 
the 3-year period ending at the close of the taxable year (or for such 
part of such period as such corporation or any predecessor has been in 
existence) was derived from sources within such a possession or was 
effectively connected with the conduct of a trade or business in such a 
possession; and
    (2) 50 percent or more of the gross income of the corporation for 
such period (or part) was derived from the active conduct of a trade or 
business within such a possession.
    These regulations amend the existing regulations under section 957 
to reflect this post-1986 Act statutory framework. These regulations 
also make corresponding changes to the regulations under sections 6038 
and 6046 (relating to information reporting requirements with respect 
to certain foreign corporations owned by United States persons).

F. Taxation of Aliens Residing in a Possession

    Under section 876, individuals who are nonresident aliens with 
respect to the United States and are bona fide residents of certain 
possessions are subject to U.S. Federal income tax on their worldwide 
income under section 1 (rather than solely on their income from sources 
within the United States or effectively connected with the conduct of a 
trade or business in the United States under section 871). Prior to the 
1986 Act, section 876 applied only to alien individuals who were bona 
fide residents of Puerto Rico. As amended by the 1986 Act, section 876 
applies also to alien individuals who are bona fide residents of 
section 931 possessions.
    These regulations amend the existing regulations under section 876 
to reflect this post-1986 Act statutory framework.

G. Entity Status

    The IRS and Treasury are aware that some taxpayers have 
deliberately treated business entities in an inconsistent manner for 
U.S. Federal income tax purposes and for purposes of determining income 
tax liabilities incurred to mirror code possessions, in order to reduce 
their overall tax liability below what otherwise would be due in the 
absence of the mirror system. The IRS and Treasury believe that such 
inconsistent treatment is inappropriate and contrary to the purpose of 
the mirror system. Accordingly, these regulations contain special rules 
requiring consistent treatment of business entities for U.S. and mirror 
code tax purposes.
    Under these rules, if an entity status election (such as a 
subchapter S election or an election under Sec.  301.7701-3(c)) is 
filed with the IRS but not with the relevant mirror code possession, 
then the appropriate tax authority of the mirror code possession may, 
at his or her discretion, deem the election also to have been made for 
mirror code tax purposes. Similarly, if any such election is filed in a 
mirror code possession but not with the IRS, the Commissioner may, at 
his discretion, deem the election to have been made for U.S. Federal 
income tax purposes. In the event that inconsistent elections are filed 
with the IRS and the mirror code possession, both the Commissioner and 
the appropriate tax authority of the mirror code possession may, at 
their individual discretion, deem the elections they received to be 
invalid and may deem the election filed with the other jurisdiction to 
have been made also for tax purposes in their own jurisdiction. 
Further, in the absence of an election, the default characterization of 
an eligible entity organized in a mirror code possession shall be 
determined under the rules applicable to domestic eligible entities 
under Sec.  301.7701-3(b). These consistency rules apply to elections 
under section 1362(a) and Sec.  301.7701-3(c), and to other similar 
elections. The IRS and Treasury request comments relating to elections 
that should be specifically mentioned or excluded from the regulations.
    These special rules generally apply to elections made after, and 
entities created after, April 11, 2005. Transition rules are provided 
for existing entities, under which these special rules generally apply 
as of the beginning of the next taxable year.

H. Effective Date

    To the extent they provide rules under the operative provisions of 
the Code relating to the possessions, as amended by 1986 Act and the 
2004 Act, these regulations generally apply to taxable years ending 
after October 22, 2004. The underlying statutory rules, however, 
generally apply to taxable years beginning after December 31, 1986. 
Accordingly, taxpayers may rely upon the guidance provided in these 
regulations with respect to prior years for which the underlying 
statutory rules are in effect, provided that they do so consistently.

II. Definitional Provisions

    As indicated above in section I of this explanation, when applying 
the operative provisions of the Code relating to the possessions, 
determinations must be made regarding whether an individual is a bona 
fide resident of a particular possession, or whether income is derived 
from sources within a particular possession or is effectively connected 
with the conduct of a trade or business in a particular possession. 
Section 937 and these regulations provide guidance on these issues, as 
discussed below.

A. Bona Fide Residency in a Possession

    The term bona fide resident has been an integral part of the 
special provisions of the Code relating to U.S. possessions since 1950. 
See sections 220 and 221 of Public Law 81-814. From the beginning, this 
term has been used to identify the class of persons entitled to Federal 
tax exemptions or other special treatment under these provisions, and 
its meaning has remained essentially unchanged through all of the 
expansions and revisions of these provisions.
    Historically, the determination of whether an individual is a bona 
fide resident of a possession has turned on the facts and circumstances 
and, specifically, on an individual's intentions with respect to the 
length and nature of his or her stay in the possession. See, e.g., 
Sec. Sec.  1.933-1(a), 1.934-1(c)(2), and 1.935-1(a)(3) (generally 
applying the principles of Sec. Sec.  1.871-2 through 1.871-5). But see 
Sec.  301.7701(b)-1(d) (applying the rules of section 7701(b) for 
determining whether alien individuals qualified as residents of mirror 
code possessions for taxable years beginning after December 31, 1984). 
The qualifier ``bona fide'' indicates that a claim of residence in a 
possession is respected for Federal tax purposes when it is made in 
good faith.
    As enacted by the 2004 Act, section 937(a) provides that an 
individual generally will be considered a bona fide resident of a 
possession only if he or she satisfies all three of the following 
conditions--
    (1) He or she is physically present in the possession for 183 days 
during the taxable year (physical presence test);
    (2) He or she does not have a tax home (determined under the 
principles of section 911(d)(3) without regard to the second sentence 
thereof) outside the possession during the taxable year (tax home 
test); and
    (3) He or she does not have a closer connection (determined under 
the principles of section 7701(b)(3)(B)(ii)) to the United States or a 
foreign country than to the possession (closer connection test).
    Section 937(a) further provides that, for purposes of the physical 
presence test, the determination as to whether a

[[Page 18924]]

person is present for any day shall be made under the principles of 
section 7701(b). The legislative history explains that, under this 
rule, an individual is to be considered present in a possession for a 
particular day if he is physically present in such possession during 
any time during such day, and in certain circumstances (e.g., certain 
medical emergencies), an individual's presence outside a possession is 
ignored. See H.R. Rep. No. 108-755, at 780 (2004).
    The tax home and closer connection tests are similar to the 
conditions that individuals historically have needed to meet to be 
considered residents of a possession.
    Congress also provided regulatory authority for the IRS and 
Treasury to create exceptions to this general definition, for cases in 
which an individual's absence from the possession is motivated by 
reasons other than tax avoidance. In particular, the legislative 
history indicates that Congress anticipated that exceptions would be 
provided for military personnel, workers in the fisheries trade, and 
retirees who may travel outside of a possession for personal reasons. 
At the same time, the legislative history makes clear that Congress 
wished to ensure that individuals who live and work stateside cannot 
avail themselves of the tax benefits that Congress intended to provide 
only to individuals who actually reside in the possessions. See H.R. 
Rep. No. 108-755, at 780 (2004).
    Consistent with this legislative history, these regulations include 
several exceptions to the general statutory rules of section 937(a).
    First, these regulations provide several alternatives to the 183-
day rule for purposes of satisfying the physical presence test. One 
alternative is that the individual spend no more than 90 days in the 
United States during the taxable year. Thus, for example, workers in 
the fisheries trade who spend considerable periods at sea, and 
individuals who travel extensively to neighboring islands to provide 
goods and services, may satisfy the physical presence requirement under 
this alternative.
    Another alternative is that the individual spend more days in the 
possession than in the United States and have no earned income (as 
defined in Sec.  1.911-3(b)) in the United States during the taxable 
year. Thus, for example, retirees who spend several months each year 
stateside for vacation, for medical treatment, or to visit relatives, 
and some time traveling in foreign countries, may satisfy the physical 
presence requirement under this alternative.
    A final alternative is that the individual have no permanent 
connection to the United States. For this purpose, the term permanent 
connection to the United States includes a permanent residence and a 
spouse or dependent with a principal place of abode in the United 
States. In other words, the absence of a permanent connection will 
enable an individual to satisfy the physical presence test. Thus, for 
example, an individual who lives in a possession but travels 
extensively in the United States for business reasons or to receive 
medical treatment may satisfy the physical presence requirement under 
this alternative.
    For purposes of determining whether the above-mentioned 
alternatives are satisfied, certain days spent in the United States are 
disregarded. In particular, days spent as a full-time student, as a 
full-time government official or employee of a possession, or as a 
professional athlete participating in a charitable event generally are 
disregarded. In addition, days spent in transit and days that an 
individual is prevented from leaving the United States because of a 
medical condition that arose while the individual was present in the 
United States generally will also be disregarded.
    The above-mentioned alternatives apply with respect to individuals 
who are U.S. citizens or resident aliens (as defined in section 
7701(b)). A different approach is appropriate in the case of 
individuals who are nonresident aliens with respect to the United 
States. For such individuals, in lieu of the above-mentioned 
alternatives, a mirrored version of the section 7701(b) substantial 
presence test applies.
    For purposes of the tax home test, these regulations provide a 
special rule for seafarers. Under this special rule, an individual will 
not be considered to have a tax home outside the relevant possession 
solely by reason of employment on a ship or other seafaring vessel that 
is predominantly used in local and international waters.
    For purposes of the closer connection test, these regulations 
provide a special rule under which another possession is not considered 
a foreign country. Thus, for example, an individual who has a tax home 
in the USVI and a closer connection to Puerto Rico, and who satisfies 
the presence test with respect to both possessions, generally will be 
considered a bona fide resident of the USVI, and not of Puerto Rico.
    Special rules apply under Federal law for determining the residence 
of military personnel for tax purposes. See 50 App. U.S.C. 571(a). 
Consistent with these special rules, these regulations provide that an 
individual's absence from or presence in a possession in compliance 
with military orders generally does not affect whether the individual 
qualifies as a bona fide resident of such possession.
    Finally, consistent with existing law (see Notice 2000-61 (2000-2 
C.B. 569)), these regulations provide that only natural persons may be 
considered bona fide residents of a possession for U.S. Federal income 
tax purposes. Thus, juridical persons such as corporations, 
partnerships, trusts, and estates cannot be considered bona fide 
residents of a possession for U.S. Federal income tax purposes.
    It should be noted that the 2004 Act modified sections 932 and 935, 
to conform the treatment of individuals who acquire or relinquish 
residency in mirror code possessions with the historical treatment of 
individuals who acquire or relinquish residency in Puerto Rico and 
section 931 possessions. Thus, for example, in order to be subject to 
the special rules of section 932(c), an individual must qualify as a 
bona fide resident of the USVI during the entire year. Accordingly, an 
individual generally is not subject to such special rules for any year 
during which he or she moves to or from the USVI.
    The 2004 Act provisions and these regulations as they relate to the 
determination of bona fide residency in a possession generally apply to 
taxable years ending after October 22, 2004, except that the physical 
presence requirement applies only to taxable years beginning after 
October 22, 2004. In addition, taxpayers may choose to apply the rules 
set forth in these regulations in their entirety (including the 
physical presence test) to any open taxable years by notifying the IRS 
upon examination of their intent to do so. Alternatively, for such 
years, U.S. citizens and resident alien individuals (as well as 
nonresident aliens in possessions other than mirror code possessions) 
may continue to apply the principles of Sec. Sec.  1.871-2 through 
1.871-5, and nonresident alien individuals in mirror code possessions 
may continue to apply the rules of Sec.  301.7701(b)-1(d) (as in effect 
for such years).

B. Income From Sources in a Possession

    In general, the rules for determining whether income is derived 
from sources within the United States have applied for purposes of 
determining whether income is derived from sources within a possession. 
See Sec.  1.863-6. The 2004 Act codified this rule in section 937(b), 
with two exceptions.

[[Page 18925]]

    First, section 937(b)(2) (U.S. income rule) provides that an item 
of income shall not be considered to be derived from sources within a 
possession (or effectively connected with the conduct of a trade or 
business within a possession) if such item of income constitutes income 
from sources within the United States or income effectively connected 
with the conduct of a trade or business in the United States under the 
general rules of sections 861 through 865.
    Second, section 937(b) provides an express grant of authority, 
consistent with the authority contained in sections 931, 934, and 957 
as amended by the 1986 Act, for Treasury and the IRS to provide 
appropriate exceptions to the general source rules.
    The legislative history to the 2004 Act indicates that Congress 
intended for Treasury and the IRS to use this authority to continue the 
existing treatment of income from the sale of goods manufactured in a 
possession. The 2004 Act legislative history further indicates that 
Congress intended for this authority to be used to prevent abuse, for 
example, to prevent U.S. persons from avoiding U.S. tax on appreciated 
property by acquiring residency in a possession prior to its 
disposition. See H.R. Rep. No. 108-755, at 781 (2004).
    The legislative history to the 1986 Act reflects similar concerns. 
For example, Congress did not believe that a mainland resident who 
moves to a possession while owning appreciated personal property such 
as corporate stock or precious metals and who sells that property in 
the possession should escape all tax, both in the United States and the 
possession, on that appreciation. Similarly, Congress did not believe 
that a resident of a possession who owns financial assets such as 
stocks or debt of companies organized in, but the underlying value of 
which is primarily attributable to activities performed outside, the 
possession should escape tax on the income from those assets.
    Accordingly, Congress anticipated that regulations would treat such 
income as sourced outside the possession where the taxpayer resides. 
See H.R. Rep. No. 99-426, at 487 and 489 (1985); S. Rep. No. 99-313, at 
481 and 484 (1986).
    These regulations include several exceptions to the general 
statutory rules of section 937(b).
    First, the regulations provide that the U.S. income rule only 
applies for income earned after December 31, 2004.
    Second, the regulations contain a special conduit rule to prevent 
the avoidance of the U.S. income rule. Under this special conduit rule, 
income is considered to be from sources within the United States for 
purposes of the U.S. income rule if, pursuant to a plan or arrangement, 
(i) the income is received in exchange for consideration provided to 
another person, and (ii) such person (or another person) provides the 
same consideration (or consideration of a like kind) to a third person 
in exchange for one or more payments constituting income from sources 
within the United States. This rule supplements, and does not 
supersede, other potentially applicable conduit rules. See, for 
example, Aiken Indus., Inc. v. Commissioner, 56 T.C. 925 (1971). Unlike 
more generally applicable conduit rules, however, the special conduit 
rule in these regulations applies only for purposes of section 937 (and 
provisions for which the rules of section 937 apply); it does not cause 
the income to be treated as income from sources within the United 
States for other purposes of the Code.
    Third, the regulations preserve the existing treatment of income 
from the sale of goods manufactured in a possession under Sec.  1.863-
3(f). These existing rules reflect a careful consideration of the 
relevant policy considerations arising with respect to the transactions 
to which they apply, and Congress did not intend for this result to be 
changed through a mechanical application of the general source rules of 
section 937(b). For the same reason, these regulations contain rules to 
preserve the results with respect to the allocation of income between 
the United States and its possessions under sections 863(c), 863(e), 
865(g)(3), and 865(h)(2)(B).
    Fourth, the regulations provide special rules for gains from 
dispositions of certain property held by a U.S. person prior to 
becoming a resident of a possession. Under these rules, such gains 
generally are treated as income from sources outside of the possession. 
These rules supplement, and do not supersede, the special source rule 
of section 1277(e) of the 1986 Act, which applies to individuals who 
become residents of Pacific possessions. Under this 1986 Act special 
source rule, gains from dispositions of certain property held by a U.S. 
person prior to becoming a resident in a Pacific possession is treated 
as income from sources within the United States for all purposes of the 
Code (including section 7654 of the 1954 Code as applicable to Guam and 
the NMI). The regulations also contain rules that are designed to 
prevent the avoidance of these special gain rules.
    Fifth, the regulations provide special rules for dividends from 
corporations created or organized in a possession (possessions 
corporations). In general, such dividends constitute income from 
sources within a possession under the principles of section 
861(a)(2)(A). A special look-through rule applies, however, when the 
shareholder owns, directly or indirectly, at least 10 percent of the 
voting stock of the corporation. Under this special rule, only a 
ratable portion of any dividend paid or accrued by a possessions 
corporation to such a shareholder is treated as income from sources 
within the possession. The ratable portion is determined by applying to 
the dividend the ratio of the corporation's income from sources within 
the possession over its total income over a three-year testing period 
ending with the year in which the dividend is paid. (See also sections 
881(b) and 957(c) for which a similar three-year testing period 
applies.) This look-through rule does not apply, however, if the 
corporation meets the following conditions (the 80/50 conditions)--
    (1) 80 percent or more of the gross income of the corporation for 
the three-year testing period was derived from sources within the 
possession or was effectively connected with the conduct of a trade or 
business in the possession; and
    (2) 50 percent or more of the gross income of the corporation for 
such period was derived from the active conduct of a trade or business 
within the possession.
    Sixth, the regulations provide rules for determining the extent to 
which income inclusions (for example, under section 951(a)) may be 
considered to be derived from sources within a possession. 
Specifically, for shareholders owning at least 10 percent of the voting 
stock of the corporation, the regulations generally apply the 
principles of section 904(h)(2), under which the source of income 
inclusions ordinarily is determined for foreign tax credit purposes. 
For all other shareholders, income inclusions are considered to be 
derived from sources within the jurisdiction in which the corporation 
is created or organized.
    Seventh, the regulations provide rules for determining the extent 
to which interest payments may be considered to be derived from sources 
within a possession. In general, interest paid by possessions 
corporations and noncorporate residents of a possession constitutes 
income from sources within the possession under the principles of 
section 861(a)(1). A special look-through rule applies, however, when 
the interest is paid by a possessions corporation to a shareholder who 
owns, directly or

[[Page 18926]]

indirectly, at least 10 percent of the voting stock of the corporation. 
Under this special rule, which is applied in accordance with the 
principles of Sec. Sec.  1.861-9 through 1.861-12, the interest is 
treated as income from sources within the possession only to the extent 
that such interest is allocable to assets giving rise to income from 
sources within the possession or income effectively connected with the 
conduct of a trade or business within the possession. This look-through 
rule does not apply, however, if the corporation meets the 80/50 
conditions described above. The regulations further provide that 
interest paid by a partnership is treated as income from sources within 
a possession only to the extent that such interest is allocable (under 
the principles of Sec.  1.882-5) to income effectively connected with 
the conduct of a trade or business in the possession.
    Special rules apply under Federal law for determining, for tax 
purposes, the source of income from the performance of services by 
military personnel. See 50 App. U.S.C. 571(b). Consistent with these 
special rules, these regulations provide that income from military 
services performed stateside (or in another possession) by a bona fide 
resident of a possession is considered to be income from sources within 
such possession, and income from military services performed in a 
possession by an individual who is not a bona fide resident of such 
possession is not considered to be income from sources within such 
possession.
    Lastly, the regulations continue the existing treatment of income 
from services performed within a possession and from dividends paid by 
corporations created or organized outside of a possession. Thus, 
compensation received for services performed in a possession 
constitutes income from sources within the possession without regard to 
the de minimis exception in section 861(a)(3), and dividends paid by 
corporations created or organized outside of a possession constitute 
income from sources outside of the possession in all cases.
    The rules of section 937(b) and these regulations generally apply 
for purposes of all provisions of the Code for which a determination 
must be made regarding whether income is derived from sources within a 
possession. They generally do not apply, however, for purposes of 
applying mirrored provisions of the Code in mirror code possessions. 
Thus, for example, gain that is treated as income from sources outside 
the USVI for purposes of section 934(b) under the special gain rules 
described above (in the paragraph regarding dispositions of certain 
property held by a U.S. person prior to becoming a resident of a 
possession), nonetheless may constitute income from sources within the 
USVI for purposes of mirrored section 904. In addition, in order to 
avoid unintended reduction of the tax base of mirror code possessions, 
certain of the special rules described above do not apply for 
determining whether individuals who are not bona fide residents of such 
possessions have income from sources within such possessions for 
purposes of sections 932 and 935.
    The 2004 Act provisions concerning the determination of whether 
income is derived from sources within a possession generally apply to 
taxable years ending after October 22, 2004, except that the U.S. 
income rule applies only to income earned after October 22, 2004. The 
regulations generally adopt these effective dates, except that the 
regulations provide that the U.S. income rule only applies for income 
earned after December 31, 2004. Also, the special rules provided for 
gains from dispositions of certain personal property apply to 
dispositions after April 11, 2005, and the conduit rule and the look-
through rules for dividends and interest from possessions corporations 
apply to amounts paid or accrued after April 11, 2005. For taxable 
years beginning after December 31, 1986, and ending before October 23, 
2004, the rules of Sec.  1.863-6 (as in effect for such years) remain 
applicable.

C. Income Effectively Connected With the Conduct of Trade or Business 
in a Possession

    In 1960, in response to concerns about the reach of a local, tax-
related subsidy program, section 934 was enacted to provide explicit 
limits on the ability of the USVI to reduce income tax liabilities. The 
legislative history explains that, ``while recognizing the desirability 
of economic development'' in the USVI, Congress believed that ``in no 
case should this be attained by granting windfall gains to taxpayers 
with respect to income derived from investments in corporations in the 
continental United States, or with respect to income in any other 
manner derived from sources outside of the Virgin Islands.'' S. Rep. 
No. 1767, 86th Cong., 2nd Sess. 4 (1960).
    In 1986, in response to certain identified abuses and other 
problems related to tax administration in the possessions, section 934 
was modified and current section 931 was enacted (among other changes 
to the rules relating to the possessions). In so doing, Congress 
expressed concerns similar to those expressed in 1960:
    ``While the committee believes it is appropriate to provide more 
local autonomy to these possessions, the committee does not intend to 
allow them to be used as tax havens. The committee believes that it may 
be appropriate for these possessions to reduce tax on local income in 
some cases, but the committee has included antiabuse rules to prevent 
use of these possessions to avoid U.S. tax. The complexity and 
ambiguity of the present law rules have provoked taxpayers to take 
return positions that, while plausible under a literal reading, would 
result in tax avoidance beyond what taxpayers would ask from this 
committee or from Congress. The committee is seeking to prevent this in 
the future.'' H.R. Rep. No. 99-426, at 485-486 (1985). See also S. Rep. 
No. 99-313, at 479 (1986).
    This concern was also expressed in the legislative history 
regarding how the IRS and Treasury might exercise their authority under 
sections 931 and 934 as enacted and modified, respectively, by the 1986 
Act, to define the scope of income that would be considered derived 
from sources within a possession or effectively connected with the 
conduct of a trade or business in a possession (possession ECI). The 
discussion in the legislative history was devoted exclusively to ways 
in which the IRS and Treasury might narrow the scope of these concepts 
(as compared to the scope they otherwise would have under a mirrored 
application of the existing principles for determining whether income 
is considered to be derived from sources within the United States or 
effectively connected with the conduct of a trade or business in the 
United States). H.R. Rep. No. 99-426, at 487 and 489 (1985); S. Rep. 
No. 99-313, at 481 and 484 (1986).
    In 2004, in response to certain abusive cases that had been 
identified, the rules relating to the possessions were again modified. 
In so doing, Congress once again expressed its concern about how such 
rules might be used as an inappropriate means to reduce U.S. taxes: 
``The conferees are further concerned that the general rules for 
determining whether income is effectively connected with the conduct of 
a trade or business in a possession present numerous opportunities for 
erosion of the U.S. tax base.'' H.R. Rep. No. 108-755, at 780 (2004). 
The U.S. income rule discussed above (see section II.B. of this 
explanation) was enacted in order to prevent such U.S. tax avoidance.

[[Page 18927]]

    Reflecting the concern that tax benefits intended to foster 
economic development in the possessions should not be permitted to be 
used as a means to reduce U.S. taxes on income derived from U.S. 
economic activity, these regulations incorporate the U.S. income rule 
of section 937(b)(2), as well as a conduit rule (as described above in 
section II.B. of this explanation) that is intended to prevent the 
avoidance of the U.S. income rule. Accordingly, income from U.S. 
sources generally will not be considered possession ECI.
    Section 937(b) also includes regulatory authority for the IRS and 
Treasury to provide exceptions to this rule. As noted above in section 
II.B. of this explanation, the legislative history to the 2004 Act 
indicates that Congress intended for Treasury and the IRS to use this 
authority to continue the existing treatment of income from the sale of 
goods manufactured in a possession. Accordingly, these regulations 
provide an exception from the U.S. income rule for such income. In 
addition, the regulations provide that the U.S. income rule only 
applies for income earned after December 31, 2004.
    Apart from the U.S. income rule, these regulations apply the same 
principles for determining whether income is possession ECI as have 
applied since the 1986 Act. See Francisco v. Commissioner, 119 T.C. 317 
(2002) aff'd, 370 F.3d 1228 (DC Cir. 2004) (principles of section 
864(c)(4) apply for determining whether U.S. source income is 
possession ECI for U.S. Federal income tax purposes).
    The rules of section 937(b) and these regulations generally apply 
for purposes of all provisions of the Code for which a determination 
must be made regarding whether income is possession ECI. They generally 
do not apply, however, for purposes of applying mirrored provisions of 
the Code in mirror code possessions. Thus, for example, U.S. source 
income that is treated as income not effectively connected with the 
conduct of a trade or business within the USVI for purposes of section 
934(b) under the U.S. income rule described above nonetheless may 
constitute income effectively connected with the conduct of a trade or 
business within the USVI for purposes of mirrored section 871 or 882.
    The 2004 Act provisions concerning the determination of whether 
income is possession ECI generally apply to taxable years ending after 
October 22, 2004, except that the U.S. income rule applies only to 
income earned after October 22, 2004. The regulations generally adopt 
these effective dates, except that the regulations provide that the 
U.S. income rule only applies for income earned after December 31, 
2004. In addition, the conduit rule applies only to amounts paid or 
accrued after April 11, 2005. For taxable years beginning after 
December 31, 1986, and ending before October 23, 2004, the principles 
of section 864(c) (including section 864(c)(4)) remain applicable.

III. Information Reporting by Residents of a Possession

    Section 7654(e), as enacted by the 1972 Act and still applicable 
with respect to section 935 possessions, provides an express grant of 
authority for the IRS and Treasury to issue regulations prescribing 
information reporting requirements for individuals to whom section 935 
applies, as necessary to carry out the provisions of sections 935 and 
7654. Section 7654(e), as amended by the 1986 Act, provides a similar 
express grant of authority for the IRS and Treasury to issue 
regulations prescribing information reporting requirements for 
individuals to whom sections 931 and 932 apply, as necessary to carry 
out the provisions of those sections and section 7654. The penalty 
provided under section 6688, as amended by the 2004 Act, for failure to 
satisfy such reporting requirements is $1,000.
    The 2004 Act supplemented this general grant of authority with a 
specific requirement under section 937(c) for information reporting by 
individuals who take the position for U.S. income tax reporting 
purposes that they became, or ceased to be, bona fide residents of 
Guam, American Samoa, the NMI, Puerto Rico, or the USVI. For taxable 
years ending after October 22, 2004, as well as for any of an 
individual's preceding three taxable years, section 937(c) requires 
that such individuals provide notice of their change in residency. 
Thus, for calendar year taxpayers, such information reporting generally 
is required if they changed their residency to or from a possession 
during 2001, 2002, 2003, or 2004 (or if they do so in any future year).
    Section 937(c) authorizes the IRS and Treasury to prescribe the 
time and manner by which taxpayers are to provide such notice. In early 
2005, the IRS will provide a form on which the notice required by 
section 937(c) is to be made, as well as instructions specifying the 
time and manner for filing the form. The IRS and Treasury anticipate 
issuing guidance that will provide appropriate exceptions to the 
general statutory rules in order to minimize the reporting burden on 
taxpayers. Reporting will not be required until the form and 
instructions are made available. The same $1,000 penalty under section 
6688 will apply in cases of failure to file this form when required.

IV. Removal of Obsolete Regulations

    This document also removes certain regulations, and cross-
references to such regulations, which became obsolete with the 
enactment of the 1986 Act. The 1986 Act amendments that rendered them 
obsolete were effective for tax years beginning after December 31, 
1986. For example, the regulations promulgated by TD 6500, 25 FR 11910; 
TD 7283, 38 FR 20825; and TD 7385, 40 FR 50260, relating to former 
section 931, were rendered obsolete with the enactment of the 1986 Act. 
Thus, such regulations have no legal effect for taxable years beginning 
after December 31, 1986. See, e.g., Specking v. Commissioner, 117 T.C. 
95 (2001), aff'd sub nom. Umbach v. Commissioner, 357 F. 3d 1108 (10th 
Cir. 2004).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
refer to the Special Analyses section of the preamble to the cross-
referencing notice of proposed rulemaking published in the Proposed 
Rules section in this issue of the Federal Register. Pursuant to 
section 7805(f) of the Code, these temporary regulations will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal authors of these regulations are W. Edward Williams 
and J. David Varley, Office of the Associate Chief Counsel 
(International), IRS. However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

[[Page 18928]]

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR parts 1, 301, and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.931-1T also issued under 26 U.S.C. 7654(e).
    Section 1.932-1T also issued under 26 U.S.C. 7654(e).
    Section 1.935-1T also issued under 26 U.S.C. 7654(e). * * *
    Section 1.937-1T also issued under 26 U.S.C. 937(a).
    Section 1.937-2T also issued under 26 U.S.C. 937(b).
    Section 1.937-3T also issued under 26 U.S.C. 937(b). * * *
    Section 1.957-3T also issued under 26 U.S.C. 957(c). * * *


0
Par. 2. In Sec.  1.170A-1, paragraph (j)(9) is revised to read as 
follows:


Sec.  1.170A-1  Charitable, etc., contributions and gifts; allowance of 
deduction.

* * * * *
    (j)(9) [Reserved]. For further guidance see Sec.  1.170A-1T(j)(9).
* * * * *

0
Par. 3. Section 1.170A-1T is added to read as follows:


Sec.  1.170A-1T  Charitable, etc., contributions and gifts; allowance 
of deduction (temporary).

    (a) through (j)(8) [Reserved]. For further guidance, see Sec.  
1.170A-1(a) through (j)(8).
    (j)(9) Charitable contributions paid by bona fide residents of a 
section 931 possession as defined in Sec.  1.931-1T(c)(1) or Puerto 
Rico are deductible only to the extent allocable to income that is not 
excluded under section 931 or 933. For the rules for allocating 
deductions for charitable contributions, see the regulations under 
section 861.
    (j)(10) and (11) [Reserved]. For further guidance, see Sec.  1.170-
1(j)(10) and (11).
    (k) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 4. In Sec.  1.243-3, paragraph (a)(2)(iii) is revised to read as 
follows:


Sec.  1.243-3  Certain dividends from foreign corporations.

* * * * *
    (a)(2) * * *
    (iii) by a domestic corporation during any period to which section 
931 (relating to income from sources within possessions of the 
UnitedStates), as in effect for taxable years beginning before January 
1, 1976, applied.

0
Par. 5. In Sec.  1.702-1, paragraph (c)(1)(iii) is revised to read as 
follows:


Sec.  1.702-1  Income and credits of partner.

* * * * *
    (c)(1) * * *
    (iii) In computing the amount of gross income received from sources 
within possessions of the United States (section 937).
* * * * *

0
Par. 6. In Sec.  1.861-3, paragraph (a)(2) is revised to read as 
follows:


Sec.  1.861-3  Dividends.

* * * * *
    (a)(2) [Reserved]. For further guidance, see Sec.  1.861-3T(a)(2).

0
Par. 7. Section 1.861-3T is added to read as follows:


Sec.  1.861-3T  Dividends (temporary).

    (a)(1) [Reserved]. For further guidance, see Sec.  1.861-3(a)(1).
    (2) Dividend from a domestic corporation. A dividend described in 
this paragraph (a)(2) is a dividend from a domestic corporation other 
than a corporation which has an election in effect under section 936. 
See paragraph (a)(5) of this section for the treatment of certain 
dividends from a DISC or former DISC.
    (a)(3) through (c) [Reserved]. For further guidance, see Sec.  
1.861-3(a)(3) through (c).
    (d) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 8. In Sec.  1.861-8, paragraphs (f)(1)(vi)(E), (F), and (H) are 
revised to read as follows:


Sec.  1.861-8  Computation of taxable income from sources within the 
United States and from other sources and activities.

* * * * *
    (f) * * *
    (1) * * *
    (vi) * * *
    (E) [Reserved].
    (F) [Reserved].
* * * * *
    (H) [Reserved].
* * * * *

0
Par. 9. Section 1.863-6 is revised to read as follows:


Sec.  1.863-6  Income from sources within a foreign country.

    The principles applied in sections 861 through 863 and section 865 
and the regulations thereunder for determining the gross and the 
taxable income from sources within and without the United States shall 
generally be applied in determining the gross and the taxable income 
from sources within and without a particular foreign country when such 
a determination must be made under any provision of Subtitle A of the 
Internal Revenue Code, including section 952(a)(5). This section shall 
not apply, however, to the extent it is determined by applying Sec.  
1.863-3 that a portion of the taxable income is from sources within the 
United States and the balance of the taxable income is from sources 
within a foreign country. In the application of this section, the name 
of the particular foreign country shall be used instead of the term 
United States, and the term domestic shall be construed to mean created 
or organized in such foreign country. In applying section 861 and the 
regulations thereunder for purposes of this section, references to 
sections 243 and 245 shall be excluded, and the exception in section 
861(a)(3) shall not apply. In the case of any item of income, the 
income from sources within a foreign country shall not exceed the 
amount which, by applying any provision of sections 861 through 863 and 
section 865 and the regulations thereunder without reference to this 
section, is treated as income from sources without the United States. 
See Sec.  1.937-2T for rules for determining income from sources within 
a possession of the United States.

0
Par. 10. Section 1.871-1 is amended by:
0
1. Removing paragraph (b)(6).
0
2. Redesignating paragraph (b)(7) as (b)(6).
0
Par. 11. Section 1.876-1 is revised to read as follows:


Sec.  1.876-1  Alien residents of Puerto Rico, Guam, American Samoa, or 
the Northern Mariana Islands.

    [Reserved]. For further guidance, see Sec.  1.876-1T.

0
Par. 12. Section 1.876-1T is added to read as follows:


Sec.  1.876-1T  Alien residents of Puerto Rico, Guam, American Samoa, 
or the Northern Mariana Islands (temporary).

    (a) Scope. Section 876 and this section apply to any nonresident 
alien individual who is a bona fide resident of Puerto Rico or of a 
section 931 possession during the entire taxable year.
    (b) In general. An individual to whom this section applies is, in 
accordance with the provisions of section 876, subject to tax under 
sections 1 and 55 in generally the same manner as an alien resident of 
the United States. See Sec. Sec.  1.1-1(b) and 1.871-1. The tax

[[Page 18929]]

generally is imposed upon the taxable income of such individual, 
determined in accordance with section 63(a) and the regulations 
thereunder, from sources both within and without the United States, 
except for amounts excluded from gross income under the provisions of 
section 931 or 933. For determining the form of return to be used by 
such an individual, see section 6012 and the regulations thereunder.
    (c) Exceptions. Though subject to the tax imposed by section 1, an 
individual to whom this section applies shall nevertheless be treated 
as a nonresident alien individual for the purpose of many provisions of 
the Internal Revenue Code relating to nonresident alien individuals. 
Thus, for example, such an individual is not allowed the standard 
deduction (section 63(c)(6)); is subject to withholding of tax at 
source under chapter 3 of the Internal Revenue Code (e.g., section 
1441(e)); is generally excepted from the collection of income tax at 
source on wages for services performed in the possession (section 
3401(a)(6)); is not allowed to make a joint return (section 
6013(a)(1)); and, if described in section 6072(c), must pay his first 
installment of estimated income tax on or before the 15th day of the 
6th month of the taxable year (section 6654(j) and (k)) and must pay 
his income tax on or before the 15th day of the 6th month following the 
close of the taxable year (sections 6072(c) and 6151(a)). In addition, 
under section 152(b)(3), an individual is not allowed a deduction for a 
dependent who is a resident of the relevant possession unless the 
dependent is a citizen or national of the United States.
    (d) Credits against tax--(1) Certain credits under the Internal 
Revenue Code are available to any taxpayer subject to the tax imposed 
by section 1, including individuals to whom this section applies. For 
example, except as otherwise provided under section 931 or 933, the 
credits provided by the following sections are allowable to the extent 
provided under such sections against the tax determined in accordance 
with this section--
    (i) Section 23 (relating to the credit for adoption expenses);
    (ii) Section 31 (relating to the credit for tax withheld on wages);
    (iii) Section 33 (relating to the credit for tax withheld at source 
on nonresident aliens); and
    (iv) Section 34 (relating to the credit for certain uses of 
gasoline and special fuels).
    (2) Certain credits under the Internal Revenue Code are not 
available to nonresident aliens or are subject to limitations based on 
such factors as principal place of abode in the United States. For 
example, the credits provided by the following sections are not 
allowable against the tax determined in accordance with this section 
except to the extent otherwise provided under such sections--
    (i) Section 22 (relating to the credit for the elderly and 
disabled);
    (ii) Section 25A (relating to the Hope Scholarship and Lifetime 
Learning Credits); and
    (iii) Section 32 (relating to the earned income credit).
    (e) Definitions. For purposes of this section:
    (1) Bona fide resident is defined in Sec.  1.937-1T.
    (2) Section 931 possession is defined in Sec.  1.931-1T(c)(1).
    (f) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 13. In Sec.  1.881-1(c), revise the third and fourth sentences to 
read as follows:


Sec.  1.881-1  Manner of taxing foreign corporations.

* * * * *
    (c) * * * The term foreign corporation has the meaning assigned to 
it by section 7701(a)(3) and (5) and the regulations thereunder. 
However, for special rules relating to possessions of the United 
States, see Sec.  1.881-5T.
* * * * *

0
Par. 14. Section 1.881-5T is added to read as follows:


Sec.  1.881-5T  Exception for certain possessions corporations 
(temporary).

    (a) Scope. Section 881(b) and this section provide special rules 
for the application of sections 881 and 884 to certain corporations 
created or organized in possessions of the United States. Paragraph (g) 
of this section provides special rules for the application of sections 
881 and 884 to corporations created or organized in the United States 
for purposes of determining tax liability incurred to certain 
possessions that administer income tax laws that are identical (except 
for the substitution of the name of the possession for the term United 
States where appropriate) to those in force in the United States. See 
Sec.  1.884-0T(b) for special rules relating to the application of 
section 884 with respect to possessions of the United States.
    (b) Operative rules. (1) Corporations described in paragraphs (c) 
and (d) of this section are not treated as foreign corporations for 
purposes of section 881. Accordingly, they are exempt from the tax 
imposed by section 881(a).
    (2) For corporations described in paragraph (e) of this section, 
the rate of tax imposed by section 881(a) on U.S. source dividends 
received is 10 percent (rather than the generally applicable 30 
percent).
    (c) U.S.V.I. and section 931 possessions. A corporation created or 
organized in, or under the law of, the United States Virgin Islands or 
a section 931 possession is described in this paragraph (c) for a 
taxable year when the following conditions are satisfied--
    (1) At all times during such taxable year, less than 25 percent in 
value of the stock of such corporation is beneficially owned (directly 
or indirectly) by foreign persons;
    (2) At least 65 percent of the gross income of such corporation is 
shown to the satisfaction of the Commissioner upon examination to be 
effectively connected with the conduct of a trade or business in such a 
possession or the United States for the 3-year period ending with the 
close of the taxable year of such corporation (or for such part of such 
period as the corporation or any predecessor has been in existence); 
and
    (3) No substantial part of the income of such corporation for the 
taxable year is used (directly or indirectly) to satisfy obligations to 
persons who are not bona fide residents of such a possession or the 
United States.
    (d) Section 935 possessions. A corporation created or organized in, 
or under the law of, a section 935 possession is described in this 
paragraph (d) for a taxable year when the following conditions are 
satisfied--
    (1) At all times during such taxable year, less than 25 percent in 
value of the stock of such corporation is owned (directly or 
indirectly) by foreign persons; and
    (2) At least 20 percent of the gross income of such corporation is 
shown to the satisfaction of the Commissioner upon examination to have 
been derived from sources within such possession for the 3-year period 
ending with the close of the preceding taxable year of such 
corporation(or for such part of such period as the corporation has been 
in existence).
    (e) Puerto Rico. A corporation created or organized in, or under 
the law of, Puerto Rico is described in this paragraph (e) for a 
taxable year when the conditions of paragraphs (c)(1) through (3) are 
satisfied(using the language ``Puerto Rico'' instead of ``such a 
possession'').
    (f) Definitions and other rules. For purposes of this section:
    (1) Section 931 possession is defined in Sec.  1.931-1T(c)(1).
    (2) Section 935 possession is defined in Sec.  1.935-1T(a)(3)(i).

[[Page 18930]]

    (3) Foreign person means any person other than--
    (i) A United States person (as defined in section 7701(a)(30) and 
the regulations thereunder); or
    (ii) A person who would be a United States person if references to 
the United States in section 7701 included references to a possession 
of the United States.
    (4) Bona fide resident--
    (i) With respect to a possession, is defined in Sec.  1.937-1T; and
    (ii) With respect to the United States, means an individual who is 
a citizen or resident of the United States and who does not have a tax 
home (as defined in section 911(d)(3)) in a foreign country.
    (5) Source. The rules of Sec.  1.937-2T shall apply for determining 
whether income is from sources within a possession.
    (6) Effectively connected income. The rules of Sec.  1.937-3T 
(other than paragraph (c) of that section) shall apply for determining 
whether income is effectively connected with the conduct of a trade or 
business in a possession.
    (7) Indirect ownership. The rules of section 318(a)(2) shall apply 
except that the language ``5 percent'' shall be used instead of ``50 
percent'' in section 318(a)(2)(C).
    (g) Mirror code jurisdictions. For purposes of applying mirrored 
section 881 to determine tax liability incurred to a section 935 
possession or the United States Virgin Islands--
    (1) The rules of paragraphs (b) through (d) of this section shall 
not apply; and
    (2) A corporation created or organized in, or under the law of, 
such possession or the United States shall not be considered a foreign 
corporation.
    (h) Example. The principles of this section are illustrated by the 
following example:

    Example 1. X is a corporation organized under the law of the 
United States Virgin Islands (USVI) with a branch located in State 
F. At least 65 percent of the gross income of X is effectively 
connected with the conduct of a trade or business in the USVI and no 
substantial part of the income of X for the taxable year is used to 
satisfy obligations to persons who are not bona fide residents of 
the United States or the USVI. Seventy-four percent of the stock of 
X is owned by unrelated individuals who are residents of the United 
States or the USVI. Y, a corporation organized under the law of 
State D, and Z, a partnership organized under the law of State F, 
each own 13 percent of the stock of X. A, an unrelated foreign 
individual, owns 100 percent of the stock of corporation Y. B and C, 
unrelated foreign individuals, each own a 50 percent interest in 
partnership Z. Thus, the condition of paragraph (c)(1) of this 
section is not satisfied, because 26 percent of X is owned 
indirectly by foreign persons (A, B, and C). Accordingly, X is 
treated as a foreign corporation for purposes of section 881.

    (i) Effective dates. Except as provided in this paragraph (i), this 
section applies to payments made after April 11, 2005. The rules of 
paragraphs (b)(2) and (e) apply to dividends paid after October 22, 
2004. However, if, on or after October 22, 2004, an increase in the 
rate of the Commonwealth of Puerto Rico's withholding tax which is 
generally applicable to dividends paid to United States corporations 
not engaged in a trade or business in the Commonwealth to a rate 
greater than 10 percent takes effect, the rules of paragraphs (b)(2) 
and (e) shall not apply to dividends received on or after the effective 
date of the increase.

0
Par. 15. In Sec.  1.884-0, paragraph (b) is redesignated as paragraph 
(c), and a new paragraph (b) is added.
    The addition reads as follows:


Sec.  1.884-0  Overview of regulation provisions for section 884.

* * * * *
    (b) Special rules for U.S. possessions. [Reserved]. For further 
guidance, see Sec.  1.884-0T(b).
* * * * *

0
Par. 16. Section 1.884-0T is added as follows.


Sec.  1.884-0T  Overview of regulation provisions for section 884 
(temporary).

    (a) [Reserved]. For further guidance, see Sec.  1.884-0(a).
    (b) Special rules for U.S. possessions. (1) Section 884 does not 
apply to a corporation created or organized in, or under the law of, 
American Samoa, Guam, the Northern Mariana Islands, or the United 
States Virgin Islands, provided that the conditions of Sec.  1.881-
5T(c)(1) through (3) are satisfied with respect to such corporation. 
The preceding sentence applies for taxable years ending after April 11, 
2005.
    (2) Section 884 does not apply for purposes of determining tax 
liability incurred to a section 935 possession or the United States 
Virgin Islands by a corporation created or organized in, or under the 
law of, such possession or the United States. The preceding sentence 
applies for taxable years ending after April 11, 2005.
    (c) [Reserved]. For further guidance, see Sec.  1.884-0(c).

0
Par. 17. In Sec.  1.901-1, paragraph (g) is revised to read as follows:


Sec.  1.901-1  Allowance of credit for taxes.

* * * * *
    (g) [Reserved]. For further guidance, see Sec.  1.901-1T(g).
* * * * *

0
Par. 18. Section 1.901-1T is added to read as follows:


Sec.  1.901-1T  Allowance of credit for taxes (temporary).

    (a) through (f) [Reserved]. For further guidance, see Sec.  1.901-
1(a) through (f).
    (g) Taxpayers to whom credit not allowed. Among those to whom the 
credit for taxes is not allowed are the following--
    (1) Except as provided in section 906, a foreign corporation;
    (2) Except as provided in section 906, a nonresident alien 
individual who is not described in section 876 (see sections 874(c) and 
901(b)(4));
    (3) A nonresident alien individual described in section 876 other 
than a bona fide resident (as defined in section 937(a) and the 
regulations thereunder) of Puerto Rico during the entire taxable year 
(see sections 901(b)(3) and (4)); and
    (4) A U.S. citizen or resident alien individual who is a bona fide 
resident of a section 931 possession (as defined in Sec.  1.931-
1T(c)(1)), the U.S. Virgin Islands, or Puerto Rico, and who excludes 
certain income from U.S. gross income to the extent of taxes allocable 
to the income so excluded (see sections 931(b)(2), 933(1), and 
932(c)(4)).
    (h) [Reserved]. For further guidance, see Sec.  1.901-1(h).
    (i) [Reserved]. For further guidance, see Sec.  1.901-1(i).
    (j) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 19. Section 1.931-1 is revised to read as follows:


Sec.  1.931-1  Exclusion of certain income from sources within Guam, 
American Samoa, or the Northern Mariana Islands.

    [Reserved]. For further guidance, see Sec.  1.931-1T.

0
Par. 20. Section 1.931-1T is added to read as follows:


Sec.  1.931-1T  Exclusion of certain income from sources within Guam, 
American Samoa, or the Northern Mariana Islands (temporary).

    (a) General rule. (1) An individual (whether a United States 
citizen or an alien), who is a bona fide resident of a section 931 
possession during the entire taxable year, shall exclude from gross 
income the income derived from sources within any section 931 
possession and the income effectively connected with the conduct of a 
trade or business by such individual within any section 931 possession, 
except amounts received for services performed

[[Page 18931]]

as an employee of the United States or any agency thereof.
    (2) The following example illustrates the application of the 
general rule in paragraph (a)(1) of this section:

    Example. D, a United States citizen, files returns on a calendar 
year basis. In April 2005, D moves to American Samoa, purchases a 
house, and accepts a permanent position with a local employer. For 
the remainder of the year and throughout 2006, D continues to live 
and work in American Samoa, and establishes a closer connection to 
American Samoa than to the United States or any foreign country. In 
September 2007, as a result of the termination of his employment in 
American Samoa, D sells his house and moves to State H. D is 
entitled to the exclusion provided in section 931 for 2006, but not 
for 2005 or 2007 (assuming that during the first quarter of 2005 and 
the last quarter of 2007, D has a tax home outside of American Samoa 
or a closer connection to the United States or a foreign country).

    (b) Deductions and credits. In any case in which any amount 
otherwise constituting gross income is excluded from gross income under 
the provisions of section 931, there shall not be allowed as a 
deduction from gross income any items of expenses or losses or other 
deductions (except the deduction under section 151, relating to 
personal exemptions), or any credit, properly allocable to, or 
chargeable against, the amounts so excluded from gross income. For 
purposes of the preceding sentence, the rules of Sec.  1.861-8 shall 
apply (with creditable expenditures treated in the same manner as 
deductible expenditures).
    (c) Definitions. For purposes of this section:
    (1) The term section 931 possession means a possession that is a 
specified possession and that has entered into an implementing 
agreement, as described in section 1271(b) of the Tax Reform Act of 
1986 (Public Law 99-514 (100 Stat. 2085)), with the United States that 
is in effect for the entire taxable year.
    (2) The term specified possession means Guam, American Samoa, or 
the Northern Mariana Islands.
    (3) The rules of Sec.  1.937-1T shall apply for determining whether 
an individual is a bona fide resident of a section 931 possession.
    (4) The rules of Sec.  1.937-2T shall apply for determining whether 
income is from sources within a section 931 possession.
    (5) The rules of Sec.  1.937-3T shall apply for determining whether 
income is effectively connected with the conduct of a trade or business 
within a section 931 possession.
    (d) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 21. Section 1.932-1 is revised to read as follows:


Sec.  1.932-1  Coordination of United States and Virgin Islands income 
taxes.

    [Reserved]. For further guidance, see Sec.  1.932-1T.

0
Par. 22. Section 1.932-1T is added to read as follows:


Sec.  1.932-1T  Coordination of United States and Virgin Islands income 
taxes (temporary).

    (a) Scope--(1) In general. Section 932 and this section set forth 
the special rules relating to the filing of income tax returns and 
income tax liabilities of individuals described in paragraph (a)(2) of 
this section. Paragraph (h) of this section also provides special rules 
requiring consistent treatment of business entities in the United 
States and in the United States Virgin Islands (Virgin Islands).
    (2) Individuals covered. This section shall apply to any individual 
who:
    (i) Is a bona fide resident of the Virgin Islands during the entire 
taxable year;
    (ii)(A) Is a citizen or resident of the United States (other than a 
bona fide resident of the Virgin Islands) during the entire taxable 
year; and
    (B) Has income derived from sources within the Virgin Islands, or 
effectively connected with the conduct of a trade or business within 
the Virgin Islands, for the taxable year; or
    (iii) Files a joint return for the taxable year with any individual 
described in paragraph (a)(2)(i) or (ii) of this section.
    (3) Definitions. For purposes of this section:
    (i) The rules of Sec.  1.937-1T shall apply for determining whether 
an individual is a bona fide resident of the Virgin Islands.
    (ii) The rules of Sec.  1.937-2T shall apply for determining 
whether income is from sources within the Virgin Islands.
    (iii) The rules of Sec.  1.937-3T shall apply for determining 
whether income is effectively connected with the conduct of a trade or 
business within the Virgin Islands.
    (b) U.S. individuals with V.I. income--(1) Dual filing requirement. 
Subject to paragraph (d) of this section, an individual described in 
paragraph (a)(2)(ii) of this section shall make an income tax return 
for the taxable year to the United States and file a copy of such 
return with the Virgin Islands. Such individuals must also attach Form 
8689, ``Allocation of Individual Income Tax to the Virgin Islands,'' to 
the U.S. income tax return and to the income tax return filed with the 
Virgin Islands.
    (2) Tax payments. (i) Each individual to whom this paragraph (b) 
applies for the taxable year shall pay the applicable percentage of the 
taxes imposed by this chapter for such taxable year (determined without 
regard to paragraph (b)(2)(ii) of this section) to the Virgin Islands.
    (ii) There shall be allowed as a credit against the tax imposed by 
this chapter for the taxable year an amount equal to the taxes required 
to be paid to the Virgin Islands under paragraph (b)(2)(i) of this 
section which are so paid. Such taxes shall be considered creditable in 
the same manner as taxes paid to the United States (e.g., under section 
31) and not as taxes paid to a foreign government (e.g., under sections 
27 and 901).
    (iii) For purposes of this paragraph (b)(2):
    (A) The term applicable percentage means the percentage which 
Virgin Islands adjusted gross income bears to adjusted gross income.
    (B) The term Virgin Islands adjusted gross income means adjusted 
gross income determined by taking into account only income derived from 
sources within the Virgin Islands and deductions properly apportioned 
or allocable thereto. For purposes of the preceding sentence, the rules 
of Sec.  1.861-8 shall apply.
    (C) Pursuant to Sec.  1.937-2T(a), the rules of Sec.  1.937-
2T(c)(1)(ii) and (c)(2) do not apply.
    (c) Bona fide residents of the Virgin Islands. Subject to paragraph 
(d) of this section, an individual described in paragraph (a)(2)(i) of 
this section shall be subject to the following income tax return filing 
requirements:
    (1) V.I. filing requirements. An individual to whom this paragraph 
(c) applies shall file an income tax return for the taxable year with 
the Virgin Islands. On this return, the individual shall report income 
from all sources and identify the source of each item of income shown 
on the return.
    (2) U.S. filing requirements. For purposes of calculating the 
income tax liability to the United States of an individual to whom this 
paragraph (c) applies, gross income shall not include any amount 
included in gross income on the return filed with the Virgin Islands 
pursuant to paragraph (c)(1) of this section, and deductions and 
credits allocable to such income shall not be taken into account, 
provided that--
    (i) The individual fully satisfied the reporting requirements of 
paragraph (c)(1) of this section; and
    (ii) The individual fully paid the tax liability referred to in 
section 934(a) to the Virgin Islands with respect to such income.

[[Page 18932]]

    (d) Joint returns. In the case of married persons, if one or both 
spouses is an individual described in paragraph (a)(2) of this section 
and they file a joint return of income tax, the spouses shall file 
their joint return with, and pay the tax due on such return to, the 
jurisdiction (or jurisdictions) where the spouse who has the greater 
adjusted gross income for the taxable year would be required under 
paragraph (b) or (c) of this section to file a return if separate 
returns were filed and all of their income were the income of such 
spouse. For this purpose, adjusted gross income of each spouse is 
determined under section 62 and the regulations thereunder but without 
regard to community property laws; and, if one of the spouses dies, the 
taxable year of the surviving spouse shall be treated as ending on the 
date of such death.
    (e) Place for filing returns--(1) U.S. returns. A return required 
under the rules of paragraphs (b) and (c) of this section to be filed 
with the United States shall be filed as directed in the applicable 
forms and instructions.
    (2) V.I. returns. A return required under the rules of paragraphs 
(b) and (c) of this section to be filed with the Virgin Islands shall 
be filed as directed in the applicable forms and instructions.
    (f) Tax accounting standards--(1) In general. A dual filing 
taxpayer must use the same tax accounting standards on the returns 
filed with the United States and the Virgin Islands. A taxpayer who has 
filed a return only with the United States or only with the Virgin 
Islands as a single filing taxpayer for a prior taxable year and is 
required to file a return only with the other jurisdiction as a single 
filing taxpayer for a later taxable year may not, for such later 
taxable year, use different tax accounting standards unless the second 
jurisdiction consents to such change. However, such change will not be 
effective for returns filed thereafter with the first jurisdiction 
unless before such later date of filing the taxpayer also obtains the 
consent of the first jurisdiction to make such change. Any request for 
consent to make a change pursuant to this paragraph (f) must be made to 
the office where the return is required to be filed under paragraph (e) 
of this section and in sufficient time to permit a copy of the consent 
to be attached to the return for the taxable year.
    (2) Definitions. For purposes of this paragraph (f):
    (i) The term dual filing taxpayer means a taxpayer who is required 
to file returns with the United States and the Virgin Islands for the 
same taxable year under the rules of paragraph (b) or (c) of this 
section.
    (ii) The term single filing taxpayer means a taxpayer who is 
required to file a return only with the United States (because the 
individual is not described in paragraph (a)(2) of this section) or 
only with the Virgin Islands (because the individual is described in 
paragraph (a)(2)(i) of this section and satisfies the conditions of 
paragraphs (c)(2)(i) and (ii) of this section) for the taxable year.
    (iii) The term tax accounting standards includes the taxpayer's 
accounting period, methods of accounting, and any election to which the 
taxpayer is bound with respect to the reporting of taxable income.
    (g) Extension of territory--(1) Section 932(a) taxpayers--(i) 
General rule. With respect to an individual to whom section 932(a) 
applies for a taxable year, for purposes of taxes imposed by Chapter 1 
of the Internal Revenue Code, the United States generally shall be 
treated, in a geographical and governmental sense, as including the 
Virgin Islands. The purpose of this rule is to facilitate the 
coordination of the tax systems of the United States and the Virgin 
Islands. Accordingly, the rule will have no effect where it is 
manifestly inapplicable or its application would be incompatible with 
the intent of any provision of the Internal Revenue Code.
    (ii) Application of general rule. Contexts in which the general 
rule of paragraph (g)(1)(i) of this section apply include:
    (A) The characterization of taxes paid to the Virgin Islands. An 
individual to whom section 932(a) applies may take income tax required 
to be paid to the Virgin Islands under section 932(b) into account 
under sections 31, 6315, and 6402(b) as payments to the United States. 
Taxes paid to the Virgin Islands and otherwise satisfying the 
requirements of section 164(a) will be allowed as a deduction under 
that section, but income taxes required to be paid to the Virgin 
Islands under section 932(b) will be disallowed as a deduction under 
section 275(a).
    (B) The determination of the source of income for purposes of the 
foreign tax credit (e.g., sections 901 through 904). Thus, for example, 
after an individual to whom section 932(a) applies determines which 
items of income constitute income from sources within the Virgin 
Islands under the rules of section 937(b), such income shall be treated 
as income from sources within the United States for purposes of section 
904.
    (C) The eligibility of a corporation to make a subchapter S 
election (sections 1361 through 1379). Thus, for example, for purposes 
of determining whether a corporation created or organized in the Virgin 
Islands may make an election under section 1362(a) to be a subchapter S 
corporation, it shall be treated as a domestic corporation and a 
shareholder to whom section 932(a) applies shall not be treated as a 
nonresident alien individual with respect to such corporation. While 
such an election is in effect, the corporation shall be treated as a 
domestic corporation for all purposes of the Internal Revenue Code. For 
the consistency requirement with respect to entity status elections, 
see paragraph (h) of this section.
    (D) The treatment of items carried over from other tax years. Thus, 
for example, if an individual to whom section 932(a) applies has for a 
taxable year a net operating loss carryback or carryover under section 
172, a foreign tax credit carryback or carryover under section 904, a 
business credit carryback or carryover under section 39, a capital loss 
carryover under section 1212, or a charitable contributions carryover 
under section 170, the carryback or carryover will be reported on the 
return filed in accordance with paragraph (b)(1) of this section, even 
though the return of the taxpayer for the taxable year giving rise to 
the carryback or carryover was required to be filed with the Virgin 
Islands under section 932(c).
    (E) The treatment of property exchanged for property of a like kind 
(section 1031). Thus, for example, if an individual to whom section 
932(a) applies exchanges real property located in the United States for 
real property located in the Virgin Islands, notwithstanding the 
provisions of section 1031(h), such exchange may qualify as a like-kind 
exchange under section 1031 (provided that all the other requirements 
of section 1031 are satisfied).
    (iii) Nonapplication of the general rule. Contexts in which the 
general rule of paragraph (g)(1)(i) of this section does not apply 
include:
    (A) The application of any rules or regulations that explicitly 
treat the United States and any (or all) of its possessions as separate 
jurisdictions (e.g., sections 931 through 937, 7651, and 7654).
    (B) The determination of any aspect of an individual's residency 
(e.g., sections 937(a) and 7701(b)). Thus, for example, an individual 
whose principal place of abode is in the Virgin Islands is not 
considered to have a principal place of abode in the United States for 
purposes of section 32(c).
    (C) The characterization of a corporation for purposes other than 
subchapter S (e.g., sections 367, 951

[[Page 18933]]

through 964, 1291 through 1298, 6038, and 6038B). Thus, for example, if 
an individual to whom section 932(a) applies transfers appreciated 
tangible property to a corporation created or organized in the Virgin 
Islands in a transaction described in section 351, he or she must 
recognize gain unless an exception under section 367(a) applies. Also, 
if a corporation created or organized in the Virgin Islands qualifies 
as a passive foreign investment company under sections 1297 and 1298 
with respect to an individual to whom section 932(a) applies, a 
dividend paid to such shareholder does not constitute qualified 
dividend income under section 1(h)(11)(B).
    (2) Section 932(c) taxpayers--(i) General rule. With respect to an 
individual to whom section 932(c) applies for a taxable year, for 
purposes of the territorial income tax of the Virgin Islands (i.e., 
mirrored sections of the Internal Revenue Code), the Virgin Islands 
generally shall be treated, in a geographical and governmental sense, 
as including the United States. The purpose of this rule is to 
facilitate the coordination of the tax systems of the United States and 
the Virgin Islands. Accordingly, the rule will have no effect where it 
is manifestly inapplicable or its application would be incompatible 
with the intent of any provision of the Internal Revenue Code.
    (ii) Application of general rule. Contexts in which the general 
rule of paragraph (g)(2)(i) of this section apply include:
    (A) The characterization of taxes paid to the United States. A 
taxpayer described in section 932(c)(1) may take income tax paid to the 
United States into account under mirrored sections 31, 6315, and 
6402(b) as payments to the Virgin Islands.
    (B) The determination of the source of income for purposes of the 
foreign tax credit (e.g., mirrored sections 901 through 904). Thus, for 
example, any item of income that constitutes income from sources within 
the United States under the rules of sections 861 through 865 shall be 
treated as income from sources within the Virgin Islands for purposes 
of mirrored section 904.
    (C) The eligibility of a corporation to make a subchapter S 
election (mirrored sections 1361 through 1379). Thus, for example, for 
purposes of determining whether a corporation created or organized in 
the United States may make an election under mirrored section 1362(a) 
to be a subchapter S corporation, it shall be treated as a domestic 
corporation and a shareholder to whom section 932(c) applies shall not 
be treated as a nonresident alien individual with respect to such 
corporation. While such an election is in effect, the corporation shall 
be treated as a domestic corporation for all purposes of the 
territorial income tax. For the consistency requirement with respect to 
entity status elections, see paragraph (h) of this section.
    (D) The treatment of items carried over from other tax years. Thus, 
for example, if an individual to whom section 932(c) applies has for a 
taxable year a net operating loss carryback or carryover under mirrored 
section 172, a foreign tax credit carryback or carryover under mirrored 
section 904, a business credit carryback or carryover under mirrored 
section 39, a capital loss carryover under mirrored section 1212, or a 
charitable contributions carryover under mirrored section 170, the 
carryback or carryover will be reported on the return filed in 
accordance with paragraph (c)(1) of this section, even though the 
return of the taxpayer for the taxable year giving rise to the 
carryback or carryover was required to be filed with the United States.
    (E) The treatment of property exchanged for property of a like kind 
(mirrored section 1031). Thus, for example, if an individual to whom 
section 932(c) applies exchanges real property located in the United 
States for real property located in the Virgin Islands, notwithstanding 
the provisions of mirrored section 1031(h), such exchange may qualify 
as a like-kind exchange under mirrored section 1031 (provided that all 
the other requirements of mirrored section 1031 are satisfied).
    (iii) Nonapplication of general rule. Contexts in which the general 
rule of paragraph (g)(2)(i) of this section does not apply include:
    (A) The determination of any aspect of an individual's residency 
(e.g., mirrored section 7701(b)). Thus, for example, an individual 
whose principal place of abode is in the United States is not 
considered to have a principal place of abode in the Virgin Islands for 
purposes of mirrored section 32(c).
    (B) The determination of the source of income for purposes other 
than the foreign tax credit (e.g., sections 932(a) and (b), 934(b), and 
937). Thus, for example, compensation for services performed in the 
United States and rentals or royalties from property located in the 
United States do not constitute income from sources within the Virgin 
Islands for purposes of section 934(b).
    (C) The definition of wages (mirrored section 3401). Thus, for 
example, services performed by an employee for an employer in the 
United States do not constitute services performed in the Virgin 
Islands under mirrored section 3401(a)(8).
    (h) Entity status consistency requirement--(1) In general. 
Taxpayers should make consistent entity status elections (as defined in 
paragraph (h)(3) of this section), where applicable, in both the United 
States and the Virgin Islands. In the case of a business entity to 
which this paragraph (h) applies:
    (i) If an entity status election is filed with the Internal Revenue 
Service but not with the Virgin Islands Bureau of Internal Revenue 
(BIR), the Director of the BIR or his delegate, at his discretion, may 
deem the election also to have been made for Virgin Islands tax 
purposes.
    (ii) If an entity status election is filed with the BIR but not 
with the Internal Revenue Service, the Commissioner, at his discretion, 
may deem the election also to have been made for U.S. Federal tax 
purposes.
    (iii) If inconsistent entity status elections are filed with the 
BIR and the Internal Revenue Service, both the Commissioner and the 
Director of the BIR or his delegate may, at their individual 
discretion, treat the elections they each received as invalid and may 
deem the election filed in the other jurisdiction to have been made 
also for tax purposes in their own jurisdiction. (See Rev. Proc. 89-8 
(1989-1 C.B. 778) for procedures for requesting the assistance of the 
Internal Revenue Service when a taxpayer is or may be subject to 
inconsistent tax treatment by the Internal Revenue Service and a U.S. 
possession tax agency.)
    (2) Scope. This paragraph (h) applies to the following business 
entities:
    (i) A business entity (as defined in Sec.  301.7701-2(a) of this 
chapter) that is domestic (as defined in Sec.  301.7701-5 of this 
chapter), or otherwise treated as domestic for purposes of the Internal 
Revenue Code, and that is owned in whole or in part by any person who 
is either a bona fide resident of the Virgin Islands or a business 
entity created or organized in the Virgin Islands.
    (ii) A business entity that is created or organized in the Virgin 
Islands and that is owned in whole or in part by any U.S. person (other 
than a bona fide resident of the Virgin Islands).
    (3) Definition. For purposes of this section, the term entity 
status election includes an election under Sec.  301.7701-3(c) of this 
chapter, an election under section 1362(a), and any other similar 
elections.
    (4) Default status. Solely for the purpose of determining 
classification of an eligible entity under Sec.  301.7701-3(b), and 
Sec.  301.7701-3(b) as mirrored in the Virgin Islands, an eligible 
entity subject

[[Page 18934]]

to this paragraph (h) shall be classified for both U.S. Federal and 
Virgin Islands tax purposes using the rule that applies to domestic 
eligible entities.
    (5) Transition rules--(i) In the case of an election filed prior to 
April 11, 2005, except as provided in paragraph (h)(5)(ii) of this 
section, the rules of paragraph (h)(1) of this section shall apply as 
of the first day of the first taxable year of the entity beginning 
after April 11, 2005.
    (ii) In the unlikely circumstance that inconsistent elections 
described in paragraph (h)(1)(iii) are filed prior to April 11, 2005, 
and the entity cannot change its classification to achieve consistency 
because of the sixty-month limitation described in Sec.  301.7701-
3(c)(1)(iv) of this chapter, then the entity may nevertheless request 
permission from the Commissioner or the Director of the BIR or his 
delegate to change such election to avoid inconsistent treatment by the 
Commissioner and the Director of the BIR or his delegate.
    (iii) Except as provided in paragraphs (h)(5)(i) and (h)(5)(ii) of 
this section, in the case of an election filed with respect to an 
entity before it became an entity described in paragraph (h)(2) of this 
section, the rules of paragraph (h)(1) of this section shall apply as 
of the first day that such entity is described in paragraph (h)(2) of 
this section.
    (iv) In the case of an entity created or organized prior to April 
11, 2005, paragraph (h)(4) of this section shall take effect for U.S. 
Federal income tax purposes (or Virgin Islands income tax purposes, as 
the case may be) as of the first day of the first taxable year of the 
entity beginning after April 11, 2005.
    (i) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. (i) A is a U.S. citizen who resides in State R. The 
Federal Individual Income Tax Return, Form 1040, that A prepares for 
2004 reports adjusted gross income of $90x, including $30x from 
sources in the U.S. Virgin Islands (USVI). The income tax liability 
reported on A's Form 1040 is $18x. A files a copy of his Federal 
Form 1040 with the USVI Bureau of Internal Revenue as required by 
section 932(a)(2) and paragraph (b)(1) of this section, and pays the 
applicable percentage of his Federal income tax liability to the 
USVI as required by section 932(b) and paragraph (b)(2) of this 
section, computed as follows:

30/90 x 18x = $6x income tax liability to the USVI

    (ii) A claims a credit against his Federal income tax liability 
reported on his Form 1040 in the amount of $6x. A attaches a Form 
8689, ``Allocation of Individual Income Tax to the Virgin Islands,'' 
to the Form 1040 filed with the Internal Revenue Service and to the 
copy of the Form 1040 filed with the USVI.

    Example 2. B, a U.S. citizen, files returns on a calendar year 
basis. In April 2005, B moves to the U.S. Virgin Islands (USVI), 
purchases a house, and accepts a permanent position with a local 
employer. For the remainder of the year and throughout 2006, B 
continues to live and work in the USVI, and establishes a closer 
connection to the USVI than to the United States or any foreign 
country. In September 2007, as a result of the termination of his 
employment in the USVI, B sells his house and moves to State G. As a 
consequence of his employment in the USVI, B earns income from the 
performance of services in the USVI from April 2005 through 
September 2007. Section 932(c) and paragraph (c) of this section 
apply to B for 2006, but not for 2005 or 2007 (assuming that during 
the first quarter of 2005 and the last quarter of 2007, B has a tax 
home outside of the USVI or a closer connection to the United States 
or a foreign country). For 2005 and 2007, B is subject to the rules 
of sections 932(a) and (b) and paragraph (b) of this section because 
he has income derived from sources within the USVI as determined 
under the rules of section 937(b) and Sec.  1.937-2T.
    Example 3. H and W are U.S. citizens. H resides in State T and W 
is a bona fide resident of the U.S. Virgin Islands (USVI). For 2004, 
H and W prepare a joint Individual Income Tax Return, Form 1040, 
which reports total adjusted gross income of $75x of which $40x is 
attributable to compensation that W received for services performed 
in the USVI and $35x to compensation that H received for services 
performed in State T. Pursuant to section 932(d) and paragraph (d) 
of this section, the joint income tax return of H and W is filed 
with the USVI as required by section 932(c) and paragraph (c) of 
this section. H and W may claim a tax credit on such return for 
income tax withheld during 2004 and paid to the Internal Revenue 
Service.

    Example 4. (i) The facts are the same as in example 3, except 
that H also earns $25x for services performed in the USVI, so that H 
and W's total adjusted gross income is $100x, and their total income 
tax liability is $20x.
    (ii) Pursuant to section 932(d) and paragraph (d) of this 
section, H and W must file a copy of their joint Federal Form 1040 
with the Bureau of Internal Revenue of the USVI as required by 
section 932(a)(2) and paragraph (b)(1) of this section, and pay the 
applicable percentage of their Federal income tax liability to the 
USVI as required by section 932(b) and paragraph (b)(2) of this 
section, computed as follows:

65/100 x 20x = $13x income tax liability to the USVI

    (iii) H and W claim a credit against their Federal income tax 
liability reported on the Form 1040 in the amount of $13x, the 
portion of their Federal income tax liability required to be paid to 
the USVI. H and W attach a Form 8689, ``Allocation of Individual 
Income Tax to the Virgin Islands,'' to the Form 1040 filed with the 
Internal Revenue Service and to the copy of the Form 1040 filed with 
the USVI.

    Example 5. J is a U.S. citizen and a bona fide resident of the 
U.S. Virgin Islands (USVI). In 2005, J receives compensation for 
services performed in the USVI in the amount of $40x. J prepares and 
files an Individual Income Tax Return, Form 1040, with the USVI and 
reports gross income of only $30x. J has not satisfied the 
conditions of section 932(c)(4) and paragraph (c) of this section 
for an exclusion from gross income for U.S. Federal income tax 
purposes and, therefore, must file a Federal income tax return in 
accordance with the Internal Revenue Code and the regulations.

    Example 6. (i) N is a U.S. citizen and a bona fide resident of 
the U.S. Virgin Islands. In 2004, N receives compensation for 
services performed in Country M. N prepares and files an Individual 
Income Tax Return, Form 1040, with the USVI and reports the 
compensation as income effectively connected with the conduct of a 
trade or business in the USVI. N claims a special credit against the 
tax on this compensation purportedly pursuant to a USVI law enacted 
within the limits of its authority under section 934.
    (ii) Under the principles of section 864(c)(4) as applied 
pursuant to section 937(b)(1) and Sec.  1.937-3T(b), compensation 
for services performed outside the USVI may not be treated as income 
effectively connected with the conduct of a trade or business in the 
USVI for purposes of section 934(b). Consequently, N is not entitled 
to claim the special credit under USVI law with respect to N's 
income from services performed in Country M. Given that N has not 
fully paid his tax liability referred to in section 934(a), he has 
not satisfied the conditions of section 932(c)(4) and paragraph (c) 
of this section for an exclusion from gross income for U.S. Federal 
income tax purposes. Accordingly, N must file a Federal income tax 
return in accordance with the Internal Revenue Code and the 
regulations.

    (j) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 23. Section 1.933-1 is amended by revising paragraphs (a) and (c) 
and adding paragraphs (d) and (e) to read as follows:


Sec.  1.933-1  Exclusion of certain income from sources within Puerto 
Rico.

    (a) [Reserved]. For further guidance, see Sec.  1.933-1T(a).
* * * * *
    (c) [Reserved]. For further guidance, see Sec.  1.933-1T(c).
    (d) [Reserved]. For further guidance, see Sec.  1.933-1T(d).
    (e) [Reserved]. For further guidance, see Sec.  1.933-1T(e).

0
Par. 24. Section 1.933-1T is added to read as follows:


Sec.  1.933-1T  Exclusion of certain income from sources within Puerto 
Rico (temporary).

    (a) General rule--(1) An individual (whether a United States 
citizen or an alien), who is a bona fide resident of Puerto Rico during 
the entire taxable year, shall exclude from gross income

[[Page 18935]]

the income derived from sources within Puerto Rico, except amounts 
received for services performed as an employee of the United States or 
any agency thereof.
    (2) The following example illustrates the application of the 
general rule in paragraph (a)(1) of this section:

    Example. E, a United States citizen, files returns on a calendar 
year basis. In April 2005, E moves to Puerto Rico, purchases a 
house, and accepts a permanent position with a local employer. For 
the remainder of the year and throughout 2006, E continues to live 
and work in Puerto Rico, and establishes a closer connection to 
Puerto Rico than to the United States or any foreign country. In 
September 2007, as a result of the termination of his employment in 
Puerto Rico, E sells his house and moves to State J. E is entitled 
to the exclusion provided in section 933 for 2006, but not for 2005 
or 2007 (assuming that during the first quarter of 2005 and the last 
quarter of 2007, E has a tax home outside of Puerto Rico or a closer 
connection to the United States or a foreign country).

    (b) [Reserved]. For further guidance, see Sec.  1.933-1(b).
    (c) Deductions and credits. In any case in which any amount 
otherwise constituting gross income is excluded from gross income under 
the provisions of section 933, there shall not be allowed as a 
deduction from gross income any items of expenses or losses or other 
deductions (except the deduction under section 151, relating to 
personal exemptions), or any credit, properly allocable to, or 
chargeable against, the amounts so excluded from gross income. For 
purposes of the preceding sentence, the rules of Sec.  1.861-8 shall 
apply (with creditable expenditures treated in the same manner as 
deductible expenditures).
    (d) Definitions. For purposes of this section:
    (1) The rules of Sec.  1.937-1T shall apply for determining whether 
an individual is a bona fide resident of Puerto Rico.
    (2) The rules of Sec.  1.937-2T shall apply for determining whether 
income is from sources within Puerto Rico.
    (e) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 25. Section 1.934-1 is revised to read as follows:


Sec.  1.934-1  Limitation on reduction in income tax liability incurred 
to the Virgin Islands.

    [Reserved]. For further guidance, see Sec.  1.934-1T.

0
Par. 26. Section 1.934-1T is added to read as follows:


Sec.  1.934-1T  Limitation on reduction in income tax liability 
incurred to the Virgin Islands (temporary).

    (a) General rule. Section 934(a) provides that tax liability 
incurred to the United States Virgin Islands (Virgin Islands) shall not 
be reduced or remitted in any way, directly or indirectly, whether by 
grant, subsidy, or other similar payment, by any law enacted in the 
Virgin Islands, except to the extent provided in section 934(b). For 
purposes of the preceding sentence, the term ``tax liability'' means 
the liability incurred to the Virgin Islands pursuant to subtitle A of 
the Internal Revenue Code, as made applicable in the Virgin Islands by 
the Act of July 12, 1921 (48 U.S.C. 1397), or pursuant to section 28(a) 
of the Revised Organic Act of the Virgin Islands (48 U.S.C. 1642), as 
modified by section 7651(5)(B).
    (b) Exception for V.I. income--(1) In general. Section 934(b)(1) 
provides an exception to the application of section 934(a). Under this 
exception, section 934(a) does not apply with respect to tax liability 
incurred to the Virgin Islands to the extent that such tax liability is 
attributable to income derived from sources within the Virgin Islands 
or income effectively connected with the conduct of a trade or business 
within the Virgin Islands.
    (2) Limitation. Section 934(b)(2) limits the scope of the exception 
provided by section 934(b)(1). Pursuant to this limitation, the 
exception does not apply with respect to an individual who is a citizen 
or resident of the United States (other than a bona fide resident of 
the Virgin Islands). For the rules for determining tax liability 
incurred to the Virgin Islands by such an individual, see section 
932(a) and the regulations thereunder.
    (3) Computation rule--(i) Operative rule. For purposes of section 
934(b)(1) and this paragraph (b), tax liability incurred to the Virgin 
Islands for the taxable year attributable to income derived from 
sources within the Virgin Islands or income effectively connected with 
the conduct of a trade or business within the Virgin Islands shall be 
computed as follows:
    (A) Add to the income tax liability incurred to the Virgin Islands 
any credit against the tax allowed under mirrored section 901(a);
    (B) Multiply by taxable income from sources within the Virgin 
Islands and income effectively connected with the conduct of a trade or 
business within the Virgin Islands (applying the rules of Sec.  1.861-8 
to determine deductions allocable to such income);
    (C) Divide by total taxable income; and
    (D) Subtract the portion of any credit allowed under mirrored 
section 901 (other than credits for taxes paid to the United States) 
determined by multiplying the amount of taxable income from sources 
outside the Virgin Islands or the United States that is effectively 
connected to the conduct of a trade or business in the Virgin Islands 
divided by the total amount of taxable income from such sources.
    (ii) Limitation. Tax liability incurred to the Virgin Islands 
attributable to income derived from sources within the Virgin Islands 
or income effectively connected with the conduct of a trade or business 
within the Virgin Islands, as computed in this paragraph (b)(3), 
however, shall not exceed the total amount of income tax liability 
actually incurred.
    (4) Definitions. For purposes of this section:
    (i) Bona fide resident. The rules of Sec.  1.937-1T shall apply for 
determining whether an individual is a bona fide resident of the Virgin 
Islands.
    (ii) Source. The rules of Sec.  1.937-2T shall apply for 
determining whether income is from sources within the Virgin Islands.
    (iii) Effectively connected income. The rules of Sec.  1.937-3T 
shall apply for determining whether income is effectively connected 
with the conduct of a trade or business in the Virgin Islands.
    (c) Exception for qualified foreign corporations--(1) In general. 
Section 934(b)(3) provides an exception to the application of section 
934(a). Under this exception, section 934(a) does not apply with 
respect to tax liability incurred to the Virgin Islands by a qualified 
foreign corporation to the extent that such tax liability is 
attributable to income which is derived from sources outside the United 
States and which is not effectively connected with the conduct of a 
trade or business within the United States.
    (2) Qualified foreign corporation. For purposes of paragraph (c)(1) 
of this section, the term qualified foreign corporation means any 
foreign corporation if 1 or more United States persons own or are 
treated as owning (within the meaning of section 958) less than 10 
percent of--
    (i) The total voting power of the stock of such corporation; and
    (ii) The total value of the stock of such corporation,
    (3) Computation rule--(i) Operative rule. For purposes of section 
934(b)(3) and this paragraph (c), tax liability incurred to the Virgin 
Islands for the taxable year attributable to income which is derived 
from sources outside

[[Page 18936]]

the United States and which is not effectively connected with the 
conduct of a trade or business within the United States shall be 
computed as follows--
    (A) Add to the income tax liability incurred to the Virgin Islands 
any credit against the tax allowed under mirrored section 901(a);
    (B) Multiply by taxable income which is derived from sources 
outside the United States and which is not effectively connected with 
the conduct of a trade or business within the United States (applying 
the rules of Sec.  1.861-8 to determine deductions allocable to such 
income);
    (C) Divide by total taxable income; and
    (D) Subtract any credit allowed under mirrored section 901 (other 
than credits for taxes paid to the United States or taxes for which a 
credit is allowable for U.S. Federal income tax purposes under section 
906 of the Internal Revenue Code).
    (ii) Limitation Tax liability incurred to the Virgin Islands 
attributable to income which is derived from sources outside the United 
States and which is not effectively connected with the conduct of a 
trade or business within the United States, as computed in this 
paragraph (c)(3), however, shall not exceed the total amount of income 
tax liability actually incurred.
    (4) U.S. income--(i) In general. For purposes of this section, 
except as provided in paragraph (c)(4)(ii) of this section, the rules 
of sections 861 through 865 and the regulations thereunder shall apply 
for determining whether income is from sources outside the United 
States or effectively connected with the conduct of a trade or business 
within the United States.
    (ii) Conduit arrangements. Income shall be considered to be from 
sources within the United States for purposes of paragraph (c)(1) of 
this section if, pursuant to a plan or arrangement--
    (A) The income is received in exchange for consideration provided 
to another person; and
    (B) Such person (or another person) provides the same consideration 
(or consideration of a like kind) to a third person in exchange for one 
or more payments constituting income from sources within the United 
States.
    (d) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. (i) S is a U.S. citizen and a bona fide resident of 
the U.S. Virgin Islands (USVI). For 2005, S files a Form 1040INFO, 
``Non-Virgin Islands Source Income of Virgin Islands Residents,'' 
with the USVI on which S reports total gross income as follows:

Compensation for services performed in the USVI..............    $50,000
Compensation for services performed in the United States.....     40,000
Compensation for services performed in Mexico................     30,000
Income from inventory sales in Latin America attributable to      20,000
 USVI Office.................................................
Interest on a U.S. bank account..............................      6,000
Interest on a V.I. bank account..............................      5,000
Dividends from a U.S. corporation............................      4,000
 

    (ii) Accordingly, S has total gross income of $155,000, 
comprising income from sources within the USVI or effectively 
connected to the conduct of a trade or business in the USVI (USVI 
ECI) of $75,000, income from sources within the United States of 
$50,000, and income from other sources (not USVI ECI) of $30,000. 
After taking into account allowable deductions, S's total taxable 
income is $120,000, of which $45,000 is taxable income from sources 
within the USVI, $15,000 is taxable income from other sources that 
is USVI ECI under the rules of section 937(b) and Sec. Sec.  1.937-
2T and 1.937-3T, and $22,500 is taxable income from sources outside 
the USVI (and outside the United States) that is not USVI ECI. S's 
tax liability incurred to the USVI pursuant to the Internal Revenue 
Code as applicable in the USVI (mirror code) is $30,000. S is 
entitled to claim a credit under section 901 of the mirror code in 
the amount of $10,000 for income tax paid to Mexico and other Latin 
American countries, for a net income tax liability of $20,000.
    (iii) Pursuant to a USVI law that was duly enacted within the 
limits of its authority under section 934, S may claim a special 
deduction relating to his business activities in the USVI. However, 
under section 934(b), S's ability to claim this special deduction is 
limited. Specifically, the maximum amount of the reduction in S's 
mirror code tax liability that may result from claiming this 
deduction, computed in accordance with paragraph (b)(3) of this 
section, is as follows:

(20,000 + 10,000) x ((45,000 + 15,000) / 120,000) / (10,000 x 
(15,000 / (15,000 / 22,500)) = 30,000 x (.5) - 10,000 x (.4) = 
15,000 - 4,000 = $11,000

    (iv) Accordingly, S's net tax liability incurred to the USVI 
must be at least $19,000 (30,000 - 11,000), prior to taking into 
account any foreign tax credit.

    Example 2. The facts are the same as Example 1, except that S is 
a U.S. citizen who resides in the United States. As required by 
section 932(a) and (b), S files with the U.S. Virgin Islands (USVI) 
a copy of his Federal income tax return and pays to the USVI the 
portion of his Federal income tax liability that his Virgin Islands 
adjusted gross income bears to his adjusted gross income. Under 
section 934(b)(2), S may not claim the special deduction offered 
under USVI law relating to business activities like his in the USVI 
to reduce any of his tax liability payable to the USVI under section 
932(b).

    Example 3. (i) Z is a nonresident alien who resides in Country 
FC. In 2005, Z receives dividends from a corporation organized under 
the law of the U.S. Virgin Islands (USVI) in the amount of $90x. Z's 
tax liability incurred to the USVI pursuant to section 871(a) of the 
Internal Revenue Code as applicable in the USVI (mirror code) is 
$27x.
    (ii) Pursuant to a USVI law that was duly enacted within the 
limits of its authority under section 934, Z may claim a special 
exemption for income relating to his investment in the USVI. The 
maximum amount of the reduction in Z's mirror code tax liability 
that may result from claiming this exemption, computed in accordance 
with paragraph (b)(3) of this section, is as follows:

27x (90x /90x) = $27x

    (iii) Accordingly, depending on the terms of the exemption as 
provided under USVI law, Z's net tax liability incurred to the USVI 
may be reduced or eliminated entirely.

    Example 4. (i) A Corp is organized under the laws of the U.S. 
Virgin Islands (USVI) and is engaged in a trade or business in the 
United States through an office in State N. All of A Corp's 
outstanding stock is owned by U.S. citizens who are bona fide 
residents of the USVI. During 2005, A Corp had $50x in gross income 
from sources within the USVI (as determined under section 937(b) and 
Sec.  1.937-2T) that is not effectively connected with the conduct 
of a trade or business in the United States; $20x in gross income 
from sources in Country H that is effectively connected with the 
conduct of A Corp's trade or business in the United States; and $10x 
in gross income from sources in Country R that is not effectively 
connected with the conduct of A Corp's trade or business in the 
United States.
    (ii) Section 934(b)(3) permits the USVI to reduce or remit the 
income tax liability of a qualified foreign corporation arising 
under the Internal Revenue Code as applicable in the USVI (mirror 
code) with respect to income that is derived from sources outside 
the United States and that is not effectively connected with the 
conduct of a trade or business in the United States. A foreign 
corporation constitutes a ``qualified foreign corporation'' under 
section 934(b)(3)(B) if less than 10 percent of the total voting 
power and value of the stock of the corporation is owned or treated 
as owned (within the meaning of section 958) by one or more United 
States persons. A U.S. citizen is a United States person as defined 
in section 7701(a)(30)(A). Given that 10 percent or more of the 
voting power and value of its stock is owned by U.S. citizens, A 
Corp does not constitute a ``qualified foreign corporation'' under 
section 934(b)(3)(B). Accordingly, the USVI may only reduce or remit 
A Corp's mirror code income tax liability with respect to its $50x 
in gross income from sources within the USVI.

    Example 5. (i) The facts are the same as in Example 4, except 
that the outstanding stock of A Corp is owned by the following 
individuals:

U.S. citizens who are bona fide residents of the USVI..........       5%
U.S. citizens who are not bona fide residents of the USVI......       3%
Nonresident aliens who are bona fide residents of the USVI.....      42%
Nonresident aliens who are not bona fide residents of the USVI.      50%
 


[[Page 18937]]

    (ii) Given that less than 10 percent of the voting power and 
value of its stock is owned by United States persons, A Corp 
constitutes a qualified foreign corporation under section 
934(b)(3)(B). Accordingly, the USVI may reduce or remit A Corp's 
mirror code income tax liability with respect to its $50x in gross 
income from sources within the USVI and its $10x in gross income 
from sources in Country R that is not effectively connected with the 
conduct of A Corp's trade or business in the United States. In no 
event, however, may the USVI reduce or remit A Corp's mirror code 
income tax liability with respect to its $20x in gross income from 
sources in Country H that is effectively connected with the conduct 
of A Corp's trade or business in the United States.

    (e) Effective date. Except as otherwise provided in this paragraph 
(e), this section applies for taxable years ending after October 22, 
2004. Paragraph (c)(4)(ii) of this section applies to amounts paid or 
accrued after April 11, 2005.

0
Par. 27. Section 1.935-1 is amended as follows:
0
1. Revise the heading and paragraphs (a)(1) through (a)(3).
0
2. Revise paragraphs (b)(1) and (b)(3), and add paragraphs (b)(5) 
through (b)(7).
0
3. Revise paragraphs (c) through (f).
0
4. Add paragraph (g).
    The revisions and additions are as follows:


Sec.  1.935-1  Coordination of individual income taxes with Guam and 
the Northern Mariana Islands.

    (a)(1) through (a)(3) [Reserved]. For further guidance, see Sec.  
1.935-1T(a)(1) through (a)(3).
    (b)(1) [Reserved]. For further guidance, see Sec.  1.935-1T(b)(1).
* * * * *
    (b)(3) [Reserved]. For further guidance, see Sec.  1.935-1T(b)(3).
* * * * *
    (b)(5) through (b)(7) [Reserved]. For further guidance, see Sec.  
1.935-1T(b)(5) through (b)(7).
    (c) through (f) [Reserved]. For further guidance, see Sec.  1.935-
1T(c) through (f).
    (g) [Reserved]. For further guidance, see Sec.  1.935-1T(g).

0
Par. 28. Section 1.935-1T is added to read as follows:


Sec.  1.935-1T  Coordination of individual income taxes with Guam and 
the Northern Mariana Islands (temporary).

    (a) Application of section--(1) Scope. Section 935 and this section 
set forth the special rules relating to the filing of income tax 
returns, income tax liabilities, and estimated income tax of 
individuals described in paragraph (a)(2) of this section. Paragraph 
(e) of this section also provides special rules requiring consistent 
treatment of business entities in the United States and in section 935 
possessions.
    (2) Individuals covered. This section shall apply to any individual 
who--
    (i) Is a bona fide resident of a section 935 possession during the 
entire taxable year, whether or not such individual is a citizen of the 
United States or a resident alien (as defined in section 
7701(b)(1)(A));
    (ii) Is a citizen of a section 935 possession but not otherwise a 
citizen of the United States;
    (iii) Has income from sources within a section 935 possession for 
the taxable year, is a citizen of the United States or a resident alien 
(as defined in section 7701(b)(1)(A)) and is not a bona fide resident 
of a section 935 possession during the entire taxable year; or
    (iv) Files a joint return for the taxable year with any individual 
described in paragraph (a)(2)(i), (ii), or (iii) of this section.
    (3) Definitions. For purposes of this section:
    (i) The term section 935 possession means Guam or the Northern 
Mariana Islands, unless such possession has entered into an 
implementing agreement, as described in section 1271(b) of the Tax 
Reform Act of 1986 (Pub. L. 99-514 (100 Stat. 2085)), with the United 
States that is in effect for the entire taxable year.
    (ii) The term relevant possession means:
    (A) With respect to an individual described in paragraph (a)(2)(i) 
of this section, the section 935 possession of which such individual is 
a bona fide resident.
    (B) With respect to an individual described in paragraph (a)(2)(ii) 
of this section, the section 935 possession of which such individual is 
a citizen.
    (C) With respect to an individual described in paragraph 
(a)(2)(iii) of this section, the section 935 possession from which such 
individual derives income.
    (iii) The rules of Sec.  1.937-1T shall apply for determining 
whether an individual is a bona fide resident of a section 935 
possession.
    (iv) The rules of Sec.  1.937-2T generally shall apply for 
determining whether income is from sources within a section 935 
possession. Pursuant to Sec.  1.937-2T(a), however, the rules of Sec.  
1.937-2T(c)(1)(ii) and (c)(2) do not apply for purposes of section 
935(a)(3) (as in effect before the effective date of its repeal) and 
paragraph (a)(2)(iii) of this section.
    (v) The term citizen of the United States means any individual who 
is a citizen within the meaning of Sec.  1.1-1(c), except that the term 
does not include an individual who is a citizen of a section 935 
possession but not otherwise a citizen of the United States. The term 
citizen of a section 935 possession but not otherwise a citizen of the 
United States means any individual who has become a citizen of the 
United States by birth or naturalization in the section 935 possession.
    (vi) With respect to the United States, the term resident means an 
individual who is a citizen (as defined in Sec.  1.1-1(c)) or resident 
alien (as defined in section 7701(b)) and who does not have a tax home 
(as defined in section 911(d)(3)) in a foreign country during the 
entire taxable year. The term does not include an individual who is a 
bona fide resident of a section 935 possession.
    (vii) The term U.S. taxpayer means an individual described in 
paragraph (b)(1)(i) or (iii)(B) of this section.
    (b) Filing requirement--(1) Tax jurisdiction. An individual 
described in paragraph (a)(2) of this section shall file an income tax 
return for the taxable year--
    (i) With the United States if such individual is a resident of the 
United States;
    (ii) With the relevant possession if such individual is described 
in paragraph (a)(2)(i) of this section; or
    (iii) If neither paragraph (b)(1)(i) nor paragraph (b)(1)(ii) of 
this section applies--
    (A) With the relevant possession if such individual is described in 
paragraph (a)(2)(ii) of this section; or
    (B) With the United States if such individual is a citizen of the 
United States, as defined in paragraph (a)(3) of this section.
    (2) [Reserved]. For further guidance, see Sec.  1.935-1(b)(2).
    (3) Place for filing returns--(i) U.S. returns. A return required 
under this paragraph (b) to be filed with the United States shall be 
filed as directed in the applicable forms and instructions.
    (ii) Guam returns. A return required under this paragraph (b) to be 
filed with Guam shall be filed as directed in the applicable forms and 
instructions.
    (iii) NMI returns. A return required under this paragraph (b) to be 
filed with the Northern Mariana Islands shall be filed as directed in 
the applicable forms and instructions.
    (4) [Reserved]. For further guidance, see Sec.  1.935-1(b)(4).
    (5) Tax payments. The tax shown on the return shall be paid to the 
jurisdiction with which such return is required to be filed and shall 
be determined by taking into account any credit under section 31 for 
tax withheld by the relevant possession or the United States on wages, 
any credit under

[[Page 18938]]

section 6402(b) for an overpayment of income tax to the relevant 
possession or the United States, and any payments under section 6315 of 
estimated income tax paid to the relevant possession or the United 
States.
    (6) Liability to other jurisdiction--(i) Filing with the relevant 
possession. In the case of an individual who is required under 
paragraph (b)(1) of this section to file a return with the relevant 
possession for a taxable year, if such individual properly files such 
return and fully pays his or her income tax liability to the relevant 
possession, such individual is relieved of liability to file an income 
tax return with, and to pay an income tax to, the United States for the 
taxable year.
    (ii) Filing with the United States. In the case of an individual 
who is required under paragraph (b)(1) of this section to file a return 
with the United States for a taxable year, such individual is relieved 
of liability to file an income tax return with, and to pay an income 
tax to, the relevant possession for the taxable year.
    (7) Information reporting. [Reserved].
    (c) Extension of territory--(1) U.S. taxpayers--(i)General rule. 
With respect to a U.S. taxpayer, for purposes of taxes imposed by 
Chapter 1 of the Internal Revenue Code, the United States generally 
shall be treated, in a geographical and governmental sense, as 
including the relevant possession. The purpose of this rule is to 
facilitate the coordination of the tax systems of the United States and 
the relevant possession. Accordingly, the rule will have no effect 
where it is manifestly inapplicable or its application would be 
incompatible with the intent of any provision of the Internal Revenue 
Code.
    (ii) Application of general rule. Contexts in which the general 
rule of paragraph (c)(1)(i) of this section apply include:
    (A) The characterization of taxes paid to the relevant possession. 
Income tax paid to the relevant possession may be taken into account 
under sections 31, 6315, and 6402(b) as payments to the United States. 
Taxes paid to the relevant possession and otherwise satisfying the 
requirements of section 164(a) will be allowed as a deduction under 
that section, but income taxes paid to the relevant possession will be 
disallowed as a deduction under section 275(a).
    (B) The determination of the source of income for purposes of the 
foreign tax credit (e.g.,, sections 901 through 904). Thus, for 
example, after a U.S. taxpayer determines which items of income 
constitute income from sources within the relevant possession under the 
rules of section 937(b), such income shall be treated as income from 
sources within the United States for purposes of section 904.
    (C) The eligibility of a corporation to make a subchapter S 
election (sections 1361 through 1379). Thus, for example, for purposes 
of determining whether a corporation created or organized in the 
relevant possession may make an election under section 1362(a) to be a 
subchapter S corporation, it shall be treated as a domestic corporation 
and a U.S. taxpayer shareholder shall not be treated as a nonresident 
alien individual with respect to such corporation. While such an 
election is in effect, the corporation shall be treated as a domestic 
corporation for all purposes of the Internal Revenue Code. For the 
consistency requirement with respect to entity status elections, see 
paragraph (e) of this section.
    (D) The treatment of items carried over from other tax years. Thus, 
for example, if a U.S. taxpayer has for a taxable year a net operating 
loss carryback or carryover under section 172, a foreign tax credit 
carryback or carryover under section 904, a business credit carryback 
or carryover under section 39, a capital loss carryover under section 
1212, or a charitable contributions carryover under section 170, the 
carryback or carryover will be reported on the return filed with the 
United States in accordance with paragraph (b)(1)(i) or (b)(1)(iii)(B) 
of this section, even though the return of the taxpayer for the taxable 
year giving rise to the carryback or carryover was required to be filed 
with a section 935 possession.
    (E) The treatment of property exchanged for property of a like kind 
(section 1031). Thus for example, if a U.S. taxpayer exchanges real 
property located in the United States for real property located in the 
relevant possession, notwithstanding the provisions of section 1031(h), 
such exchange may qualify as a like-kind exchange under section 1031 
(provided that all the other requirements of section 1031 are 
satisfied).
    (iii) Nonapplication of general rule. Contexts in which the general 
rule of paragraph (c)(1)(i) of this section does not apply include:
    (A) The application of any rules or regulations that explicitly 
treat the United States and any (or all) of its possessions as separate 
jurisdictions (e.g.,, sections 931 through 937, 7651, and 7654).
    (B) The determination of any aspect of an individual's residency 
(e.g., sections 937(a) and 7701(b)). Thus, for example, an individual 
whose principal place of abode is in the relevant possession is not 
considered to have a principal place of abode in the United States for 
purposes of section 32(c).
    (C) The determination of the source of income for purposes other 
than the foreign tax credit (e.g., sections 935, 937, and 7654). Thus, 
for example, income determined to be derived from sources within the 
relevant possession under section 937(b) shall not be considered income 
from sources within the United States for purposes of Form 5074, 
``Allocation of Individual Income Tax to Guam or the Commonwealth of 
the Northern Mariana Islands''.
    (D) The definition of wages (section 3401). Thus, for example, 
services performed by an employee for an employer in the relevant 
possession do not constitute services performed in the United States 
under section 3401(a)(8).
    (E) The characterization of a corporation for purposes other than 
subchapter S (e.g., sections 367, 951 through 964, 1291 through 1298, 
6038, and 6038B). Thus, for example, if a U.S. taxpayer transfers 
appreciated tangible property to a corporation created or organized in 
the relevant possession in a transaction described in section 351, he 
or she must recognize gain unless an exception under section 367(a) 
applies. Also, if a corporation created or organized in the relevant 
possession qualifies as a passive foreign investment company under 
sections 1297 and 1298 with respect to a U.S. taxpayer, a dividend paid 
to such shareholder does not constitute qualified dividend income under 
section 1(h)(11)(B).
    (2) Application in relevant possession. In applying the territorial 
income tax of the relevant possession, such possession generally shall 
be treated, in a geographical and governmental sense, as including the 
United States. Thus, for example, income tax paid to the United States 
may be taken into account under sections 31, 6315, and 6402(b) as 
payments to the relevant possession. Moreover, a citizen of the United 
States (as defined in paragraph (a)(3) of this section) not a resident 
of the relevant possession will not be treated as a nonresident alien 
individual for purposes of the territorial income tax of the relevant 
possession. Thus, for example, a citizen of the United States (as so 
defined), or a resident of the United States, will not be treated as a 
nonresident alien individual for purposes of section 1361(b)(1)(C) of 
the Guamanian Territorial income tax.
    (d) Special rules for estimated income tax--(1) In general. An 
individual must make each payment of estimated income tax (and any 
amendment to the estimated tax payment) to the jurisdiction with which 
the individual

[[Page 18939]]

reasonably believes, as of the date of that payment (or amendment), 
that he or she will be required to file a return for the taxable year 
under paragraph (b)(1) of this section. In determining the amount of 
such estimated income tax, income tax paid to the relevant possession 
may be taken into account under sections 31 and 6402(b) as payments to 
the United States, and vice versa. For other rules relating to 
estimated income tax, see section 6654.
    (2) Joint estimated income tax. In the case of married persons 
making a joint payment of estimated income tax, the taxpayers must make 
each payment of estimated income tax (and any amendment to the 
estimated tax payment) to the jurisdiction where the spouse who has the 
greater estimated adjusted gross income for the taxable year would be 
required under paragraph (d)(1) of this section to pay estimated income 
tax if separate payments were made. For this purpose, estimated 
adjusted gross income of each spouse for the taxable year is determined 
without regard to community property laws.
    (3) Erroneous payment. If the individual or spouses erroneously pay 
estimated income tax to the United States instead of the relevant 
possession or vice versa, only subsequent payments or amendments of the 
payments are required to be made pursuant to paragraph (d)(1) or (d)(2) 
of this section with the other jurisdiction.
    (4) Place for payment. Estimated income tax required under this 
paragraph (d) to be paid to Guam or the Northern Mariana Islands shall 
be paid as directed in the applicable forms and instructions issued by 
the relevant possession. Estimated income tax required under paragraph 
(d)(1) of this section to be paid to the United States shall be paid as 
directed in the applicable forms and instructions.
    (5) Liability to other jurisdiction--(i) Filing with Guam or the 
Northern Mariana Islands. Subject to paragraph (d)(6) of this section, 
an individual required under this paragraph (d) to pay estimated income 
tax (and amendments thereof) to Guam or the Northern Mariana Islands is 
relieved of liability to pay estimated income tax (and amendments 
thereof) to the United States.
    (ii) Filing with the United States. Subject to paragraph (d)(6) of 
this section, an individual required under this paragraph (d) to pay 
estimated income tax (and amendments thereof) to the United States is 
relieved of liability to pay estimated income tax (and amendments 
thereof) to the relevant possession.
    (6) Underpayments. The liability of an individual described in 
paragraph (a)(2) of this section for underpayments of estimated income 
tax for a taxable year, as determined under section 6654, shall be to 
the jurisdiction with which the individual is required under paragraph 
(b) of this section to file his or her return for the taxable year.
    (e) Entity status consistency requirement--(1) In general. 
Taxpayers should make consistent entity status elections (as defined in 
paragraph (e)(3)(ii) of this section), when applicable, in both the 
United States and section 935 possessions. In the case of a business 
entity to which this paragraph (e) applies:
    (i) If an entity status election is filed with the Internal Revenue 
Service but not with the relevant possession, the appropriate tax 
authority of the relevant possession, at his discretion, may deem the 
election also to have been made for the relevant possession tax 
purposes.
    (ii) If an entity status election filed with the relevant 
possession but not with the Internal Revenue Service, the Commissioner, 
at his discretion, may deem the election also to have been made for 
U.S. Federal tax purposes.
    (iii) If inconsistent entity status elections are filed with the 
relevant possession and the Internal Revenue Service, both the 
Commissioner and the appropriate tax authority of the relevant 
possession may, at their individual discretion, treat the elections 
they each received as invalid and may deem the election filed in the 
other jurisdiction to have been made also for tax purposes in their own 
jurisdiction. (See Rev. Proc. 89-8 (1989-1 C.B. 778) for procedures for 
requesting the assistance of the Internal Revenue Service when a 
taxpayer is or may be subject to inconsistent tax treatment by the 
Internal Revenue Service and a U.S. possession tax agency.)
    (2) Scope. This paragraph (e) applies to the following business 
entities:
    (i) A business entity (as defined in Sec.  301.7701-2(a) of this 
chapter) that is domestic (as defined in Sec.  301.7701-5 of this 
chapter), or otherwise treated as domestic for purposes of the Internal 
Revenue Code, and that is owned in whole or in part by any person who 
is either a bona fide resident of a section 935 possession or a 
business entity created or organized in a section 935 possession.
    (ii) A business entity that is created or organized in a section 
935 possession and that is owned in whole or in part by any U.S. person 
(other than a bona fide resident of such possession).
    (3) Definitions. For purposes of this section--
    (i) The term appropriate tax authority of the relevant possession 
means the individual responsible for tax administration in such 
possession or his delegate.
    (ii) The term entity status election includes an election under 
Sec.  301.7701-3(c) of this chapter, an election under section 1362(a), 
and any other similar elections.
    (4) Default status. Solely for the purpose of determining 
classification of an eligible entity under Sec.  301.7701-3(b), and 
Sec.  301.7701-3(b) as mirrored in the relevant possession, an eligible 
entity subject to this paragraph (e) shall be classified for both U.S. 
Federal and the relevant possession tax purposes using the rule that 
applies to domestic eligible entities.
    (5) Transition rules--(i) In the case of an election filed prior to 
April 11, 2005, except as provided in paragraph (e)(5)(ii) of this 
section, the rules of paragraph (e)(1) of this section shall apply as 
of the first day of the first taxable year of the entity beginning 
after April 11, 2005.
    (ii) In the unlikely circumstance that inconsistent elections 
described in paragraph (e)(1)(iii) are filed prior to April 11, 2005, 
and the entity cannot change its classification to achieve consistency 
because of the sixty-month limitation described in Sec.  301.7701-
3(c)(1)(iv) of this chapter, then the entity may nevertheless request 
permission from the Commissioner or appropriate tax authority of the 
relevant possession to change such election to avoid inconsistent 
treatment by the Commissioner and the appropriate tax authority of the 
relevant possession.
    (iii) Except as provided in paragraphs (e)(5)(i) and (e)(5)(ii) of 
this section, in the case of an election filed with respect to an 
entity before it became an entity described in paragraph (e)(2) of this 
section, the rules of paragraph (e)(1) of this section shall apply as 
of the first day that such entity is described in paragraph (e)(2) of 
this section.
    (iv) In the case of an entity created or organized prior to April 
11, 2005, paragraph (e)(4) of this section shall take effect for U.S. 
Federal income tax purposes (or the relevant possession income tax 
purposes, as the case may be) as of the first day of the first taxable 
year of the entity beginning after April 11, 2005.
    (f) Examples. The application of this section is illustrated by the 
following examples:

    Example 1. B, a United States citizen, files returns on a 
calendar year basis. In April 2005, B moves to Possession G, which 
is a section 935 possession, purchases a house, and accepts a 
permanent position with a

[[Page 18940]]

local employer. For the remainder of the year and throughout 2006, B 
continues to live and work in Possession G, and establishes a closer 
connection to Possession G than to the United States or any foreign 
country. In September 2007, as a result of the termination of his 
employment in Possession G, B sells his house and moves to State H. 
As a consequence of his employment in Possession G, B earns income 
from the performance of services in Possession G from April 2005 
through September 2007. Section 935(b)(1)(B) and paragraph 
(b)(1)(ii) of this section apply to B for 2006, but not for 2005 or 
2007 (assuming that during the first quarter of 2005 and the last 
quarter of 2007, B has a tax home outside of Possession G or a 
closer connection to the United States or a foreign country). For 
2005 and 2007, B is subject to the rules applicable to individuals 
described in paragraph (a)(2)(iii) of this section because he has 
income derived from sources within Possession G as determined under 
the rules of section 937(b) and Sec.  1.937-2T.

    Example 2. The facts are the same as in Example 1 except that 
B's employment terminated in September 2008 rather than 2007. B 
properly pays his April 2005 estimated tax to the United States, 
continues to pay estimated tax for the 2005 tax year to the United 
States under paragraph (d) of this section, and properly files his 
2005 return with the United States.
    (i)(A) On the date of each payment of estimated tax in 2006, B 
reasonably believes that he would be required to file his return for 
2006 with Possession G under paragraph (b)(1) of this section.
    (B) In August 2006, B determines that he has overpaid tax for 
the previous year in the amount of $1000. B properly pays all 
estimated taxes to Possession G for 2006, subtracting the $1000 
overpayment from his estimated tax payments pursuant to section 
6402(b), and properly files his tax return with Possession G.
    (ii) In April 2007, B reasonably believes that he would be 
returning to the United States in the Fall of 2007, and properly 
pays estimated tax to the United States. By June 2007, B reasonably 
believes that he would not be moving from Possession G and would be 
a bona fide resident of Possession G for the entire taxable year. B 
makes his remaining estimated tax payments to Possession G. On his 
2007 tax return filed with Possession G, pursuant to section 6315, B 
properly takes into account payments made to both the United States 
and Possession G as estimated taxes.
    (iii) In April and June 2008, B reasonably believes that he 
would be a bona fide resident of Possession G for the entire taxable 
year 2008 and properly pays estimated taxes to Possession G. By the 
time B pays his estimated taxes for September 2008, B's employment 
terminates and he moves to State H. B properly makes his remaining 
estimated tax payments to the United States. On his return for 2008, 
properly filed with the United States, B determines that he has 
underpaid estimated taxes throughout 2008 in an amount subject to 
penalty under section 6654. B owes the United States an estimated 
tax penalty under section 6654.

    (g) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 29. Section 1.937-1T is added to read as follows:


Sec.  1.937-1T  Bona fide residency in a possession (temporary).

    (a) Scope--(1) In general. Section 937(a) and this section set 
forth the rules for determining whether an individual qualifies as a 
bona fide resident of a particular possession (the relevant possession) 
for purposes of the Internal Revenue Code, including Subpart D, Part 
III, Subchapter N, Chapter 1 of the Internal Revenue Code as well as 
section 865(g)(3), section 876, section 881(b), paragraphs (2) and (3) 
of section 901(b), section 957(c), section 3401(a)(8)(C), and section 
7654(a).
    (2) Definitions. For purposes of this section and Sec. Sec.  1.937-
2 and 1.937-3--
    (i) Possession means one of the following United States 
possessions: American Samoa, Guam, the Northern Mariana Islands, Puerto 
Rico, or the Virgin Islands. When used in a geographical sense, the 
term comprises only the territory of each such possession (without 
application of sections 932(c)(3) and 935(c)(2) (as in effect before 
the effective date of its repeal)).
    (ii) United States, when used in a geographical sense, is defined 
in section 7701(a)(9), and without application of sections 932(a)(3) 
and 935(c)(1) (as in effect before the effective date of its repeal).
    (b) Bona fide resident--(1) General rule. An individual qualifies 
as a bona fide resident of the relevant possession if such individual 
satisfies the requirements of paragraphs (c) through (e) of this 
section with respect to such possession.
    (2) Special rule for members of the Armed Forces. A member of the 
Armed Forces of the United States who qualified as a bona fide resident 
of the relevant possession in a prior taxable year shall be deemed to 
have satisfied the requirements of paragraphs (c) through (e) of this 
section for a subsequent taxable year if such individual otherwise is 
unable to satisfy such requirements by reason of being absent from such 
possession or present in the United States during such year solely in 
compliance with military orders. Conversely, a member of the Armed 
Forces of the United States who did not qualify as a bona fide resident 
of the relevant possession in a prior taxable year shall not be 
considered to have satisfied the requirements of paragraphs (c) through 
(e) of this section for a subsequent taxable year by reason of being 
present in such possession solely in compliance with military orders. 
Armed Forces of the United States is defined (and members of the Armed 
Forces are described) in section 7701(a)(15).
    (3) Juridical persons. Only natural persons may qualify as bona 
fide residents of a possession. The rules governing the tax treatment 
of bona fide residents of a possession do not apply to juridical 
persons (e.g., corporations, partnerships, trusts, and estates).
    (4) Transition rule. For taxable years beginning before October 23, 
2004, and ending after October 22, 2004, an individual will be 
considered to qualify as a bona fide resident of the relevant 
possession if such individual satisfies the requirements of paragraphs 
(d) and (e) of this section with respect to such possession for such 
year.
    (c) Presence test--(1) In general. A United States citizen or 
resident alien (as defined in section 7701(b)(1)(A)) individual 
satisfies the requirements of this paragraph (c) for a taxable year if 
during that taxable year such individual--
    (i) Was present in the relevant possession for at least 183 days;
    (ii) Was present in the United States for no more than 90 days;
    (iii) Had no earned income (as defined in Sec.  1.911-3(b)) in the 
United States and was present for more days in the relevant possession 
than in the United States; or
    (iv) Had no permanent connection (see paragraph (c)(4) of this 
section) to the United States.
    (2) Special rule for alien individuals. A nonresident alien 
individual (as defined in section 7701(b)(1)(B)) satisfies the 
requirements of this paragraph (c) for a taxable year if during that 
taxable year such individual satisfies the substantial presence test of 
Sec.  301.7701(b)-1(c) of this chapter (except for the substitution of 
the name of the relevant possession for the term United States where 
appropriate).
    (3) Days of presence. For purposes of paragraph (c)(1) of this 
section--
    (i) An individual is considered to be present in the relevant 
possession on any day that he or she is physically present in such 
possession at any time during the day.
    (ii) An individual is considered to be present in the United States 
on any day that he or she is physically present in the United States at 
any time during the day. However, the following days shall be excluded 
and will not count as days of presence in the United States:
    (A) Any day that an individual is prevented from leaving the United 
States because of a medical condition

[[Page 18941]]

that arose while the individual was present in the United States (as 
described in Sec.  301.7701(b)-3(c) of this chapter);
    (B) Any day that an individual is in transit between two points 
outside the United States (as described in Sec.  301.7701(b)-3(d) of 
this chapter), and is physically present in the United States for fewer 
than 24 hours;
    (C) Any day that an individual is temporarily present in the United 
States as a professional athlete to compete in a charitable sports 
event (as described in Sec.  301.7701(b)-3(b)(5) of this chapter);
    (D) Any day during which the individual is temporarily in the 
United States as a student (as defined in section 152(f)(2)); and
    (E) In the case of an individual who is an elected representative 
of the relevant possession, or who serves full time as an elected or 
appointed official or employee of the government of the relevant 
possession (or any political subdivision thereof), any day spent 
serving the relevant possession in such role.
    (iii) If, during a single day, an individual is physically 
present--
    (A) In the United States and in the relevant possession, such day 
shall be considered a day of presence in the relevant possession;
    (B) In two possessions, such day shall be considered a day of 
presence in the possession where the individual's tax home is located 
(applying the rules of paragraph (d) of this section).
    (4) Permanent connection. For purposes of paragraph (c)(1) of this 
section--
    (i) A permanent connection to the United States includes--
    (A) A permanent home (as described in Sec.  301.7701(b)-2(d)(2) of 
this chapter) in the United States;
    (B) A spouse or dependent (as defined in section 152 and the 
regulations thereunder) whose principal place of abode is in the United 
States; or
    (C) Current registration to vote in any political subdivision of 
the United States.
    (ii) However, a permanent connection to the United States does not 
include--
    (A) A valid professional license conferred by any political 
subdivision of the United States; or
    (B) Relatives (other than those specified in paragraph (c)(4)(B) of 
this section) whose principal place of abode is in the United States.
    (d) Tax home test--(1) General rule. An individual satisfies the 
requirements of this paragraph (d) for a taxable year if such 
individual did not have a tax home outside the relevant possession 
during any part of the taxable year. For purposes of section 937 and 
this section, an individual's tax home is determined under the 
principles of section 911(d)(3) without regard to the second sentence 
thereof. Thus, under section 937, an individual's tax home is 
considered to be located at the individual's regular or principal (if 
more than one regular) place of business. If the individual has no 
regular or principal place of business because of the nature of the 
business, or because the individual is not engaged in carrying on any 
trade or business within the meaning of section 162(a), then the 
individual's tax home is the individual's regular place of abode in a 
real and substantial sense.
    (2) Special rule for seafarers. For purposes of section 937 and 
this section, an individual will not be considered to have a tax home 
outside the relevant possession solely by reason of employment on a 
ship or other seafaring vessel that is predominantly used in local and 
international waters. For this purpose, a vessel will be considered to 
be predominantly used in local and international waters if, during the 
taxable year, the aggregate amount of time it is used in international 
water and in the water within three miles of the relevant possession 
exceeds the aggregate amount of time it is used in the territorial 
water of the United States or any foreign country.
    (3) Special rule for students and government officials. Any days 
described in paragraphs (c)(3)(ii)(D) and (E) of this section shall be 
disregarded for purposes of determining whether an individual has a tax 
home outside the relevant possession under paragraph (d)(1) of this 
section during any part of the taxable year.
    (e) Closer connection test. An individual satisfies the 
requirements of this paragraph (e) for a taxable year if such 
individual did not have a closer connection to the United States or a 
foreign country than to the relevant possession. For purposes of the 
preceding sentence--
    (1) The principles of section 7701(b)(3)(B)(ii) and Sec.  
301.7701(b)-2(d) of this chapter shall apply; and
    (2) Another possession shall not be considered a foreign country.
    (f) Examples. The principles of this section are illustrated by the 
following examples:

    Example 1. Presence test. H and W are U.S. citizens who live for 
part of the taxable year in a condominium, which they own, located 
in Possession P. H and W also own a house in State N where they live 
for 120 days a year to be near their grown children and 
grandchildren. H and W are retired and their income consists solely 
of pension payments, dividends, interest, and Social Security 
benefits. In 2005, H and W are only present in Possession P for a 
total of 175 days because of a 70 day vacation to Europe and Asia. 
Thus, in 2005, H and W are not present in Possession P for at least 
183 days, are present in the United States for more than 90 days, 
and have a permanent connection to the United States by reason of 
their permanent home. However, under paragraph (c)(1)(iii) of this 
section, H and W each still satisfy the presence test in paragraph 
(c) of this section with respect to Possession P because they have 
no earned income in the United States and are physically present for 
more days in Possession P than in the United States.

    Example 2. Presence test. T, a U.S. citizen, is a sales 
representative for a company based in Possession V. T lives with his 
wife and minor children in their house in Possession V, where he is 
also registered to vote. T's business travel requires T to spend 120 
days in the United States and another 120 days in foreign countries. 
When traveling on business, T generally stays at hotels but 
sometimes stays with his brother, who lives in State A. Under 
paragraphs (c)(1)(iv) and (c)(4) of this section, T satisfies the 
presence test in paragraph (c) of this section because he has no 
permanent connection to the United States.

    Example 3. Alien resident of possession--presence test. F is a 
citizen of Country G. F's tax home is in Possession C and F has no 
closer connection to the United States or a foreign country than to 
Possession C. F is physically present in Possession C for 123 days 
and in the United States for 110 days every year. Accordingly, F is 
a nonresident alien with respect to the United States under section 
7701(b), and a bona fide resident of Possession C under paragraphs 
(b), (c)(2), (d), and (e) of this section.

    Example 4. Seafarers--tax home. S, a U.S. citizen, is employed 
by a fishery and spends 250 days at sea on a fishing vessel. When 
not at sea, S resides with his wife at a house they own in 
Possession G. The fishing vessel upon which S works departs and 
arrives at various ports in Possession G, other possessions, and 
foreign countries, but is in international or local waters (within 
the meaning of paragraph (d)(2) of this section) for 225 days. Under 
paragraph (d)(2) of this section, S will not be considered to have a 
tax home outside Possession G for purposes of section 937 and this 
section solely by reason of S's employment on board the fishing 
vessel.

    Example 5. Seasonal workers--tax home and closer connection. P, 
a U.S. citizen, is a permanent employee of a hotel in Possession I, 
but works only during the tourist season. For the remainder of each 
year, P lives with her husband and children in Possession Q, where 
she has no outside employment. Most of P's personal belongings, 
including her automobile, are located in Possession Q. P is 
registered to vote in, and has a driver's license issued by, 
Possession Q. P does her personal banking in Possession Q and P 
routinely lists her address in Possession Q on forms and documents. 
P satisfies the presence test of paragraph (c) of this section with 
respect to both Possession Q and Possession I, because, among other 
reasons,

[[Page 18942]]

under paragraph (c)(1)(ii) of this section she does not spend more 
than 90 days in the United States during the taxable year. P 
satisfies the tax home test of paragraph (d) of this section only 
with respect to Possession I, because her regular place of business 
is in Possession I. P satisfies the closer connection test of 
paragraph (e) of this section with respect to both Possession Q and 
Possession I, because she does not have a closer connection to the 
United States or to any foreign country (and for this purpose, under 
paragraph (e)(2) of this section, Possession Q is not treated as a 
foreign country with respect to Possession I). Therefore, P is a 
bona fide resident of Possession I for purposes of the Internal 
Revenue Code.

    Example 6. Closer connection to United States than to 
possession. Z, a U.S. citizen, relocates to Possession V in 2003 to 
start an investment consulting and venture capital business. Z's 
wife and two teen-aged children remain in State C to allow the 
children to complete high school. Z travels back to the United 
States regularly to see his wife and children, to engage in business 
activities, and to take vacations. He has an apartment available for 
his full-time use in Possession V, but he remains a joint-owner of 
the residence in State C where his wife and children reside. Z and 
his family have automobiles and personal belongings such as 
furniture, clothing, and jewelry located at both residences. 
Although Z is a member of the Possession V Chamber of Commerce, Z 
also belongs to and has current relationships with social, 
political, cultural, and religious organizations in State C. Z 
receives mail in State C, including brokerage statements, credit 
card bills, and bank advices. Z is not a bona fide resident of 
Possession V because he has a closer connection to the United States 
than to Possession V and therefore fails to satisfy the requirements 
of paragraphs (b)(1) and (e) of this section.

    (g) Information reporting requirement. The following individuals 
are required to file notice of their new tax status in such time and 
manner as the Commissioner may prescribe by notice, form, instructions, 
or other publication (see Sec.  601.601(d)(2) of this chapter):
    (1) Individuals who take the position for U.S. tax reporting 
purposes that they qualify as bona fide residents of a possession for a 
tax year subsequent to a tax year for which they were required to file 
Federal income tax returns as citizens or residents of the United 
States who did not so qualify.
    (2) Citizens and residents of the United States who take the 
position for U.S. tax reporting purposes that they do not qualify as 
bona fide residents of a possession for a tax year subsequent to a tax 
year for which they were required to file income tax returns (with the 
Internal Revenue Service, the tax authorities of a possession, or both) 
as individuals who did so qualify.
    (3) Bona fide residents of Puerto Rico or a section 931 possession 
(as defined in Sec.  1.931-1T(c)(1)) who take a position for U.S. tax 
reporting purposes that they qualify as bona fide residents of such 
possession for a tax year subsequent to a tax year for which they were 
required to file income tax returns as bona fide residents of the 
United States Virgin Islands or a section 935 possession (as defined in 
Sec.  1.935-1T(a)(3)(i)).
    (h) Effective date. Except as provided in this paragraph (h), this 
section shall apply to taxable years ending after October 22, 2004. 
Paragraph (g) of this section also applies to the 3 taxable years 
preceding the first taxable year ending after October 22, 2004.

0
Par. 30. Section 1.937-2T is added to read as follows:


Sec.  1.937-2T  Income from sources within a possession (temporary).

    (a) Scope. Section 937(b) and this section set forth the rules for 
determining whether income is considered to be from sources within a 
particular possession (the relevant possession) for purposes of the 
Internal Revenue Code, including section 957(c) and Subpart D, Part 
III, Subchapter N, Chapter 1 of the Internal Revenue Code, as well as 
section 7654(a) of the 1954 Internal Revenue Code (until the effective 
date of its repeal). Paragraphs (c)(1)(ii) and (c)(2) of this section 
do not apply, however, for purposes of sections 932(a) and (b) and 
935(a)(3) (as in effect before the effective date of its repeal). In 
the case of a possession or territory that administers income tax laws 
that are identical (except for the substitution of the name of the 
possession or territory for the term United States where appropriate) 
to those in force in the United States, these rules do not apply for 
purposes of the application of such laws. These rules also do not 
affect the determination of whether income is considered to be from 
sources without the United States for purposes of the Internal Revenue 
Code.
    (b) In general. Except as provided in paragraphs (c) through (i) of 
this section, the principles of sections 861 through 865 and the 
regulations thereunder (relating to the determination of the gross and 
the taxable income from sources within and without the United States) 
generally shall be applied in determining the gross and the taxable 
income from sources within and without the relevant possession. In the 
application of such principles, the name of the relevant possession 
shall be used instead of the term United States, the term bona fide 
resident of followed by the name of the relevant possession shall be 
used instead of the term United States resident, and the term domestic 
shall be construed to mean created or organized in such possession.
    (c) U.S. income--(1) In general. Except as provided in paragraph 
(d) of this section, income from sources within the relevant possession 
shall not include any item of income determined under the rules of 
sections 861 through 865 and the regulations thereunder to be--
    (i) From sources within the United States; or
    (ii) Effectively connected with the conduct of a trade or business 
within the United States.
    (2) Conduit arrangements. Income shall be considered to be from 
sources within the United States for purposes of paragraph (c)(1) of 
this section if, pursuant to a plan or arrangement--
    (i) The income is received in exchange for consideration provided 
to another person; and
    (ii) Such person (or another person) provides the same 
consideration (or consideration of a like kind) to a third person in 
exchange for one or more payments constituting income from sources 
within the United States.
    (d) Income from certain sales of inventory property. For special 
rules that apply to determine the source of income from certain sales 
of inventory property, see Sec.  1.863-3(f).
    (e) Income from services--(1) No de minimis rule. In applying the 
principles of section 861 and the regulations thereunder pursuant to 
paragraph (b) of this section, the exception in section 861(a)(3) shall 
not apply.
    (2) Service in the Armed Forces. In the case of a member of the 
Armed Forces of the United States, the following rules shall apply for 
determining the source of compensation for services performed in 
compliance with military orders:
    (i) If the individual is a bona fide resident of a possession and 
such services are performed in the United States or in another 
possession, the compensation constitutes income from sources within the 
possession of which the individual is a bona fide resident (and not 
from sources within the United States or such other possession).
    (ii) If the individual is not a bona fide resident of a possession 
and such services are performed in a possession, the compensation 
constitutes income from sources within the United States (and not from 
sources within such possession).
    (f) Gains from certain dispositions of property-- (1) Property of 
former U.S. residents. (i) Income from sources within the relevant 
possession shall not include gains from the disposition of property 
described in paragraph (f)(1)(ii) of this section by an individual 
described in paragraph (f)(1)(iii) of this section. See also section 
1277(e) of

[[Page 18943]]

Public Law 99-514 (100 Stat. 2985) (providing that gains from the 
disposition of certain property by individuals who acquired residency 
in certain possessions shall be considered to be from sources within 
the United States).
    (ii) Property is described in this paragraph (f)(1)(ii) when the 
following conditions are satisfied--
    (A) The property is of a kind described in section 731(c)(3)(C)(i) 
or 954(c)(1)(B); and
    (B) The property was owned by the individual before such individual 
became a bona fide resident of the relevant possession.
    (iii) An individual is described in this paragraph (f)(1)(iii) when 
the following conditions are satisfied--
    (A) For the taxable year for which the source of the gain must be 
determined, the individual is a bona fide resident of the relevant 
possession; and
    (B) For any of the 10 years preceding such year, the individual was 
a citizen or resident of the United States (other than a bona fide 
resident of the relevant possession).
    (iv) If an individual described in paragraph (f)(1)(iii) of this 
section exchanges property described in paragraph (f)(1)(ii) of this 
section for other property in a transaction in which gain or loss is 
not required to be recognized (in whole or in part) under U.S. income 
tax principles, such other property shall also be considered property 
described in paragraph (f)(1)(ii) of this section.
    (v) If an individual described in paragraph (f)(1)(iii) of this 
section owns, directly or indirectly, at least 10 percent (by value) of 
any entity to which property described in paragraph (f)(1)(ii) of this 
section is transferred in a transaction in which gain or loss is not 
required to be recognized (in whole or in part) under U.S. income tax 
principles, any gain recognized upon a disposition of the property by 
such entity shall be treated as income from sources outside the 
relevant possession if any gain recognized upon a direct or indirect 
disposition of the individual's interest in such entity would have been 
so treated under paragraph (f)(1)(iv) of this section.
    (2) Special rules under section 865 for possessions--(i) Except as 
provided in paragraph (f)(1) of this section--
    (A) Gain that is considered to be derived from sources outside of 
the United States under section 865(g)(3) shall be considered income 
from sources within Puerto Rico; and
    (B) Gain that is considered to be derived from sources outside of 
the United States under section 865(h)(2)(B) shall be considered income 
from sources within the possession in which the liquidating corporation 
is created or organized.
    (ii) In applying the principles of section 865 and the regulations 
thereunder pursuant to paragraph (b) of this section, the rules of 
section 865(g) shall not apply, but the special rule of section 
865(h)(2)(B) shall apply with respect to gain recognized upon the 
liquidation of corporations created or organized in the United States.
    (g) Dividends--(1) Dividends from certain possessions 
corporations--(i) In general. Except as provided in paragraph 
(g)(1)(ii) of this section, with respect to any possessions 
shareholder, only the possessions source ratio of any dividend paid or 
accrued by a corporation created or organized in a possession 
(possessions corporation) shall be treated as income from sources 
within such possession. For purposes of this paragraph (g)--
    (A) The possessions source ratio shall be a fraction, the numerator 
of which equals the gross income of the possessions corporation from 
sources within the possession in which it is created or organized 
(applying the rules of this section) for the testing period, and the 
denominator of which equals the total gross income of the corporation 
for the testing period; and
    (B) The term possessions shareholder means any individual who is a 
bona fide resident of the possession in which the corporation is 
created or organized and who owns, directly or indirectly, at least 10 
percent of the total voting stock of the corporation.
    (ii) Dividends from corporations engaged in the active conduct of a 
trade or business in the relevant possession. The entire amount of any 
dividend paid or accrued by a possessions corporation shall be treated 
as income from sources within the possession in which it is created or 
organized when the following conditions are met--
    (A) 80 percent or more of the gross income of the corporation for 
the testing period was derived from sources within such possession 
(applying the rules of this section) or was effectively connected with 
the conduct of a trade or business in such possession (applying the 
rules of Sec.  1.937-3T); and
    (B) 50 percent or more of the gross income of the corporation for 
the testing period was derived from the active conduct of a trade or 
business within such possession.
    (iii) Testing period. For purposes of this paragraph (g)(1), the 
term testing period means the 3-year period ending with the close of 
the taxable year of the payment of the dividend (or for such part of 
such period as the corporation has been in existence).
    (iv) Subsidiary look-through rule. For purposes of this paragraph 
(g)(1), if a possessions corporation owns (directly or indirectly) at 
least 25 percent (by value) of the stock of another corporation, such 
possessions corporation shall be treated as if it--
    (A) Directly received its proportionate share of the income of such 
other corporation; and
    (B) Actively conducted any trade or business actively conducted by 
such other corporation.
    (2) Dividends from other corporations. In applying the principles 
of section 861 and the regulations thereunder pursuant to paragraph (b) 
of this section, the special rules relating to dividends for which 
deductions are allowable under section 243 or 245 shall not apply.
    (h) Income inclusions. For purposes of determining whether an 
amount described in section 904(h)(1)(A) constitutes income from 
sources within the relevant possession--
    (1) If the individual owns (directly or indirectly) at least 10 
percent of the total voting stock of the corporation from which such 
amount is derived, the principles of section 904(h)(2) shall apply. In 
the case of an individual who is not a possessions shareholder (as 
defined in paragraph (g)(1)(i)(B) of this section), the preceding 
sentence shall apply only if the corporation qualifies as a United 
States-owned foreign corporation for purposes of section 904(h); and
    (2) In all other cases, the amount shall be considered income from 
sources in the jurisdiction in which the corporation is created or 
organized.
    (i) Interest--(1) Interest from certain possessions corporations--
(i) In general. Except as provided in paragraph (i)(1)(ii) of this 
section, with respect to any possessions shareholder (as defined in 
paragraph (g)(1)(i)(B) of this section), interest paid or accrued by a 
possessions corporation shall be treated as income from sources within 
the possession in which it is created or organized to the extent that 
such interest is allocable to assets that generate, have generated, or 
could reasonably have been expected to generate income from sources 
within such possession (under the rules of this section) or income 
effectively connected with the conduct of a trade or business within 
such possession (under the rules of Sec.  1.937-3T). For purposes of 
the preceding sentence, the principles of Sec. Sec.  1.861-9 through 
1.861-12 shall apply.
    (ii) Interest from corporations engaged in the active conduct of a 
trade or

[[Page 18944]]

business in the relevant possession. The entire amount of any interest 
paid or accrued by a possessions corporation shall be treated as income 
from sources within the possession in which it is created or organized 
when the conditions of paragraphs (g)(1)(ii) (A) and (B) of this 
section are met (applying the rules of paragraphs (g)(1) (iii) and (iv) 
of this section).
    (2) Interest from partnerships. Interest paid or accrued by a 
partnership shall be treated as income from sources within a possession 
only to the extent that such interest is allocable to income 
effectively connected with the conduct of a trade or business in such 
possession. For purposes of the preceding sentence, the principles of 
Sec.  1.882-5 shall apply (as if the partnership were a foreign 
corporation and as if the trade or business in the possession were a 
trade or business in the United States).
    (j) Indirect ownership. For purposes of this section, the rules of 
section 318(a)(2) shall apply except that the language ``5 percent'' 
shall be used instead of ``50 percent'' in section 318(a)(2)(C).
    (k) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X, a U.S. citizen, resides in State N and acquires 
the stock of Corporation C, a domestic corporation, in 2000. X moves 
to the Northern Mariana Islands (NMI) in 2003. In 2004, while a bona 
fide resident of the NMI, X recognizes gain on the sale of the 
Corporation C stock. Pursuant to section 1277(e) of the Tax Reform 
Act of 1986, Public Law 99-514 (100 Stat. 2085) (October 22, 1986), 
this gain is treated as income from sources within the United States 
for all purposes of the Internal Revenue Code (including section 
7654, as in effect with respect to the NMI), and not as income from 
sources in the NMI.

    Example 2. X, a U.S. citizen, resides in State F and acquires a 
5 percent interest in Partnership P in 2003. X moves to the U.S. 
Virgin Islands (USVI) in 2004. In 2006, while a bona fide resident 
of the USVI, X recognizes gain on the sale of the interest in 
Partnership P. Pursuant to paragraph (f)(1) of this section, the 
gain shall not be treated as income from sources within the USVI for 
purposes of the Internal Revenue Code (for example, for purposes of 
section 934(b)).

    Example 3. X, a bona fide resident of Possession I, a section 
931 possession (as defined in Sec.  1.931-1T(c)(1)), is engaged in a 
trade or business in the United States through an office in State H. 
In 2005, this office materially participates in the sale of 
inventory property in Possession I, such that the income from these 
inventory sales is considered effectively connected to this trade or 
business in the United States under section 864(c)(4)(B)(iii). This 
income shall not be treated as income from sources within Possession 
I for purposes of section 931(a)(1) pursuant to paragraph (c)(1)(ii) 
of this section, but nonetheless shall continue to be treated as 
income from sources without the United States under section 862 (for 
example, for purposes of section 904).

    Example 4. (i) X, a bona fide resident of Possession I, owns 25 
percent of the outstanding shares of A Corp, a corporation organized 
under the laws of Possession I. In 2006, X receives a dividend of 
$70x from A Corp. During 2004 through 2006, A Corp has gross income 
from the following sources:

------------------------------------------------------------------------
                                                              Sources
                  Year                     Possession I       outside
                                              sources      possession I
------------------------------------------------------------------------
2004....................................            $10x            $20x
2005....................................             20x             10x
2006....................................             25x             15x
------------------------------------------------------------------------

    (ii) A Corp owns 50 percent of the outstanding shares of B Corp, 
a corporation organized under the laws of Country FC. During 2004 
through 2006, B Corp has gross income from the following sources:

------------------------------------------------------------------------
                                                              Sources
                  Year                     Possession I       outside
                                              sources      possession I
------------------------------------------------------------------------
2004....................................            $10x             $6x
2005....................................             14x              8x
2006....................................             10x              4x
------------------------------------------------------------------------

    (iii) A Corp is treated as having received 50 percent of the 
gross income of B Corp. Therefore, for 2004 through 2006, the gross 
income of A Corp is from the following sources:

------------------------------------------------------------------------
                                                              Sources
                  Year                     Possession I       outside
                                              sources      possession I
------------------------------------------------------------------------
2004....................................            $15x            $23x
2005....................................             27x             14x
2006....................................             30x             17x
                                         -----------------
    Totals..............................             72x             54x
------------------------------------------------------------------------

    (iv) Pursuant to paragraph (g) of this section, the portion of the 
dividend of $70x that X receives from Corp A in 2006 that is treated as 
income from sources within Possession I is 72/126 of $70x, or $40x.

    Example 5. X is a U.S. citizen and a bona fide resident of the 
Northern Mariana Islands (NMI). In 2005, X receives compensation for 
services performed as a member of the crew of a fishing boat. Ten 
percent of the services for which X receives compensation are 
performed in the NMI, and 90 percent of X's services are performed 
in international waters. X is a ``United States person'' as defined 
in section 7701(a)(30)(A). Accordingly, pursuant to section 
863(d)(1)(A), the compensation that X receives for services 
performed in international waters is treated as income from sources 
within the United States for purposes of the Internal Revenue Code 
(including section 7654, as in effect with respect to the NMI). 
Under the principles of section 861(a)(3) as applied pursuant to 
paragraph (b) of this section, the compensation that X receives for 
services performed in the NMI is treated as income from sources 
within the NMI.



    (l) Effective date. Except as otherwise provided in this paragraph 
(l), this section applies to income earned in tax years ending after 
October 22, 2004. Paragraph (c)(1) of this section applies to income 
earned after December 31, 2004. Paragraph (f) of this section applies 
to dispositions after April 11, 2005. Paragraphs (c)(2), (g)(1), (h), 
and (i) of this section apply to amounts paid or accrued after April 
11, 2005.

0
Par. 31. Section 1.937-3T is added to read as follows:


Sec.  1.937-3T  Income effectively connected with the conduct of a 
trade or business in a possession (temporary).

    (a) Scope. Section 937(b) and this section set forth the rules for 
determining whether income is effectively connected with the conduct of 
a trade or business within a particular possession (the relevant 
possession) for purposes of the Internal Revenue Code, including 
sections 881(b) and 957(c) and Subpart D, Part III, Subchapter N, 
Chapter 1 of the Internal Revenue Code. Paragraph (c) of this section 
does not apply, however, for purposes of section 881(b). In the case of 
a possession or territory that administers income tax laws that are 
identical (except for the substitution of the name of the possession or 
territory for the term United States where appropriate) to those in 
force in the United States, these rules do not apply for purposes of 
the application of such laws.
    (b) In general. Except as provided in paragraphs (c) and (d) of 
this section, the principles of section 864(c) and the regulations 
thereunder (relating to the determination of income, gain or loss which 
is effectively connected with the conduct of a trade or business within 
the United States) shall generally be applied in determining whether 
income is effectively connected with the conduct of a trade or business 
within the relevant possession (except for the substitution of the name 
of the relevant possession for the term United States where 
appropriate), without regard to whether the taxpayer qualifies as a 
nonresident alien individual or a foreign corporation with respect to 
such possession. For purposes of the preceding sentence, all income 
other than income from sources within the relevant possession (as 
determined under the rules of 1.937-2T) shall be considered income from 
sources

[[Page 18945]]

without the relevant possession, and subject to the rules of this 
section, the principles of section 864(c)(4) shall apply for purposes 
of determining whether such income constitutes income effectively 
connected with the conduct of a trade or business in the relevant 
possession.
    (c) U.S. income--(1) In general. Except as provided in paragraph 
(d) of this section, income considered to be effectively connected with 
the conduct of a trade or business within the relevant possession shall 
not include any item of income determined under the rules of sections 
861 through 865 and the regulations thereunder to be--
    (i) From sources within the United States; or
    (ii) Effectively connected with the conduct of a trade or business 
within the United States.
    (2) Conduit arrangements. Income shall be considered to be from 
sources within the United States for purposes of paragraph (c)(1) of 
this section if, pursuant to a plan or arrangement--
    (i) The income is received in exchange for consideration provided 
to another person; and
    (ii) Such person (or another person) provides the same 
consideration (or consideration of a like kind) to a third person in 
exchange for one or more payments constituting income from sources 
within the United States.
    (d) Income from certain sales of inventory property. Paragraph (c) 
of this section shall not apply to income from sales of inventory 
property described in Sec.  1.863-3(f).
    (e) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X is a bona fide resident of Possession I, a section 
931 possession (as defined in Sec.  1.931-1T(c)(1)). X has an office 
in Possession I from which X conducts a business consisting of the 
development and sale of specialized computer software. A purchaser 
of software will frequently pay X an additional amount to install 
the software on the purchaser's operating system and to ensure that 
the software is functioning properly. X performs the installation 
services at the purchaser's place of business which may be in 
Possession I, in the United States, or in another country. The 
provision of such services is not de minimis and constitutes a 
separate transaction under the rules of Sec.  1.861-18. Under the 
principles of section 864(c)(4) as applied pursuant to paragraph (b) 
of this section, the compensation that X receives for personal 
services performed outside of Possession I is not considered to be 
effectively connected with the conduct of a trade or business in 
Possession I for purposes of section 931(a)(2).

    Example 2. (i) F Bank is organized under the laws of Country FC 
and operates an active banking business from offices in the U.S. 
Virgin Islands (USVI). In connection with this banking business, F 
Bank makes loans to and receives interest payments from borrowers 
who reside in the USVI, in the United States, and in Country FC.
    (ii) Under the principles of section 861(a)(1) as applied 
pursuant to Sec.  1.937-2T(b), interest payments received by F Bank 
from borrowers who reside in the United States or in Country FC 
constitute income from sources outside of the USVI. Under the 
principles of section 864(c)(4) as applied pursuant to paragraph (b) 
of this section, interest income from sources outside of the USVI 
generally may constitute income that is effectively connected with 
the conduct of a trade or business within the USVI for purposes of 
the Internal Revenue Code. However, interest payments received by F 
Bank from borrowers who reside in the United States constitute 
income from sources within the United States under section 
861(a)(1). Accordingly, under paragraph (c)(1) of this section, such 
interest income shall not be treated as effectively connected with 
the conduct of a trade or business in the USVI for purposes of the 
Internal Revenue Code (for example, for purposes of section 934(b)). 
Interest payments received by F Bank from borrowers who reside in 
Country FC, however, may be treated as effectively connected with 
the conduct of a trade or business in the USVI for purposes of the 
Internal Revenue Code (including section 934(b)).
    (iii) To the extent that, as described in section 934(a), the 
USVI administers income tax laws that are identical (except for the 
substitution of the name of the USVI for the term United States 
where appropriate) to those in force in the United States, interest 
payments received by F Bank from borrowers who reside in the United 
States or in Country FC may be treated as income that is effectively 
connected with the conduct of a trade or business in the USVI for 
purposes of F Bank's income tax liability to the USVI under mirrored 
section 882.

    Example 3. (i) G is a partnership that is organized under the 
laws of, and that operates an active financing business from offices 
in, Possession I. Interests in G are owned by D, a bona fide 
resident of Possession I, and N, an alien individual who resides in 
Country FC. Pursuant to a pre-arrangement, G loans $x to T, a 
business entity organized under the laws of Country FC, and T in 
turn loans $y to E, a U.S. resident. In accordance with the 
arrangement, E pays interest to T, which in turn pays interest to G.
    (ii) The arrangement constitutes a conduit arrangement under 
paragraph (c)(2) of this section, and the interest payments received 
by G are treated as income from sources within the United States for 
purposes of paragraph (c)(1) of this section. Accordingly, the 
interest received by G shall not be treated as effectively connected 
with the conduct of a trade or business in Possession I for purposes 
of the Internal Revenue Code (including sections 931(a)(2) and 
934(b), if applicable with respect to D). Whether such interest 
constitutes income from sources within the United States for other 
purposes of the Internal Revenue Code under generally applicable 
conduit principles will depend on the facts and circumstances. See, 
for example, Aiken Indus., Inc. v. Commissioner, 56 T.C. 925 (1971).
    (iii) If Possession I administers income tax laws that are 
identical (except for the substitution of the name of the possession 
for the term ``United States'' where appropriate) to those in force 
in the United States, the interest received by G may be treated as 
income effectively connected with the conduct of a trade or business 
in Possession I under mirrored section 864(c)(4) for purposes of 
determining the Possession I territorial income tax liability of N 
under mirrored section 871.

    (f) Effective date. Except as otherwise provided in this paragraph 
(f), this section applies to income earned in taxable years ending 
after October 22, 2004. Paragraph (c)(1) of this section applies to 
income earned after December 31, 2004. Paragraph (c)(2) of this section 
applies to amounts paid or accrued after April 11, 2005.

0
Par. 32. Section 1.957-3 is revised to read as follows:


Sec.  1.957-3  United States person defined.

    [Reserved]. For further guidance, see Sec.  1.957-3T.

0
Par. 33. Section 1.957-3T is added to read as follows:


Sec.  1.957-3T  United States person defined (temporary).

    (a) Basic rule--(1) In general. The term United States person has 
the same meaning for purposes of sections 951 through 965 which it has 
under section 7701(a)(30) and the regulations thereunder, except as 
provided in paragraphs (b) and (c) of this section which provide, with 
respect to corporations organized in possessions of the United States, 
that certain residents of such possessions are not United States 
persons. The effect of determining that an individual is not a United 
States person for such purposes is to exclude such individual in 
determining whether a foreign corporation created or organized in, or 
under the laws of, a possession of the United States is a controlled 
foreign corporation. See Sec.  1.957-1 for the definition of the term 
controlled foreign corporation.
    (2) Special provisions applicable to possessions of the United 
States. For purposes of this section--
    (i) The term possession of the United States means the Commonwealth 
of Puerto Rico (Puerto Rico) or any section 931 possession.
    (ii) The term section 931 possession has the same meaning which it 
has under Sec.  1.931-1T(c)(1).
    (iii) The rules of Sec.  1.937-1T shall apply for determining 
whether an

[[Page 18946]]

individual is a bona fide resident of a possession of the United 
States.
    (iv) The rules of Sec.  1.937-2T shall apply for determining 
whether income is from sources within a possession of the United 
States.
    (v) The rules of Sec.  1.937-3T shall apply for determining whether 
income is effectively connected with the conduct of a trade or business 
in a possession of the United States.
    (b) Puerto Rico corporation and resident. An individual (who, 
without regard to this paragraph (b), is a United States person) shall 
not be considered a United States person with respect to a foreign 
corporation created or organized in, or under the laws of, Puerto Rico 
for the taxable year of such corporation which ends with or within the 
taxable year of such individual if--
    (1) Such individual is a bona fide resident of Puerto Rico during 
his entire taxable year in which or with which the taxable year of such 
foreign corporation ends; and
    (2) A dividend received by such individual from such corporation 
during the taxable year of such corporation would, for purposes of 
section 933(1), be treated as income derived from sources within Puerto 
Rico.
    (c) Section 931 possession corporation and resident. An individual 
(who, without regard to this paragraph (c), is a United States person) 
shall not be considered a United States person with respect to a 
foreign corporation created or organized in, or under the laws of, a 
section 931 possession for the taxable year of such corporation which 
ends with or within the taxable year of such individual if--
    (1) Such individual is a bona fide resident of such section 931 
possession during his entire taxable year in which or with which the 
taxable year of such foreign corporation ends; and
    (2) Such corporation satisfies the following conditions--
    (i) 80 percent or more of its gross income for the 3-year period 
ending at the close of the taxable year (or for such part of such 
period as such corporation or any predecessor has been in existence) 
was derived from sources within section 931 possessions or was 
effectively connected with the conduct of a trade or business in 
section 931 possessions; and
    (ii) 50 percent or more of its gross income for such period (or 
part) was derived from the active conduct of a trade or business within 
section 931 possessions.
    (d) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.


Sec.  1.957-4  [Removed]

0
Par. 34. Section 1.957-4 is removed.

0
Par. 35. In Sec.  1.1402(a)-11, paragraph (b) is revised to read as 
follows:


Sec.  1.1402(a)-11  Ministers and members of religious orders.

* * * * *
    (b) In employ of American employer. If a minister or member of a 
religious order engaged in a trade or business described in section 
1402(c) and Sec.  1.1402(c)-5 is a citizen of the United States and 
performs service, in his capacity as a minister or member of a 
religious order, as an employee of an American employer, as defined in 
section 3121(h) and the regulations thereunder in part 31 of this 
chapter (Employment Tax Regulations), his net earnings from self-
employment derived from such service shall be computed as provided in 
paragraph (a) of this section but without regard to the exclusions from 
gross income provided in section 911, relating to earned income from 
sources without the United States, and section 931, relating to income 
from sources within certain possessions of the United States. Thus, 
even though all the income of the minister or member for service of the 
character to which this paragraph is applicable was derived from 
sources without the United States, or from sources within certain 
possessions of the United States, and therefore may be excluded from 
gross income, such income is included in computing net earnings from 
self-employment.
* * * * *

0
Par. 36. Section 1.1402(a)-12 is revised to read as follows:


Sec.  1.1402(a)-12  Continental shelf and certain possessions of the 
United States.

    [Reserved]. For further guidance, see Sec.  1.1402(a)-12T.

0
Par. 37. Section 1.1402(a)-12T is added to read as follows:


Sec.  1.1402(a)-12T  Continental shelf and certain possessions of the 
United States (temporary).

    (a) Certain possessions. For purposes of the tax on self-employment 
income, the exclusion from gross income provided by section 931 
(relating to bona fide residents of certain possessions of the United 
States) shall not apply. Net earnings from self-employment are subject 
to the tax on self-employment income even if such amounts are excluded 
from gross income under section 931.
    (b) Continental shelf. For the definition of the term United States 
and for other geographical definitions relating to the continental 
shelf, see section 638 and Sec.  1.638-1.
    (c) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 38. In Sec.  1.6038-2, paragraph (d) is revised to read as 
follows:


Sec.  1.6038-2  Information returns required of United States persons 
with respect to annual accounting periods of certain foreign 
corporations.

* * * * *
    (d) [Reserved]. For further guidance, see Sec.  1.6038-2T(d).

0
Par. 39. Section 1.6038-2T is added to read as follows:


Sec.  1.6038-2T.  Information returns required of United States persons 
with respect to annual accounting periods of certain foreign 
corporations (temporary).

    (a) through (c) [Reserved]. For further guidance, see Sec.  1.6038-
2(a) through (c).
    (d) U.S. person--(1) In general. For purposes of section 6038 and 
this section, the term United States person has the meaning assigned to 
it by section 7701(a)(30), except as provided in paragraphs (d)(2) and 
(3) of this section.
    (2) Special rule for individuals residing in certain possessions. 
With respect to individuals who are bona fide residents of Puerto Rico 
or any section 931 possession, as defined in Sec.  1.931-1T(c)(1), the 
term United States person has the meaning assigned to it by Sec.  
1.957-3T.
    (3) Special rule for certain nonresident aliens. An individual for 
whom an election under section 6013(g) or (h) is in effect shall, 
subject to the exceptions contained in paragraph (d)(2) of this 
section, be considered a United States person for purposes of section 
6038 and this section.
    (e) through (l)(2) [Reserved]. For further guidance, see Sec.  
1.6038-2(e) through (l)(2).
    (m) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 40. Section 1.6046-1 is amended as follows:
0
1. Revise the heading.
0
2. Revise paragraph (f)(3).
0
3. Remove the undesignated paragraph that follows paragraph 
(f)(3)(iii).
    The revisions are as follows:


Sec.  1.6046-1  Returns as to organization or reorganization of foreign 
corporations and as to acquisitions of their stock.

* * * * *
    (f)(3) [Reserved]. For further guidance, see Sec.  1.6046-1T(f)(3).
* * * * *

0
Par. 41. Section 1.6046-1T is added to read as follows:

[[Page 18947]]

Sec.  1.6046-1T  Returns as to organization or reorganization of 
foreign corporations and as to acquisitions of their stock (temporary).

    (a) through (f)(2) [Reserved]. For further guidance, see Sec.  
1.6046-1(a) through (f)(2).
    (f)(3) U.S. person--(i) In general. For purposes of section 6046 
and this section, the term United States person has the meaning 
assigned to it by section 7701(a)(30), except as provided in paragraphs 
(f)(3)(ii) and (iii) of this section.
    (ii) Special rule for individuals residing in certain possessions. 
With respect to individuals who are bona fide residents of Puerto Rico 
or any section 931 possession, as defined in Sec.  1.931-1T(c)(1), the 
term United States person has the meaning assigned to it by Sec.  
1.957-3T.
    (iii) Special rule for certain nonresident aliens. An individual 
for whom an election under section 6013(g) or (h) is in effect shall, 
subject to the exceptions contained in paragraph (f)(3)(ii) of this 
section, be considered a United States person for purposes of section 
6046 and this section.
    (f)(4) through (k) [Reserved]. For further guidance, see Sec.  
1.6046-1(f)(4) through (k).
    (l) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 42. The authority citation for part 301 continues to read, in 
part, as follows:

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


0
Par. 43. Section 301.6688-1 is revised to read as follows:


Sec.  301.6688-1  Assessable penalties with respect to information 
required to be furnished with respect to possessions.

    [Reserved]. For further guidance, see Sec.  301.6688-1T.

0
Par. 44. Section 301.6688-1T is added to read as follows:


Sec.  301.6688-1T  Assessable penalties with respect to information 
required to be furnished with respect to possessions (temporary).

    (a) In general. Each individual who is subject to an information 
reporting requirement promulgated under the authority of section 937(c) 
or 7654 and who fails to fully satisfy such requirement within the time 
prescribed for reporting such information shall, in addition to any 
criminal penalty provided by law, pay a penalty of $1000 for each such 
failure. Information reporting requirements promulgated under the 
authority of sections 937(c) and 7654(e) include the following:
    (1) The requirement to file Form 8689, ``Allocation of Individual 
Income Tax to the Virgin Islands,'' under Sec.  1.932-1T(b)(1) of this 
chapter, for certain individuals with income from sources within the 
United States Virgin Islands.
    (2) [Reserved].
    (3) [Reserved].
    (4) The requirement for individuals to report that they became or 
ceased to be a bona fide resident of a possession under Sec.  1.937-
1T(g) of this chapter.
    (b) Manner of payment. The penalty set forth in paragraph (a) of 
this section shall be paid in the same manner as tax upon the issuance 
of a notice and demand therefor.
    (c) Reasonable cause--(1) In general. The penalty set forth in 
paragraph (a) of this section shall not apply if it is established to 
the satisfaction of the appropriate tax authority (as defined in 
paragraph (c)(2) of this section) that the failure to file the 
information return or furnish the information within the prescribed 
time was due to reasonable cause and not to willful neglect. An 
individual who wishes to avoid the penalty must make an affirmative 
showing of all facts alleged as a reasonable cause for failure to file 
the information return on time, or furnish the information on time, in 
the form of a written statement containing a declaration that it is 
made under penalties of perjury. Such statement must be filed with the 
appropriate tax authority. In determining whether there was reasonable 
cause for failure to furnish the required information, account will be 
taken of the fact that the individual was unable to furnish the 
required information in spite of the exercise of ordinary business care 
and prudence in his effort to furnish the information. An individual 
will be considered to have exercised ordinary business care and 
prudence in his effort to furnish the required information if he made 
reasonable efforts to furnish the information but was unable to do so 
because of a lack of sufficient facts on which to make a proper 
determination.
    (2) Appropriate tax authority. For purposes of this section, the 
appropriate tax authority is the person responsible for tax 
administration in the jurisdiction to which the information is required 
to be provided. Thus, in the case of information required under section 
937(c) or under section 7654 to be provided to the Internal Revenue 
Service, the appropriate tax authority is the Commissioner. In the case 
of information required under section 7654 (as in effect with respect 
to section 935 possessions (as defined in Sec.  1.935-1T(a)(3)(i) of 
this chapter) to be provided to the tax authorities of a section 935 
possession, the appropriate tax authority is the person responsible for 
tax administration in such possession or his delegate. See Sec.  1.935-
1(b) of this chapter for the rules that specify where returns of income 
tax must be filed for the taxable year by individuals to whom section 
935 applies.
    (d) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 45. In Sec.  301.7701(b)-1, paragraph (d) is revised to read as 
follows:


Sec.  301.7701(b)-1  Resident alien.

* * * * *
    (d) [Reserved]. For further guidance, see Sec.  301.7701(b)-1T(d).
* * * * *

0
Par. 46. Section 301.7701(b)-1T is added to read as follows:


Sec.  301.7701(b)-1T  Resident alien.

    (a) through (c) [Reserved]. For further guidance, see Sec.  
301.7701(b)-1(a) through (c).
    (d) Application of section 7701(b) to the possessions and 
territories--(1) Application to aliens for purposes of mirror systems. 
Section 7701(b) provides the basis for determining whether an alien 
individual is a resident of a United States possession or territory 
that administers income tax laws that are identical (except for the 
substitution of the name of the possession or territory for the term 
United States where appropriate) to those in force in the United 
States, for purposes of applying such laws with respect to income tax 
liability incurred to such possession or territory.
    (2) Non-application for bona fide resident determination. Section 
7701(b) does not provide the basis for determining whether an 
individual (including an alien individual) is a bona fide resident of a 
United States possession or territory for U.S. Federal income tax 
purposes. For the applicable rules for making this determination, see 
section 937(a) and the regulations thereunder.
    (e) [Reserved]. For further guidance, see Sec.  301.7701(b)-1(e).
    (f) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 47. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


[[Page 18948]]



0
Par. 48. In Sec.  602.101, paragraph (b) is amended by adding an entry 
in numerical order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                                * * * * *
1.937-1T...................................................    1545-1930
 
                                * * * * *
------------------------------------------------------------------------


Linda M. Kroening,
Acting Deputy Commissioner for Services and Enforcement.

    Approved: March 25, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-7087 Filed 4-6-05; 11:05 am]
BILLING CODE 4830-01-P