[Federal Register Volume 73, Number 69 (Wednesday, April 9, 2008)]
[Rules and Regulations]
[Pages 19350-19377]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 08-1105]



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Part IV





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 301



Source Rules Involving U.S. Possessions and Other Conforming Changes; 
Final Rule

  Federal Register / Vol. 73, No. 69 / Wednesday, April 9, 2008 / Rules 
and Regulations  

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[TD 9391]
RIN 1545-BF85


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations that provide rules 
under section 937(b) of the Internal Revenue Code (Code) for 
determining whether income is derived from sources within a U.S. 
possession or territory specified in section 937(a)(1) (generally 
referred to in this preamble as a ``territory'') and whether income is 
effectively connected with the conduct of a trade or business within a 
territory. The final regulations also provide 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, Public Law 99-
514 (100 Stat. 2085) (the 1986 Act) and the American Jobs Creation Act 
of 2004, Public Law 108-357 (118 Stat. 1418) (the 2004 Act). Conforming 
changes are also made to regulations under sections 1, 170A, 861, 871, 
901, 1402, 6038, 6046, and 7701 of the Code.

DATES: Effective Date: These regulations are effective on April 9, 
2008.
    Applicability Date: For dates of applicability, see Sec. Sec.  1.1-
1(d), 1.170A-1(k), 1.861-3(d), 1.861-8(h), 1.871-1(d), 1.876-1(f), 
1.881-1(f), 1.881-5(i), 1.884-0(b), 1.901-1(j), 1.931-1(d), 1.932-1(j), 
1.933-1(e), 1.934-1(e), 1.935-1(g), 1.937-2(l), 1.937-3(f), 1.957-3(d), 
1.1402(a)-12(c), 1.6038-2(m), 1.6046-1(l), 301.6688-1(d), 301.7701(b)-
9(b)(5).

FOR FURTHER INFORMATION CONTACT:  J. David Varley (202) 435-5262 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On April 11, 2005, the Treasury Department and the IRS published in 
the Federal Register temporary regulations (TD 9194, 70 FR 18920, as 
corrected at 70 FR 32589-01), which provided rules to implement section 
937 and to conform existing regulations to other legislative changes 
with respect to the territories. A notice of proposed rulemaking (REG-
159243-03, 70 FR 18949) cross-referencing the temporary regulations was 
published in the Federal Register on the same day. Written comments 
were received in response to the notice of proposed rulemaking and a 
public hearing on the proposed regulations was held on July 21, 2005.
    After consideration of the comments, the Treasury Department and 
the IRS on January 31, 2006, published in the Federal Register final 
regulations (TD 9248, 71 FR 4996, as corrected at 71 FR 14099) under 
section 937(a) concerning the determination of bona fide residency in 
the territories. Following further comments and consideration, the 
Treasury Department and the IRS on November 14, 2006, published in the 
Federal Register final regulations (TD 9297, 71 FR 66232, as corrected 
at 71 FR 75882) under section 937(a) providing additional rules for 
determining bona fide residency in the territories.
    The proposed regulations relating to source and effectively 
connected income with respect to the territories (specifically, 
Sec. Sec.  1.937-2 and 1.937-3) as well as the other rules concerning 
the territories are adopted as amended by this Treasury decision, and 
the corresponding temporary regulations are removed.

Explanation of Provisions and Summary of Comments

    The final regulations under Code section 937(b) provide rules for 
determining whether income is from sources within a territory and 
whether income is effectively connected with the conduct of a trade or 
business within a territory (territory ECI). Section 937(b)(1) provides 
that, except as provided in regulations, rules similar to the rules for 
determining whether income is from sources within the United States or 
is effectively connected with the conduct of a trade or business within 
the United States will apply for purposes of determining whether income 
is from sources within a specified territory or effectively connected 
with the conduct of a trade or business in any such territory. Section 
937(b)(2) provides that, except as provided in regulations, any U.S. 
source income or U.S. effectively connected income will not be treated 
as territory source income or as territory ECI.
    The U.S. tax consequences of classifying income as being from 
sources within a territory or as being territory ECI vary from 
territory to territory. The final regulations under Code sections 931 
through 935 contain rules implementing the operative substantive and 
procedural provisions of U.S. income tax law specifically applicable to 
each territory, including the rules regarding the filing requirements 
and the determination of the income tax liability of bona fide 
residents and other persons with territory source income. In addition 
to the rules under Code sections 937(b) and 931 through 935, the final 
regulations provide conforming changes to rules under related 
provisions of the Code.
    The Treasury Department and the IRS recognize that the interaction 
of section 937 and other sections of the Code relating to the 
territories requires a balance between implementing the policies 
Congress intended in section 937(b) while recognizing the territories' 
efforts to retain and attract workers and businesses. As discussed in 
more detail in this preamble, the final regulations seek to achieve 
this balance. For example, the final regulations allow an individual to 
elect, under the special gain rule that applies to property owned by an 
individual before the individual became a bona fide resident of the 
territory, to treat as territory source the portion of the gain that 
accrued while the individual was a bona fide resident of the territory. 
The Treasury Department and the IRS will continue to consider comments 
received and anticipate that additional changes to the final 
regulations may be made.

I. Territory Source Income and Territory ECI

A. Territory Source Income

    Section 937(b)(1) expressly grants the Treasury Department and the 
IRS the regulatory authority to provide exceptions to the general 
territory source rule, which otherwise applies sourcing principles 
similar to those of the U.S. source rules. The legislative history to 
section 937 indicates that Congress intended that the Treasury 
Department and the IRS use this authority to provide exceptions to the 
general rules regarding territory source income and territory ECI as 
appropriate. H.R. Conf. Rep. 108-755, at 795 (2004). The legislative 
history indicates that Congress anticipated that the regulatory 
authority would be used to continue the existing treatment of income 
from the sale of goods manufactured in a territory and to prevent 
abuse, such as acquiring residence in a territory just prior to the 
disposition of appreciated property in order to avoid U.S. tax on such 
disposition. Id.
    Under the temporary and proposed regulations, except as otherwise 
specifically provided, the principles of sections 861 through 865 and 
the regulations under those provisions

[[Page 19351]]

generally apply for purposes of determining the gross and taxable 
income from sources within and without a territory. The temporary and 
proposed regulations further state that in the application of such 
principles, the name of the relevant territory will be used instead of 
the term ``United States''; the term ``bona fide resident of'' followed 
by the name of the relevant territory will be used instead of the term 
``United States resident''; and the term ``domestic'' will be construed 
to mean created or organized in the relevant territory.
    The temporary and proposed regulations also provide exceptions to 
the general rule for determining whether income is from sources within 
a territory. In accordance with the legislative history to the 2004 
Act, the temporary and proposed regulations preserve the manufacturing-
sales income rules in Sec.  1.863-3(f). In addition, the temporary and 
proposed regulations provide special rules preventing dividends and 
interest paid by certain closely held territory corporations from being 
territory source income. Similarly, the temporary and proposed 
regulations provide that gains from dispositions of appreciated 
property owned by an individual prior to becoming a resident is not 
territory source income under a special 10-year look-back rule, and 
there are special rules regarding compensation for military service. As 
discussed in more detail in part I.C., the temporary and proposed 
regulations also reflect section 937(b)(2), which is the statutory 
exception to the general territory source rule.
1. General Territory Source Rule
    In response to the temporary and proposed regulations, commentators 
requested further guidance regarding the application of the general 
rule for determining whether income is from sources within a territory. 
In particular, commentators questioned whether, in applying the 
principles of section 861 through 865, the only permissible 
modifications to the U.S. source rules were the substitutions described 
in Sec.  1.937-2T(b).
    The Treasury Department and the IRS agree that the general rule for 
determining whether income is from sources within a territory should be 
modified to provide greater flexibility in applying the principles of 
sections 861 through 865 as well as to prevent abuse. Consequently, the 
final regulations provide that it generally will be sufficient to make 
certain specified substitutions described in Sec.  1.937-2(b) when 
determining whether income is from within or without a territory. 
However, the final regulations provide that additional substitutions 
may be necessary to accomplish the intent of section 937(b).
    The final regulations also provide a necessary limitation and rule 
of application to reflect the Congressional intent in enacting the 
rules of section 937(b)(1). Under this limiting rule, in no event will 
a bona fide resident of a territory or other person have, as a result 
of the application of the principles of the U.S. source rules, more 
income from sources within the relevant territory than the amount of 
income from sources within the United States that a similarly situated 
U.S. person who is not a bona fide resident of a territory would have 
under the U.S. source rules.
    Conforming amendments are made to the territory ECI rules to 
reflect these amendments to the territory source rules. See part I.B. 
Taxpayers may choose to apply the amendments to the territory source 
and ECI rules retroactively to open taxable years ending after October 
22, 2004.
2. Space and Ocean Income and International Communications Income
    Section 863(d) provides that income derived from space or ocean 
activity is sourced within the United States if it is derived by a U.S. 
person and is sourced without the United States if derived by a foreign 
person. Section 863(e) generally provides that income derived from 
international telecommunications activity by a U.S. person is treated 
as one-half from sources within the United States and one-half from 
sources without the United States. Commentators specifically requested 
greater clarity regarding how the principles of sections 863(d) and (e) 
were to be applied to determine whether income from space and ocean 
activity and international communications is from sources within a 
territory.
    The Treasury Department and IRS agree that the kinds of further 
modifications to the general rule that are discussed in part I.A.1 
would be specifically warranted with respect to applying the principles 
of the space and ocean and international communications source rules in 
the territories. Consequently, the final regulations provide that in 
applying the principles of section 863(d) and (e) to determine whether 
a bona fide resident's income is within or without a territory, the 
term ``bona fide resident of a possession'' will be used instead of the 
term ``United States person.''
3. Transportation Income
    Under section 863(c)(1), transportation income is treated as U.S. 
source if it is attributable to transportation beginning and ending in 
the United States. However, section 863(c)(2) provides that if the 
transportation begins or ends in the United States but is not described 
in section 863(c)(1), then one-half of the income is U.S. source (the 
50-50 source rule). Section 863(c)(2) provides an exception to the 50-
50 source rule in the case of transportation income derived from 
personal services of a taxpayer, unless such income is attributable to 
transportation that begins (or ends) in the United States and ends (or 
begins) in a territory. In the case of transportation income derived in 
connection with a vessel, the rules of section 863(c)(2) apply only in 
the case of taxpayers who are citizens or resident aliens.
    Commentators argued that the rules of section 863(c)(2) should not 
apply to transportation income derived from personal services of bona 
fide residents of the U.S. Virgin Islands. These commentators argued 
that the application of these rules to a bona fide resident of the U.S. 
Virgin Islands is contrary to Congressional intent in enacting section 
934(b), as interpreted by the commentators. Accordingly, they 
maintained, the Treasury Department and the IRS should exercise their 
regulatory authority under section 937(b)(1) to provide that 
transportation income that is derived from personal services of a bona 
fide resident of the U.S. Virgin Islands and that otherwise would be 
sourced under the 50-50 source rule principles of section 863(c)(2), 
should be sourced entirely within the U.S. Virgin Islands, regardless 
of the beginning or endpoint of the transportation to which the income 
is attributable.
    The Treasury Department and the IRS believe that their regulatory 
authority under section 937(b)(1) does not extend to deviating from the 
source rules of section 863(c)(2). Congress clearly contemplated 
territorial tax issues when enacting section 863(c) as it provided 
special source rules in the case of transportation income derived from 
transportation between the United States and the territories. See H.R. 
Conf. Rep. 98-861, at 1622 (1984). Congress intended that these rules 
also would apply for purposes of determining the source of income in 
territories that mirror the U.S. income tax. Id. When section 863(c)(2) 
was amended by the 1986 Act, the same legislation that enacted sections 
932 and 934(b)

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applicable to the U.S. Virgin Islands, Congress preserved the special 
50-50 source rule applicable to transportation between the United 
States and a territory and specifically applied the rule to such income 
that is derived from personal services. See H.R. Conf. Rep. 99-841, at 
II-599 (1986).
    Furthermore, the commentators premised their argument for changing 
the source of transportation income on section 934, which only applies 
to the U.S. Virgin Islands. In the 2004 Act, Congress sought to 
rationalize the source of income rules applicable to the territories. 
See H.R. Conf. Rep. 108-755, at 794 (2004). Thus, the rules set forth 
in section 937 for determining bona fide residency and source of income 
are intended to apply uniformly to the territories rather than to 
provide tailored exceptions applicable to only certain territories such 
as the U.S. Virgin Islands.
    Consequently, Sec.  1.937-2 does not incorporate special rules with 
respect to transportation income between the United States and the U.S. 
Virgin Islands.
4. De Minimis Rule
    Section 861(a)(3) generally provides that compensation for labor or 
personal services performed in the United States is U.S. source income. 
Under the principles of section 861(a)(3), income from services 
performed in a territory is treated as territory source income. 
However, while section 861(a)(3) provides a de minimis exception to 
this general rule for services performed by nonresident aliens in the 
United States for minimal compensation over a short period of time, the 
temporary and proposed regulations specifically provide that the de 
minimis exception does not apply for determining whether income from 
services is from sources within a territory. Consequently, a U.S. 
citizen or resident alien who is not a bona fide resident of the U.S. 
Virgin Islands, for example, may have to file an income tax return with 
and pay tax to the U.S. Virgin Islands under section 932(a) even if the 
individual is engaged in only de minimis personal services in the 
territory. In this regard, the temporary and proposed regulations carry 
over the pre-existing rules in former Sec.  1.863-6 for determining 
income within and without a territory. See Sec.  1.863-6 (2004).
    Several commentators requested a de minimis exception to the 
general rules for the sourcing of income from personal services in a 
territory. The Treasury Department and the IRS agree that such a rule 
reduces taxpayer burden and promotes efficient tax administration. 
Accordingly, the final regulations eliminate the rule in the temporary 
and proposed regulations that specifically provides that in applying 
the principles of section 861(a)(3), the de minimis exception does not 
apply. An example in the final regulations illustrates that a U.S. 
citizen or resident who is not a bona fide resident of a territory but 
who performs services in a territory temporarily for no more than 90 
days during the taxable year and for no more than $3000 (in the 
aggregate) generally will not have income from sources within the 
territory.
5. Gains From Certain Dispositions of Personal Property
    The temporary and proposed regulations provide a special rule for 
gains from dispositions of certain property held by a U.S. person prior 
to becoming a resident of a territory. See Sec.  1.937-2T(f)(1). Under 
this rule, gains from dispositions of such property within 10 years 
after becoming a territory resident generally are treated as income 
from sources outside of the territory. The special gain rule 
supplements, and does not supersede, the similar special gain rule of 
section 1277(e) of the 1986 Act, which applies to individuals who 
become residents of American Samoa, Guam, or the Northern Mariana 
Islands (NMI) (collectively, the Pacific territories).
    Commentators noted that the special gain rule characterizes all 
gain from property of former U.S. residents as non-territory source 
income, including any gain attributable to appreciation that occurs 
while the individual is a bona fide resident of the relevant territory. 
For example, if a U.S. citizen and lifelong resident of a territory who 
owns stock in a corporation moves to the United States for a few years 
and then re-establishes bona fide residence in the territory and sells 
the stock within 10 years, most of the appreciation in the stock may be 
attributable to the period in which the individual was a bona fide 
resident of the territory. However, under the special gain rule, 
because of the period of U.S. residence, none of the gain would qualify 
as territory source income.
    The Treasury Department and the IRS agree that the special gain 
rule should be modified to target more precisely gain attributable to 
appreciation occurring during the time that an individual was not a 
bona fide resident of the relevant territory. Accordingly, the final 
regulations provide that an individual may elect to split the source of 
gains from the sale or other disposition of appreciated property 
subject to the special gain rule by using a mark-to-market allocation 
in the case of marketable securities and a time-based allocation rule 
in the case of other personal property. This election will more 
accurately target the abuse that the special gain rule was intended to 
address. The election also operates to modify the special gain rule of 
the 1986 Act, as authorized therein. Individuals may retroactively 
apply the election to dispositions made after April 11, 2005.

B. Territory ECI

    Section 937(b)(1) provides that rules similar to those for 
determining whether income is effectively connected with the conduct of 
a trade or business within the United States should also apply in 
determining whether income is territory ECI, except as provided in 
regulations. Accordingly, the temporary and proposed regulations 
generally provide that the principles of section 864(c)(4) apply for 
purposes of determining whether any income from sources without a 
territory (U.S. source or other non-territory source income) is treated 
as territory ECI.
    Section 864(c)(4) limits the types of income from foreign sources 
that can be effectively connected income to certain rents or royalties; 
dividends or interest connected with the conduct of a banking or 
financial business; gain from the sale or exchange of inventory; and 
insurance company income. Personal services income that is foreign 
source cannot be effectively connected income under section 864(c)(4).
    Commentators requested that, instead of applying the principles of 
section 864(c)(4), the final regulations adopt the principles of 
section 864(c)(2) and (c)(5) for purposes of determining whether income 
from sources without a territory is territory ECI. This would expand 
the types of non-territory source income that could be treated as 
territory ECI and particularly would include income from personal 
services. For territories such as the U.S. Virgin Islands this would 
mean that additional types of non-territory source income may be 
eligible for reductions of territorial income tax because section 
934(b) allows the U.S. Virgin Islands to reduce its territorial income 
tax on income that is effectively connected with the conduct of a trade 
or business in the U.S. Virgin Islands. These commentators believe that 
Congress intended for section 934 (and similar provisions applicable to 
other territories) to promote economic activity in the territories and 
that the section 937 regulations should better reflect the policy 
choices that these commentators believe were made in section 934(b).

[[Page 19353]]

    Congress provided in section 937(b)(1) that rules similar to those 
for determining whether income is effectively connected with the 
conduct of a trade or business within the United States should also 
apply in determining whether income is territory ECI, except as 
provided in regulations. The legislative history to section 937 
indicates that Congress was concerned about U.S. citizens and residents 
claiming to be exempt from U.S. tax on their worldwide income and 
claiming reductions from territorial income tax when they did not live 
and work in the territories. H.R. Conf. Rep. 108-755, at 793-94. 
Adopting the principles of section 864(c)(2) and (c)(5) to determine 
whether income is territory ECI would allow personal services income 
derived from sources outside a territory (for example, U.S. source 
income) to be treated as territory ECI, contrary to Congressional 
intent. The Treasury Department and the IRS do not believe their 
regulatory authority extends to prescribing the use of the principles 
of section 864(c)(2) and (c)(5) for purposes of determining whether 
income for sources without a territory is territory ECI.
    Furthermore, section 934 does not provide a basis for interpreting 
the regulatory authority under section 937(b) in such a liberal manner. 
In enacting section 937, Congress amended the rules related to the 
territories notwithstanding section 934. Moreover, the legislative 
history to section 934 does not reflect these commentators' view of 
Congressional intent in enacting section 934. Even while recognizing 
the goal of encouraging economic development in the U.S. Virgin Islands 
through appropriate territorial income tax reductions, the legislative 
history of section 934 indicates that the statute was enacted in part 
because of concerns that certain territorial income tax programs, which 
were intended to provide incentives to corporations and residents of 
the U.S. Virgin Islands that made new investments in the U.S. Virgin 
Islands, were having the effect of reducing the tax liability 
attributable to not only income from sources within the territory but 
also income from sources within the United States. S. Rep. No. 1767, 
86th Cong. 2nd Sess. 4 (1960); see also H.R. Rep. No. 99-426, at 485-
486 (1985); and S. Rep. No. 99-313, at 479 (1986). The legislative 
history to section 934 indicates that economic development in the U.S. 
Virgin Islands should not be attained by granting tax reductions to 
taxpayers (other than certain U.S. Virgin Islands corporations) with 
respect to income derived from investments from sources outside of the 
territories. Id.
    Other commentators suggested that U.S. source services income 
should be treated differently from other non-territory source services 
income. Specifically, they suggested that the rules of section 
864(c)(4) should apply to U.S. source personal services income while 
the principles of section 864(c)(2) and (c)(5) should apply to other 
non-territory source personal services income. The Treasury Department 
and the IRS note that the legislative history to section 937 indicates 
that Congress was concerned about U.S. citizens and residents claiming 
reduced rates of territorial income taxation on personal services 
income by individuals that were not living and working in the 
territories. H.R. Conf. Rep. 108-755, at 793-94. Congress also 
expressed concern about possible opportunities for erosion of the U.S. 
tax base associated with the territory ECI rule. Id.
    For these reasons, the Treasury Department and IRS have not adopted 
the commentators' suggestions regarding the determination of whether 
income is effectively connected with the conduct of a trade or business 
in a territory under section 937(b)(1). Accordingly, the general rule 
in the temporary and proposed regulations for determining territory ECI 
is adopted in the final regulations with minor modifications.
    Similar to the modifications made to the general rule for 
determining whether income is from sources within a territory, the 
final regulations amend the general territory ECI rule to provide that 
additional substitutions beyond the routine substitution of the name of 
the relevant territory for the term ``United States'' may be necessary 
in some cases to accomplish the intent of section 937(b)(1). The final 
regulations also adopt a limitation similar to its counterpart in the 
general territory source rule, precluding any application of the 
principles of section 864(c) from resulting in a greater amount of 
territory ECI than the amount of U.S. effectively connected income that 
a similarly situated U.S. person who is not a bona fide resident of a 
territory would have under U.S. rules. Taxpayers may choose to apply 
these rules in Sec.  1.937-3(b) retroactively to open taxable years 
ending after October 22, 2004.

C. U.S. Income Rule

    Section 937(b)(2) provides that notwithstanding the general 
territory source rule, any income from sources within the United States 
or effectively connected with the conduct of a trade or business within 
the United States is not treated as income from sources within a 
territory or as territory ECI (the U.S. income rule). The legislative 
history to section 937(b)(2) indicates that Congress wanted the 
Treasury Department and the IRS to create regulatory exceptions to the 
general rules for determining territory source and territory ECI and to 
the U.S. income rule ``as appropriate.'' H.R. Conf. Rep. 108-755, at 
794. Congress anticipated that these exceptions would be used ``to 
prevent abuse.'' Id. at 795. Congress was ``concerned that the general 
rules for determining whether income is effectively connected with the 
conduct of a trade or business in a [territory] present numerous 
opportunities for erosion of the U.S. tax base.'' Id. at 794.
    The temporary and proposed regulations generally adopt the U.S. 
income rule without exception. However, the temporary and proposed 
regulations tighten the provision by adding an anti-conduit rule to 
prevent the avoidance of the U.S. income rule.
    In response to the temporary and proposed regulations, commentators 
requested that the Treasury Department and the IRS exercise their 
regulatory authority to provide additional exceptions to the U.S. 
income rule.
1. Scope of the U.S. Income Rule
    Numerous commentators argued that the scope of the U.S. income rule 
should be narrowed. The commentators argued that without additional 
regulatory exceptions, the U.S. income rule will hamper efforts to 
promote private sector economic development in the territories because 
it does not permit a territory to provide tax reductions for U.S. 
source business income even if all of the activity generating that 
income occurs in the territory. In addition, these commentators argued 
that Congress intended to encourage the economic development of the 
territories by allowing, for example, the U.S. Virgin Islands to 
provide territory tax incentives under section 934 with respect to 
income effectively connected with the conduct of a trade or business in 
the U.S. Virgin Islands, even where that income is from U.S. sources.
    Commentators proposed various amendments to the general scope of 
the U.S. income rule. For example, one commentator essentially 
suggested that the U.S. income rule should not apply to income that is 
already treated as territory ECI under the general rule of section 
937(b)(1), which applies the principles of section 864(c)(4) to income 
from U.S. sources. Thus, under this suggestion, the U.S. income rule 
would have no application to the determination of whether U.S. source 
income may be treated as territory ECI.

[[Page 19354]]

The commentator further argued that Congress was only concerned about 
U.S. source personal services income being treated as territory ECI and 
that such income is already prevented from being treated as territory 
ECI if the principles of section 864(c)(4) apply under the general 
rule.
    This purportedly limited purpose for enacting section 937(b)(2) is 
difficult to reconcile with the statute's breadth, as a broad 
application to U.S. source income appears to be the most significant 
effect of the U.S. income rule. If adopted, such a rule would render 
the U.S. income rule largely unnecessary. The legislative history to 
section 937 indicates that Congress clearly intended that the U.S. 
income rule would apply to prevent U.S. source income from being 
treated as territory ECI. The legislative history also indicates that 
Congressional concern about the erosion of the U.S. tax base through 
the source and effectively connected income rules was a more general 
concern and not limited to personal services income. Consequently, the 
Treasury Department and the IRS do not believe that their regulatory 
authority under section 937(b)(2) extends to providing such a broad 
exception to the U.S. income rule.
    Other commentators suggested that the U.S. income rule should apply 
only when an item of income is U.S. source or attributable to a U.S. 
permanent establishment, as determined under the U.S. model treaty 
rules, as opposed to income effectively connected with the conduct of a 
U.S. trade or business. In the case of territory source income or 
territory ECI, this suggested change would essentially limit the 
application of the U.S. income rule to income that is attributable to a 
fixed place of business in the United States.
    This suggestion would permit a trade or business to carry on 
significant activities in the United States as long as it does not do 
so through a fixed physical location, such as an office, branch, 
factory, or place of management, or as long as it maintains a facility 
in the U.S. that is used for certain permissible activities such as 
storing, displaying, or delivering goods, purchasing or collecting 
information, or other activities of a preparatory or auxiliary nature, 
such as advertising or supplying information. See U.S. Treasury 
Department, Model Income Tax Treaty art. 5 (2006). A territory business 
could also utilize independent agents to carry on business in the 
United States without triggering the U.S. income rule. Id.
    If the U.S. income rule did not apply, income attributable to these 
activities could be eligible for territory tax incentives, a result 
that potentially could lead to an erosion of the U.S. tax base with 
respect to income that is from U.S. sources or effectively connected 
with the conduct of a U.S. trade or business. In light of the 
Congressional concerns with U.S. base erosion and the consequent lack 
of authority to provide such a broad regulatory exception, the final 
regulations do not adopt a permanent establishment standard as part of 
the U.S. income rule.
    Some commentators similarly suggested that the U.S. income rule 
should apply only when an item of income is both U.S. source and 
attributable to a U.S. office or fixed place of business. Thus, any 
U.S. source income not effectively connected with a trade or business 
in the United States could be treated as territory ECI and therefore 
qualify for tax incentives in certain territories. This suggested 
change also would render the U.S. income rule inapplicable to all 
territory source income that is effectively connected with the conduct 
of a U.S. trade or business. The legislative history to section 937 
does not suggest that Congress intended the Treasury Department to 
exercise its regulatory authority to allow income earned by a U.S. 
trade or business to receive territory tax benefits. Therefore, the 
Treasury Department and the IRS do not believe there is adequate 
regulatory authority to adopt this suggestion.
    Other commentators requested exceptions to the U.S. income rule for 
certain classes of non-territory source income that may otherwise be 
territory ECI. For example, commentators requested that insurance 
income from insuring U.S. risks, interest income from U.S. payors to 
finance centers, or rents and royalties from the use of intangible 
property in the United States be excepted from the scope of the U.S. 
income rule to the extent income is territory ECI. These commentators 
asserted that, notwithstanding that such income is generally U.S. 
source, the economic activity that gives rise to the income occurs in 
the territories. Accordingly, these commentators argued, this income 
does not provide the opportunities to erode the U.S. tax base that the 
U.S. income rule was intended to prevent.
    Even though the activities giving rise to these classes of income 
may result from sufficient economic activity in the territory so that 
the income otherwise would constitute territory ECI, the Treasury 
Department and the IRS note that these classes of income often arise in 
part from U.S.-based activities such as marketing. Thus, the Treasury 
Department and the IRS do not believe that their regulatory authority 
extends to removing income derived from the specified activities from 
the express coverage of the U.S. income rule under section 937(b)(2). 
However, the final regulations do provide additional examples 
illustrating that income from personal services that, for example, lead 
to the development of intangible property is not subject to the U.S. 
income rule if such services income is from territory sources. See part 
I.C.2.
2. Examples Illustrating the U.S. Income Rule
    Although the proposed and temporary regulations include several 
examples applying section 937(b) and temporary regulations Sec. Sec.  
1.937-2T and -3T, comments received by the Treasury Department and the 
IRS indicated a need for additional examples illustrating the operation 
of the U.S. income rule. In Notice 2006-76 (2006-38 IRB 459) (see Sec.  
601.601(d)(2)(ii)(b)), the Treasury Department and the IRS provided two 
additional examples in response to this concern and explained that 
taxpayers may treat the examples set forth in the notice as 
illustrative of the rules in the temporary regulations. The Treasury 
Department and the IRS also signaled in the notice that these two 
additional examples, or substantially similar examples, would be 
included in the final regulations.
    Commentators responded positively to the publication of the 
examples in Notice 2006-76, and the Treasury Department and the IRS did 
not receive any substantive questions or comments. Accordingly, the 
examples in Notice 2006-76 are included in the final regulations.
    The final regulations also provide a new example with respect to 
the provision of contingent-payment contractual terms for services 
performed in a territory. This example clarifies that compensation 
income received for providing personal services that lead to the 
development of intangible property for the service recipient is not 
subject to the U.S. income rule to the extent that the compensation 
income is from sources within the territory.

II. Operative Provisions

A. American Samoa

    Under section 931(a), income from sources in a section 931 
possession generally is excluded from the gross income of a bona fide 
resident of a section 931 possession. (American Samoa currently is the 
only section 931 possession because it is the only territory that has 
entered into an implementing agreement under sections

[[Page 19355]]

1271(b) and 1277(b) of the 1986 Act.) However, under section 931(d), 
the exclusion does not apply to amounts received for services performed 
as an employee of the United States or any agency thereof. The final 
regulations clarify that for this purpose under current law, an 
employee of the government of a section 931 possession is not an 
employee of the United States or of an agency of the United States. 
Thus, compensation received as an employee of the territorial 
government of a section 931 possession is properly excluded from U.S. 
gross income. A conforming clarification with respect to Puerto Rico is 
included in the final regulations under section 933.
    The effect of this rule change will be mainly administrative. 
Employees of the territorial government now will report their 
compensation as gross income on only the territorial income tax return 
and thus, depending on their other income, may be spared a U.S. filing 
obligation, and all tax on such compensation will be paid directly to 
the territorial government rather than potentially through a cover-over 
mechanism under section 7654. The Treasury Department and the IRS 
believe that this change will reduce overall taxpayer burden and 
enhance the efficiency of Federal tax administration, while also more 
fully reflecting the independent operation of the territorial taxing 
authority.
    Rev. Rul. 56-127 (1956-1 CB 323) (see Sec.  601.601(d)(2)(ii)(b)), 
which held under prior law that employees of the government of American 
Samoa are considered employees of the United States or an agency 
thereof, is no longer determinative and is obsoleted by this Treasury 
decision.

B. Guam and the Northern Mariana Islands

    Although section 935 was repealed by the 1986 Act, neither Guam nor 
the NMI has agreed to the entry into force of the implementing 
agreement required under sections 1271(b) and 1277(b) of the 1986 Act, 
and therefore neither of those territories is a section 931 possession 
as defined in Sec.  1.931-1(c)(1). Rather, section 935 remains in 
effect with respect to bona fide residents of Guam and the NMI. The 
final regulations under section 935 generally retain the provisions of 
the temporary and revised regulations without modification.

C. Puerto Rico

    The final regulations generally retain the provisions of the 
temporary and proposed regulations under section 933 without 
modification. However, the final regulations explicitly provide that 
for purposes of the section 933 exclusion, employees of the Puerto Rico 
territorial government are not treated as employees of the United 
States or of a Federal agency. This language, which comports with the 
consistent historical understanding that the compensation of such 
employees is excludable from Federal gross income, is added only for 
conformity with the revision being made to the final section 931 
regulations to address certain obsolete guidance with respect to 
American Samoa, as explained in part II.A.

D. United States Virgin Islands

    Section 932(c) generally provides that an individual (whether a 
U.S. citizen or alien) who is a bona fide resident of the U.S. Virgin 
Islands must file an income tax return with the U.S. Virgin Islands tax 
authorities. If the individual properly reports income from all sources 
identifying the source of each item of income on this return and pays 
all tax properly due with respect to such income, then such income is 
excluded from gross income for Federal income tax purposes. 
Consequently, such individuals have a Federal income tax return filing 
obligation if they fail to report or properly identify the source of 
any of their income on their U.S. Virgin Islands income tax return or 
if they fail to pay all of the tax properly due with respect to their 
income. The temporary and proposed regulations reflect this statutory 
filing regime.
    Commentators asked for additional guidance with respect to the U.S. 
filing obligations of individuals who take the position that they are 
bona fide residents of the U.S. Virgin Islands and file their income 
tax returns with the U.S. Virgin Islands under section 932(c). In 
particular, commentators asked for clarification with respect to 
correcting inadvertent errors on U.S. Virgin Islands income tax 
returns, determining the amount of any residual Federal income tax 
liability for individuals who fail to pay all the tax properly due to 
the U.S. Virgin Islands, and clarification of the application of the 
statute of limitations on assessments of Federal income tax by the IRS.
    Although the final regulations generally continue to reflect the 
statutory regime under 932(c) as set forth in the temporary and 
proposed regulations, the Treasury Department and the IRS agree that 
additional guidance with respect to the Federal filing requirements and 
obligations under section 932(c) is warranted. The final regulations 
provide an example illustrating that a bona fide resident of the U.S. 
Virgin Islands will not be subject to any U.S. filing requirement if, 
in order to correct a return previously filed with the U.S. Virgin 
Islands, that individual timely files an amended return with the U.S. 
Virgin Islands. The Treasury Department and the IRS believe that 
individuals generally should first avail themselves of similar 
administrative remedies that the U.S. Virgin Islands may provide.
    The final regulations also provide a new rule for purposes of 
determining the residual Federal income tax liability, if any, of 
individuals who are bona fide residents of the U.S. Virgin Islands. 
Under this new rule, such individuals are allowed a credit for amounts 
already paid to the U.S. Virgin Islands. Thus, their residual Federal 
income tax liability should equal the difference between their entire 
income tax liability and the amount of income tax already paid to the 
U.S. Virgin Islands.
    Section 932(b) provides a similar credit for U.S. citizens and 
resident aliens who are not bona fide residents of the U.S. Virgin 
Islands. If such individuals have income from sources within the U.S. 
Virgin Islands or income that is effectively connected with the conduct 
of a trade or business in the U.S. Virgin Islands, then sections 932(a) 
and (b) generally require such individuals to file an income tax return 
with both the IRS and the U.S. Virgin Islands tax authorities, paying 
an applicable percentage of taxes attributable to such income to the 
U.S. Virgin Islands. The individual may claim a credit for the tax 
required to be paid to the U.S. Virgin Islands, so that only the 
balance is due to the United States. Like the temporary and proposed 
regulations, the final regulations reflect these statutory rules. In 
the event that an individual who is not a bona fide resident pays more 
tax to the U.S. Virgin Islands than is required, Rev. Proc. 2006-23 
(2006-1 CB 900) (see Sec.  601.601(d)(2)(ii)(b)) provides procedures 
for requesting U.S. competent authority assistance for resolving 
inconsistent tax treatment with respect to such payments by the IRS and 
the U.S. Virgin Islands tax authorities.
    With respect to the Federal statute of limitations, the final 
regulations incorporate the interim rules announced in Notice 2007-31 
(2007-16 IRB 971) under the authority of section 7654(e). Accordingly, 
the final regulations under section 932(c) provide that the Federal 
statute of limitations under section 6501(a) for a U.S. citizen or 
resident alien who claims to be a bona fide resident of the U.S. Virgin 
Islands generally will start running upon the filing of an income tax 
return with the U.S. Virgin Islands. This general rule

[[Page 19356]]

applies as long as the IRS and U.S. Virgin Islands have in place an 
agreement for the automatic exchange of information satisfying the 
requirements of the Commissioner of the IRS. Because the working 
arrangement announced in Notice 2007-31 satisfies this condition, this 
general rule applies to years ending on or after December 31, 2006. In 
the event that the working arrangement is terminated and in the absence 
of a successor agreement, an individual claiming to be a bona fide 
resident of the U.S. Virgin Islands generally must file an income tax 
return with the IRS in order to start the Federal statute of 
limitations period. In such circumstances, however, the Commissioner 
may by administrative pronouncement specify other rules for this 
purpose. For years ending before December 31, 2006, the U.S. filing 
requirements provided in Notice 2007-19 (2007-11 IRB 689) continue to 
apply. See Sec.  601.601(d)(2)(ii)(b).
    The temporary and proposed regulations amend the regulations under 
section 6688 (concerning assessable penalties with respect to 
information reporting under section 7654) to conform to changes made by 
the 2004 Act. The temporary and proposed regulations provide that the 
penalty applies to individuals who are subject to reporting 
requirements promulgated under the authority of section 937(c) 
(concerning individuals who become or cease to be bona fide residents 
of a territory) or section 7654 (concerning the coordination of United 
States and territorial income taxes). This information reporting 
includes the requirement to file Form 8689, ``Allocation of Individual 
Income Tax to the U.S. Virgin Islands,'' and the requirement to file 
Form 8898, ``Statement for Individuals Who Begin or End Residence in a 
U.S. Possession.''
    One commentator noted that section 6688 applies only to 
``individuals described in section 7654(a)'' and therefore should not 
extend to Form 8689, which is required of only U.S. citizens or 
residents (other than bona fide residents of the U.S. Virgin Islands) 
who have income derived from sources within the U.S. Virgin Islands or 
effectively connected with the conduct of a trade or business in the 
U.S. Virgin Islands, or spouses who file joint returns with such 
individuals. The Treasury Department and the IRS agree that such 
individuals are not described in section 7654(a), which generally 
applies only to bona fide residents of an applicable territory. The 
final regulations under section 6688 are amended accordingly.

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

    In general, corporations created or organized in a territory are 
treated as foreign corporations for Federal income tax purposes, 
including the subpart F provisions relating to controlled foreign 
corporations. Section 957(c), however, provides a significant exception 
for bona fide residents of Puerto Rico and section 931 possessions. In 
cases where the exception applies, such an individual is not treated as 
a U.S. person for purposes of subpart F. Consequently, such an 
individual is not treated as a U.S. shareholder under section 951(b), 
and where such individuals own more than 50 percent of the vote or 
value of a corporation created or organized under the laws of Puerto 
Rico (a Puerto Rico corporation) or a section 931 possession (a section 
931 corporation), as the case may be, such a corporation is not treated 
as a controlled foreign corporation under section 957(a).
    In the case of a bona fide resident of Puerto Rico, the exception 
applies under section 957(c)(1) with respect to a Puerto Rico 
corporation 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. 
With respect to bona fide residents of a section 931 possession, the 
exception applies under section 957(c)(2) with respect to a corporation 
organized or created in the section 931 possession if: (1) 80 percent 
or more of the gross income of the corporation during the three-year 
testing period ending at the close of the taxable year (or applicable 
part) was derived from sources within such territory or was effectively 
connected with the conduct of a trade or business in such a territory; 
and (2) 50 percent of 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 territory (the 80/50 conditions).
    For purposes of determining whether income is from sources within 
Puerto Rico, the temporary and proposed regulations generally apply the 
territory source rules in Sec.  1.937-2T, including the special rules 
for determining whether dividends to individuals who own more than 10 
percent of the total voting of a territory corporation are from sources 
within the relevant territory. Those dividend source rules treat only a 
ratable portion of any dividend paid or accrued by a territory 
corporation to such a shareholder as territory source income unless the 
corporation meets the same 80/50 conditions as those applied under 
section 957(c)(2). Consequently, under the temporary and proposed 
regulations, unless a Puerto Rico corporation's gross income is derived 
entirely from sources within Puerto Rico, the corporation must meet the 
same 80/50 conditions applicable to a section 931 corporation in order 
for section 957(c)(1) to apply.
    Commentators from Puerto Rico objected to the effect of the 
temporary and proposed regulations with respect to the application of 
section 957(c)(1). The commentators noted that since 1986, all 
dividends from Puerto Rico corporations were treated as income from 
sources within Puerto Rico, and therefore such corporations were not 
treated as controlled foreign corporations for 10 percent shareholders 
who were bona fide residents of Puerto Rico. Commentators noted that 
the legislative history to neither the 2004 Act nor the 1986 Act, which 
amended section 957(c) by applying the 80/50 conditions with respect to 
section 931 corporations but did not specifically apply those 
conditions to Puerto Rico corporations, makes any reference to 
Congressional intent to apply the 80/50 conditions to Puerto Rico 
corporations.
    The Treasury Department and the IRS believe that given the distinct 
statutory tests under sections 957(c)(1) and (c)(2), the 80/50 
conditions should apply only to section 931 corporations. Therefore, 
the final regulations provide that the special dividend source rules of 
Sec.  1.937-2(g)(1) (including the 80/50 conditions) will not apply 
when determining, for purposes of section 957(c)(1), whether a dividend 
received by the Puerto Rico corporation during the taxable year would 
be treated under section 933(1) as derived from sources within Puerto 
Rico. Rather, the principles of section 861(a)(2)(A) under the general 
territory source rules will apply, and consequently dividends from 
Puerto Rico corporations generally will be treated as income from 
sources within Puerto Rico for purposes of applying section 957(c)(1) 
unless the U.S. income rule prevents the dividends from being sourced 
to Puerto Rico because, for example, the dividends are from sources 
within the United States under section 861(a)(2)(B).
    The temporary and proposed regulations contain related rules under 
sections 6038 and 6046 with respect to information reporting 
requirements concerning certain foreign corporations owned by a United 
States person who is a bona fide resident of Puerto Rico or a section 
931 possession. Under the temporary regulations, the special definition 
of United States person under

[[Page 19357]]

section 957(c) also applies for purposes of sections 6038 and 6046. 
However, because the final regulations no longer apply the 80/50 
conditions to bona fide residents of Puerto Rico (for purposes of 
subpart F), the Treasury Department and the IRS are concerned that such 
individuals may no longer have to provide information concerning their 
controlled foreign corporations, including those formed in Puerto Rico.
    The Treasury Department and the IRS believe that the information 
required under sections 6038 and 6046 is necessary for purposes of 
determining whether such individuals have a Federal income tax 
liability. Thus, the final regulations continue to apply the 80/50 
conditions of Sec.  1.937-2(g)(1) when defining United States person 
for purposes of the information reporting requirements under sections 
6038 and 6046.
    With respect to bona fide residents of a section 931 possession, 
the final regulations continue to apply the same exception (with the 
80/50 conditions) for purposes of section 957(c) and sections 6038 and 
6046.

F. Entity Status

    With respect to section 935 possessions and the U.S. Virgin Islands 
(mirror code territories), the temporary and proposed regulations 
contain special rules requiring consistent treatment of certain 
business entities for U.S. and mirror code tax purposes. The rules 
generally apply to elections under section 1362(a) (subchapter S 
corporations), Sec.  301.7701-3(c) (eligible entities), and other 
similar elections. The rules provide, among other things, that if an 
entity files an election with the IRS but not with the relevant mirror 
code territory, then the appropriate tax authority of the mirror code 
territory may, at its 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 territory but not with the IRS, the Commissioner 
may, at his or her discretion, deem the election to have been made for 
U.S. Federal income tax purposes.
    The Treasury Department and the IRS specifically requested comments 
relating to elections that should be specifically mentioned or excluded 
from the entity status election rules. Commentators requested two 
limited exceptions to the requirement for making consistent elections 
in the case of a U.S. entity that files an election with the IRS but 
not with the relevant mirror code territory.
    The first comment related to a U.S. entity that elects to be 
treated as a real estate mortgage investment conduit under section 
860D(b) (a REMIC) for U.S. tax purposes. The commentator noted that a 
REMIC would be classified as a foreign corporation for mirror code tax 
purposes unless it either files an election in the mirror code 
territory or the appropriate tax authority of the relevant mirror code 
territory exercises his or her discretion to treat the entity as if an 
election had been made. The commentator requested that the entity 
consistency rules be restricted so as not to apply to a publicly traded 
REMIC unless five percent or more of the REMIC's ownership is held by a 
bona fide resident of the relevant territory or a corporation created 
or organized in the relevant territory.
    The second comment similarly requested an exception to the 
consistent election requirement in the case of a U.S. corporation that, 
prior to the temporary and proposed regulations, made an election with 
the IRS under section 1362(a) to be an S corporation but had a 
shareholder who was a bona fide resident of a mirror code territory who 
treated the entity as a foreign C corporation for purposes of the 
individual's taxation in the territory. The commentator requested that 
such individuals be allowed under these circumstances to make a one-
time election in the mirror code territory to treat the U.S. entity for 
purposes of mirror code taxation as either a domestic S corporation or 
a foreign C corporation (as it would be in the absence of an 
affirmative election under section 1362(a) by the entity or a deemed 
election by the mirror code tax authority).
    The Treasury Department and the IRS are concerned about the 
possibility of inappropriate tax results from inconsistent treatment of 
entities in the United States and mirror code jurisdictions and believe 
that this problem exists even in circumstances in which the owners of 
the entity hold less than five percent of the interests in the entity. 
Furthermore, the Treasury Department and the IRS believe that treating 
the entity consistently in the territory and the United States should 
not impose an undue burden on the entity. Thus, the Treasury Department 
and the IRS do not believe that a special exception in the entity 
consistency rules is necessary in either case.
    As provided in the temporary and proposed regulations, which are 
finalized here without change, the ability of the tax authority in a 
mirror code jurisdiction to deem an election to have been made for 
territorial tax purposes is discretionary. The Treasury Department and 
the IRS anticipate that, to the extent the entity status rules apply, 
this discretion will be exercised in situations where taxpayers treat a 
business entity in an inconsistent manner with the result that it 
reduces their overall tax liability below what otherwise would be due 
in the absence of the mirror system. In addition, and as a general 
matter, the Treasury Department and the IRS encourage taxpayers to take 
consistent positions in both jurisdictions or, if this is not possible, 
to seek available administrative assistance from the relevant 
jurisdiction including, for example, requesting a pre-filing or similar 
agreement with respect to an entity's classification as well as 
requesting competent authority assistance concerning any inconsistent 
positions taken by the IRS and a territory with respect to the entity 
classification of an entity. See, for example, Rev. Proc. 2007-17 
(2007-4 IRB 368) (IRS pre-filing agreement procedures) and Rev. Proc. 
2006-23 (2006-1 CB 900) (U.S. competent authority assistance procedures 
with respect to the territories). See Sec.  601.601(d)(2)(ii)(b).

III. Miscellaneous Changes

    The final regulations also reflect various nonsubstantive stylistic 
edits to the proposed and temporary regulations to enhance clarity and 
readability.

Effect on Other Documents

    Rev. Rul. 56-127 (1956-1 CB 323) is obsolete as of April 9, 2008.

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. Because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is J. David Varley, 
Office of the Associate Chief Counsel (International), IRS. However, 
other personnel from the IRS and Treasury

[[Page 19358]]

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.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 301 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 1.931-1 also issued under 26 U.S.C. 7654(e).
    Section 1.932-1 also issued under 26 U.S.C. 7654(e). * * *
    Section 1.934-1 also issued under 26 U.S.C. 934(b)(4). * * *
    Section 1.935-1 also issued under 26 U.S.C. 7654(e). * * *
    Section 1.937-2 also issued under 26 U.S.C. 937(b).
    Section 1.937-3 also issued under 26 U.S.C. 937(b). * * *
    Section 1.957-3 also issued under 26 U.S.C. 957(c). * * *


0
Par. 2. Section 1.1-1 is amended by revising the second sentence of 
paragraph (b) and adding a new paragraph (d) to read as follows:


Sec.  1.1-1  Income tax on individuals.

* * * * *
    (b) * * * Pursuant to section 876, a nonresident alien individual 
who is a bona fide resident of a section 931 possession (as defined in 
Sec.  1.931-1(c)(1) of this chapter) or Puerto Rico during the entire 
taxable year is, except as provided in section 931 or 933 with respect 
to income from sources within such possessions, subject to taxation in 
the same manner as a resident alien individual. * * *
* * * * *
    (d) Effective/applicability date. The second sentence of paragraph 
(b) of this section applies to taxable years ending after April 9, 
2008.

0
Par. 3. Section 1.170A-1 is amended by revising paragraph (j)(9) and 
the heading for paragraph (k) and adding a new sentence at the end of 
paragraph (k) to read as follows:


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

* * * * *
    (j)(9) Charitable contributions paid by bona fide residents of a 
section 931 possession as defined in Sec.  1.931-1(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.
* * * * *
    (k) Effective/applicability date. * * * Paragraph (j)(9) of this 
section is applicable for taxable years ending after April 9, 2008.


Sec.  1.170A-1T  [Removed]

0
Par. 4. Section 1.170A-1T is removed.
0
Par. 5. Section 1.861-3 is amended by revising paragraph (a)(2) and 
revising the heading for paragraph (d) and adding a new sentence at the 
end of paragraph (d) to read as follows:


Sec.  1.861-3  Dividends.

* * * * *
    (a) * * *
    (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 that 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.
* * * * *
    (d) Effective/applicability date. * * * Paragraph (a)(2) of this 
section applies to taxable years ending after April 9, 2008.


Sec.  1.861-3T  [Removed]

0
Par. 6. Section 1.861-3T is removed.
0
Par. 7. Section 1.861-8 is amended by adding paragraphs (f)(1)(vi)(E), 
(f)(1)(vi)(F), (f)(1)(vi)(H), and (h) 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) The tax base for individuals entitled to the benefits of 
section 931 and the section 936 tax credit of a domestic corporation 
that has an election in effect under section 936;
    (F) The exclusion for income from Puerto Rico for bona fide 
residents of Puerto Rico under section 933;
* * * * *
    (H) The income derived from the U.S. Virgin Islands or from a 
section 935 possession (as defined in Sec.  1.935-1(a)(3)(i)).
* * * * *
    (h) Effective/applicability date. Paragraphs (f)(1)(vi)(E), 
(f)(1)(vi)(F), and (f)(1)(vi)(H) of this section apply to taxable years 
ending after April 9, 2008.

0
Par. 8. Section 1.871-1 is amended by revising paragraph (b)(1)(iii) 
and revising the heading for paragraph (c) and adding a new sentence at 
the end of paragraph (c) to read as follows:


Sec.  1.871-1  Classification and manner of taxing alien individuals.

* * * * *
    (b) * * *
    (1) * * *
    (iii) Nonresident alien individuals who are bona fide residents of 
a section 931 possession (as defined in Sec.  1.931-1(c)(1) of this 
chapter) or Puerto Rico during the entire taxable year. An individual 
described in paragraph (b)(1)(i) or (ii) of this section is subject to 
tax pursuant to the provisions of subpart A (section 871 and 
following), part II, subchapter N, chapter 1 of the Code, and the 
regulations under those provisions. The provisions of subpart A do not 
apply to individuals described in this paragraph (b)(1)(iii), but such 
individuals, except as provided in section 931 or 933, are subject to 
the tax imposed by section 1 or 55. See Sec.  1.876-1.
* * * * *
    (c) Effective/applicability date. * * * Paragraph (b)(1)(iii) of 
this section applies to taxable years ending after April 9, 2008.

0
Par. 9. 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.

    (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 
generally is imposed upon the taxable income of such individual, 
determined in accordance with section 63(a) and the regulations under 
that section, 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

[[Page 19359]]

used by such an individual, see section 6012 and the regulations under 
that section.
    (c) Exceptions. Though subject to the tax imposed by section 1, an 
individual to whom this section applies will nevertheless be treated as 
a nonresident alien individual for the purpose of many provisions of 
the Internal Revenue Code (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 Code (for example, 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.  1.937-1; and
    (2) ``Section 931 possession'' is defined in Sec.  1.931-1(c)(1).
    (f) Effective/applicability date. This section applies to taxable 
years ending after April 9, 2008.


Sec.  1.876-1T  [Removed]

0
Par. 10. Section 1.876-1T is removed.

0
Par. 11. Section 1.881-1 is amended by revising the last sentence of 
paragraph (c) and the heading of paragraph (f) to read as follows:


Sec.  1.881-1  Manner of taxing foreign corporations.

* * * * *
    (c) * * * However, for special rules relating to possessions of the 
United States, see Sec.  1.881-5.
* * * * *
    (f) Effective/applicability date. * * *

0
Par. 12. Section 1.881-5 is amended as follows:
0
1. Revise paragraphs (a), (b), (c), (d), (e), (f), (f)(1), (f)(2), 
(f)(3), (f)(5), (f)(6), (f)(7), (g), (h), and (i).
0
2. Remove paragraph (f)(8).
    The revisions read as follows:


Sec.  1.881-5  Exception for certain possessions corporations.

    (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.  1.884-0(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. Virgin Islands and section 931 possessions. A corporation 
created or organized in, or under the law of, the U.S. 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 (c)(3) of 
this section 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-
1(c)(1);and
    (2) ``Section 935'' possession is defined in Sec.  1.935-
1(a)(3)(i).

[[Page 19360]]

    (3) Foreign person means any person other than--
    (i) A United States person (as defined in section 7701(a)(30) and 
the regulations under that section); 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.
* * * * *
    (5) Source. The rules of Sec.  1.937-2 will apply for determining 
whether income is from sources within a possession.
    (6) Effectively connected income. The rules of Sec.  1.937-3 (other 
than paragraph (c) of that section) will 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) will apply 
except that the language ``5 percent'' will 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 U.S. Virgin Islands--
    (1) The rules of paragraphs (b) through (d) of this section will 
not apply; and
    (2) A corporation created or organized in, or under the law of, 
such possession or the United States will not be considered a foreign 
corporation.
    (h) Example. The principles of this section are illustrated by the 
following example:

    Example. X is a corporation organized under the law of the U.S. 
Virgin Islands 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 U.S. Virgin Islands 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 U.S. Virgin Islands. Seventy-four percent of the stock 
of X is owned by unrelated individuals who are residents of the 
United States or the U.S. Virgin Islands. 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/applicability dates. Except as otherwise provided in 
this paragraph (i), this section applies to payments made in taxable 
years ending after April 9, 2008. If, on or after April 9, 2008, there 
takes effect an increase in the Commonwealth of Puerto Rico's 
withholding tax 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, the rules of paragraphs (b)(2) and (e) 
of this section will not apply to dividends received on or after the 
effective date of the increase. Paragraph (f)(4) of this section 
applies to payments made after January 31, 2006. Taxpayers may choose 
to apply paragraph (f)(4) of this section to payments made after 
October 22, 2004.

0
Par. 13. Section 1.884-0 is amended by revising paragraph (b) to read 
as follows:


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

* * * * *
    (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 U.S. Virgin 
Islands, provided that the conditions of Sec.  1.881-5(c)(1) through 
(c)(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 U.S. 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 9, 2008.
* * * * *


Sec.  1.884-0T  [Removed]

0
Par. 14. Section 1.884-0T is removed.

0
Par. 15. Section 1.901-1 is amended by revising paragraph (g) and 
adding new paragraph (j) to read as follows:


Sec.  1.901-1  Allowance of credit for taxes.

* * * * *
    (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 under that section) of Puerto Rico during the entire 
taxable year (see sections 901(b)(3) and (4)).
    (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-
1(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)).
* * * * *
    (j) Effective/applicability date. Paragraph (g) of this section 
applies to taxable years ending after April 9, 2008.


Sec.  1.901-1T  [Removed]

0
Par. 16. Section 1.901-1T is removed.

0
Par. 17. 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.

    (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, will 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 as an employee of the 
United States or any agency thereof. For purposes of section 931(d) and 
this section, an employee of the government of a section 931 possession 
will not be considered an employee of the United States or of an agency 
of the United States.
    (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 2008, D moves to American Samoa, where he 
purchases a house and accepts a permanent position with a local 
employer. For the remainder of the year and for the following three 
taxable years, D continues to live and work in American Samoa and 
has a closer connection to American Samoa than to the United States 
or any foreign country. Assuming that D otherwise meets the 
requirements under section 937(a) and Sec.  1.937-1(b) and (f)(1) 
(year-of-move exception), D is considered a bona fide resident of 
American Samoa for 2008. Accordingly, under section 931 and 
paragraph (a)(1) of this section, D should exclude from his 2008 
Federal gross income any income from sources within American Samoa 
and any income that is effectively connected with the conduct of a 
trade or business within American Samoa, as determined under section 
937(b) and Sec. Sec.  1.937-2 and 1.937-3, as applicable.


[[Page 19361]]


    (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 will 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 will 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.  1.937-1 will apply for determining whether 
an individual is a bona fide resident of a section 931 possession;
    (4) The rules of Sec.  1.937-2 will apply for determining whether 
income is from sources within a section 931 possession; and
    (5) The rules of Sec.  1.937-3 will apply for determining whether 
income is effectively connected with the conduct of a trade or business 
within a section 931 possession.
    (d) Effective/applicability date. This section applies to taxable 
years ending after April 9, 2008.


Sec.  1.931-1T  [Removed]

0
Par. 18. Section 1.931-1T is removed.

0
Par. 19. Section 1.932-1 is revised to read as follows:


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

    (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 will 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.  1.937-1 will apply for determining whether 
an individual is a bona fide resident of the Virgin Islands;
    (ii) The rules of Sec.  1.937-2 will apply for determining whether 
income is from sources within the Virgin Islands; and
    (iii) The rules of Sec.  1.937-3 will 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 Virgin Islands income--(1) Dual filing 
requirement. Subject to paragraph (d) of this section, an individual 
described in paragraph (a)(2)(ii) of this section must 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 U.S. 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 must 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) A credit against the tax imposed by this chapter for the 
taxable year will be allowed in an amount equal to the taxes that are 
required to be paid to the Virgin Islands under paragraph (b)(2)(i) of 
this section and are so paid. Such taxes will be considered creditable 
in the same manner as taxes paid to the United States (for example, 
under section 31) and not as taxes paid to a foreign government (for 
example, under sections 27 and 901).
    (iii) For purposes of this paragraph (b)(2)--
    (A) The term applicable percentage means the percentage that 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 to such income. For purposes of the preceding sentence, 
the rules of Sec.  1.861-8 will apply; and
    (C) Pursuant to Sec.  1.937-2(a), the rules of Sec.  1.937-
2(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 will be subject to the following income tax return filing 
requirements:
    (1) Virgin Islands filing requirements. An individual to whom this 
paragraph (c) applies must file an income tax return for the taxable 
year with the Virgin Islands. On this return, the individual must 
report income from all sources and identify the source of each item of 
income shown on the return.
    (2) U.S. filing requirements. (i) For purposes of calculating the 
income tax liability to the United States of an individual to whom this 
paragraph (c) applies, gross income will 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 will not be taken into account, 
provided that--
    (A) The individual fully satisfied the reporting requirements of 
paragraph (c)(1) of this section; and
    (B) The individual fully paid the tax liability referred to in 
section 934(a) to the Virgin Islands with respect to such income.
    (ii) For purposes of the U.S. statute of limitations under section 
6501(a), an income tax return filed with the Virgin Islands by an 
individual who takes the position that he or she is a bona fide 
resident of the Virgin Islands described in paragraph (a)(2)(i) of this 
section (or an individual who files a joint return with such an 
individual under paragraph (d) of this section) will be deemed to be a 
U.S. income tax return, provided that the United States and the Virgin 
Islands have entered into an agreement for the routine exchange of 
income tax information satisfying the requirements of the Commissioner. 
The working arrangement announced in Notice 2007-31 satisfies the 
condition of the preceding sentence. See Notice 2007-31 (2007-16 IRB 
971) (applicable to taxable years ending on or after December 31, 2006, 
unless and until arrangement terminates). In the absence of such an 
agreement, individuals to whom this paragraph (c) applies generally 
must file an income tax return for the taxable year with the United 
States to begin the period of limitations

[[Page 19362]]

for Federal income tax purposes as provided in section 6501(a), and in 
such circumstances the Commissioner may by revenue procedure, notice, 
or other administrative pronouncement specify U.S. filing and other 
information reporting requirements for such individuals. For taxable 
years ending before December 31, 2006, the rules provided in section 3 
of Notice 2007-19 (2007-11 IRB 689) will apply. See Sec.  
601.601(d)(2)(ii)(b).
    (3) U.S. tax payments. In the case of an individual who is required 
to file an income tax return with the United States as a consequence of 
failing to satisfy the requirements of paragraphs (c)(2)(i)(A) and (B) 
of this section, there will be allowed as a credit against the tax 
imposed by this chapter for the taxable year an amount equal to the 
amount of the tax liability referred to in section 934(a) to the extent 
paid to the Virgin Islands. Such taxes shall be considered creditable 
in the same manner as taxes paid to the United States (for example, 
under section 31) and not as taxes paid to a foreign government (for 
example, under sections 27 and 901).
    (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 must 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 under that section but 
without regard to community property laws; and, if one of the spouses 
dies, the taxable year of the surviving spouse will be treated as 
ending on the date of such death.
    (e) Place for filing returns--(1) U.S. returns. Except as otherwise 
provided for returns filed under paragraph (c)(4) of this section, a 
return required under the rules of paragraphs (b) and (c) of this 
section to be filed with the United States must be filed as directed in 
the applicable forms and instructions.
    (2) Virgin Islands returns. A return required under the rules of 
paragraphs (b) and (c) of this section to be filed with the Virgin 
Islands must 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), the terms--
    (i) 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) 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; and
    (iii) 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 (Code), the United States generally will 
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 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 (for example, 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 will 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 will be treated as a domestic corporation and a 
shareholder to whom section 932(a) applies will not be treated as a 
nonresident alien individual with respect to such corporation. While 
such an election is in effect, the corporation will 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 taxable 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); and
    (E) The treatment of property exchanged for property of a like kind

[[Page 19363]]

(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 (for example, sections 931 through 937, 7651, and 7654).
    (B) The determination of any aspect of an individual's residency 
(for example, 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 (for example, sections 367, 951 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 (that is, 
mirrored sections of the Code), the Virgin Islands generally will 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 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 (for example, 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 will 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 will be treated as a domestic 
corporation and a shareholder to whom section 932(c) applies will not 
be treated as a nonresident alien individual with respect to such 
corporation. While such an election is in effect, the corporation will 
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 taxable 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; 
and
    (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 
(for example, 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 (for example, 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); and
    (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 (IRS) 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 IRS, the Commissioner, at his discretion, may deem the 
election also to have been made for Federal tax purposes; and
    (iii) If inconsistent entity status elections are filed with the 
BIR and the IRS, 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. 2006-23 (2006-1 CB 900) (see Sec.  
601.601(d)(2)(ii)(b) of this chapter) for procedures for requesting the 
assistance

[[Page 19364]]

of the IRS when a taxpayer is or may be subject to inconsistent tax 
treatment by the IRS 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 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) of this 
chapter and under that section as mirrored in the Virgin Islands, an 
eligible entity subject to this paragraph (h) will be classified for 
both 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 will 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) of this section 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 will 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 will take effect for 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. For 
2008, A files with the IRS a Form 1040, ``U.S. Individual Income Tax 
Return,'' reporting adjusted gross income of $90x, which includes 
$30x from sources in the Virgin Islands. The income tax liability 
reported on A's Form 1040 is $18x. A files a copy of his Form 1040 
with the Virgin Islands as required by section 932(a)(2) and 
paragraph (b)(1) of this section. A pays to the Virgin Islands the 
applicable percentage of his Federal income tax liability as 
required by section 932(b) and paragraph (b)(2) of this section, 
computed as follows: $30x/$90x x $18x = $6x income tax liability to 
the Virgin Islands.
    (ii) A claims a credit in the amount of $6x against his Federal 
income tax liability reported on his Form 1040. A attaches a Form 
8689, ``Allocation of Individual Income Tax to the U.S. Virgin 
Islands,'' to the Form 1040 filed with the IRS and to the copy filed 
with the Virgin Islands.
    Example 2. (i) B, a U.S. citizen, files returns on a calendar 
year basis. In November 2008, B moves to the Virgin Islands, 
purchases a house, and accepts a permanent position with a local 
employer. For the remainder of the year and throughout 2009, B 
continues to live and work in the Virgin Islands and has a closer 
connection to the Virgin Islands than to the United States or any 
foreign country. As a consequence of his employment in the Virgin 
Islands, B earns income from the performance of services in the 
Virgin Islands during 2008 and 2009.
    (ii) For 2008, B does not qualify as a bona fide resident under 
section 937(a) and Sec.  1.937-1(b) and (f)(1). Therefore, B is 
subject to the rules of sections 932(a) and (b) and paragraph (b) of 
this section for 2008 because he has income derived from sources 
within the Virgin Islands as determined under the rules of section 
937(b) and Sec.  1.937-2.
    (iii) For 2009, assuming that B otherwise satisfies the 
requirements of section 937(a) and Sec.  1.937-1(b), B qualifies as 
a bona fide resident of the Virgin Islands. Therefore, section 
932(c) and paragraph (c) of this section apply to B for 2009, and he 
must file his income tax return with the Virgin Islands under 
paragraph (c)(1) of this section. Provided that B fully satisfies 
the reporting requirements of paragraph (c)(1) of this section and 
fully pays the tax liability referred to in section 934(a), B will 
have no Federal income tax filing requirement or liability under 
paragraphs (c)(2) and (3) of this section.
    Example 3. H and W are U.S. citizens. H resides in State T and W 
is a bona fide resident of the Virgin Islands. For 2008, H and W 
prepare a joint Form 1040, ``U.S. Individual Income Tax Return,'' 
reporting total adjusted gross income of $75x, of which $40x is 
attributable to compensation that W received for services performed 
in the Virgin Islands and $35x to compensation that H received for 
services performed in State T. Pursuant to section 932(d) and 
paragraph (d) of this section, because W would have the greater 
adjusted gross income if computed separately, H and W must file 
their joint Form 1040 with the Virgin Islands as required by section 
932(c) and paragraph (c)(1) of this section. H and W may claim a tax 
credit on such return for income tax withheld during 2008 and paid 
to the IRS.
    Example 4. (i) The facts are the same as in Example 3, except 
that H also earns $25x for services performed in the Virgin Islands, 
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, because H would have the greater adjusted gross income if 
computed separately, H and W must file their joint Form 1040 with 
the IRS and must file a copy of that joint Form 1040 with the Virgin 
Islands as required by section 932(a)(2) and paragraph (b)(1) of 
this section. H and W must pay the applicable percentage of their 
Federal income tax liability to the Virgin Islands as required by 
section 932(b) and paragraph (b)(2) of this section, computed as 
follows: $65x /$100x x $20x = $13x income tax liability to the 
Virgin Islands.
    (iii) H and W claim a credit against their Federal income tax 
liability reported on their joint Form 1040 in the amount of $13x, 
the portion of their Federal income tax liability required to be 
paid to the Virgin Islands. H and W attach a Form 8689, ``Allocation 
of Individual Income Tax to the U.S. Virgin Islands,'' to their 
joint Form 1040 filed with the IRS and to the copy filed with the 
Virgin Islands.
    Example 5. N, a U.S. citizen and calendar year taxpayer, takes 
the position that he is a bona fide resident of the Virgin Islands 
for the 2007 taxable year. On April 15, 2008, N files a Form 1040, 
``U.S. Individual Income Tax Return,'' with the Virgin Islands for 
his 2007 taxable year. N does not file a Form 1040 with the IRS. 
Because there is an agreement in force between the United States and 
the Virgin Islands for the routine exchange of income tax 
information, under paragraph (c)(2)(ii) of this section, the Federal 
3-year period of limitations under section 6501(a) will expire on 
April 15, 2011, and the IRS will make no further assessment of 
income tax after that date for N's 2007 taxable year except as 
otherwise authorized by section 6501.
    Example 6. (i) J is a U.S. citizen and a bona fide resident of 
the Virgin Islands. In 2008, J receives compensation for services 
performed as an employee in the Virgin Islands in the amount of 
$40x. J files with the Virgin Islands a Form 1040, ``U.S. Individual 
Income Tax Return,'' reporting gross income of only $30x. Based on 
these facts, J has not satisfied the conditions of section 932(c)(4) 
and paragraph (c) of this section for an exclusion from gross income 
for Federal income tax purposes.
    (ii) The facts are the same as in paragraph (i) of this Example 
6 except that on or before

[[Page 19365]]

the last day prescribed for filing an income tax return for J's 2008 
taxable year, J files with the Virgin Islands an amended Form 1040 
for 2008, correctly reporting the full $40x of compensation. 
Provided that J otherwise fully satisfies the reporting requirements 
of paragraph (c)(1) of this section and fully pays the tax liability 
referred to in section 934(a), J will have no Federal income tax 
filing requirement or liability under paragraphs (c)(2) and (3) of 
this section.
    Example 7. (i) N is a U.S. citizen and a bona fide resident of 
the Virgin Islands. In 2008, N receives compensation for services 
performed in Country M. N files with the Virgin Islands a Form 1040, 
``U.S. Individual Income Tax Return,'' reporting the compensation as 
income effectively connected with the conduct of a trade or business 
in the Virgin Islands. N claims a special credit against the tax on 
this compensation pursuant to a Virgin Islands 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.  1.937-3(b), compensation for 
services performed outside the Virgin Islands may not be treated as 
income effectively connected with the conduct of a trade or business 
in the Virgin Islands for purposes of section 934(b). Consequently, 
N is not entitled to claim the special credit under Virgin Islands 
law with respect to N's income from services performed in Country M. 
Because 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 Federal income tax purposes. Therefore, income 
reported on the Form 1040 as filed with the Virgin Islands must be 
included in N's Federal gross income. Under paragraph (c)(3) of this 
section, the amount of tax paid to the Virgin Islands on such income 
will be allowed as a credit against N's Federal income tax 
liability.

    (j) Effective/applicability date. Except as otherwise provided in 
this paragraph (j), this section applies to taxable years ending after 
April 9, 2008. Taxpayers may choose to apply paragraph (c)(2)(ii) of 
this section to open taxable years ending on or after December 31, 
2006.


Sec.  1.932-1T  [Removed]

0
Par. 20. Section 1.932-1T is removed.

0
Par. 21. Section 1.933-1 is amended by revising paragraphs (a), (c), 
(d), and (e) to read as follows:


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

    (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, will exclude from gross income 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. For purposes of section 933 and this section, an employee of 
the government of Puerto Rico will not be considered an employee of the 
United States or of an agency of the United States.
    (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 2008, E moves to Puerto Rico, where he 
purchases a house and accepts a permanent position with a local 
employer. For the remainder of the year and for the following three 
taxable years, E continues to live and work in Puerto Rico and has a 
closer connection to Puerto Rico than to the United States or any 
foreign country. Assuming that E otherwise meets the requirements 
under section 937(a) and Sec.  1.937-1(b) and (f)(1) (year-of-move 
exception), E is considered a bona fide resident of Puerto Rico for 
2008. Accordingly, under section 933(1) and paragraph (a)(1) of this 
section, E should exclude from his 2008 Federal gross income any 
income from sources within Puerto Rico, as determined under section 
937(b) and Sec.  1.937-2.
* * * * *
    (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 will 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 will apply (with 
creditable expenditures treated in the same manner as deductible 
expenditures).
    (d) Definitions. For purposes of this section--
    (1) The rules of Sec.  1.937-1 will apply for determining whether 
an individual is a bona fide resident of Puerto Rico; and
    (2) The rules of Sec.  1.937-2 will apply for determining whether 
income is from sources within Puerto Rico.
    (e) Effective/applicability date. Paragraphs (a), (c), (d), and (e) 
of this section apply to taxable years ending after April 9, 2008.


Sec.  1.933-1T  [Removed]

0
Par. 22. Section 1.933-1T is removed.

0
Par. 23. 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.

    (a) General rule. Section 934(a) provides that tax liability 
incurred to the United States Virgin Islands (Virgin Islands) must 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 (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 Virgin Islands 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 under that section.
    (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 will 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.

[[Page 19366]]

    (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, will 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.  1.937-1 will apply for 
determining whether an individual is a bona fide resident of the Virgin 
Islands;
    (ii) Source. The rules of Sec.  1.937-2 will apply for determining 
whether income is from sources within the Virgin Islands; and
    (iii) Effectively connected income. The rules of Sec.  1.937-3 will 
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 that is derived from sources outside the United 
States and that 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 that is derived 
from sources outside the United States and that is not effectively 
connected with the conduct of a trade or business within the United 
States will 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 that is derived from sources outside 
the United States and that 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.
    (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 Federal income tax purposes under section 906 
of the Code).
    (ii) Limitation. Tax liability incurred to the Virgin Islands 
attributable 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 within the United States, as computed in this 
paragraph (c)(3), however, will 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 under those provisions 
will 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 will 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 Virgin Islands. For 2008, S files a Form 1040INFO, ``Non-Virgin 
Islands Source Income of Virgin Islands Residents,'' with the Virgin 
Islands on which S reports total gross income as follows:

Compensation for services performed in the Virgin Islands--$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 Virgin 
Islands office--$20,000
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 Virgin Islands or 
effectively connected to the conduct of a trade or business in the 
Virgin Islands (Virgin Islands ECI) of $75,000, income from sources 
within the United States of $50,000, and income from other sources 
(not Virgin Islands 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 Virgin Islands, 
$15,000 is taxable income from other sources that is Virgin Islands 
ECI under the rules of section 937(b) and Sec. Sec.  1.937-2 and 
1.937-3, and $22,500 is taxable income from sources outside the 
Virgin Islands (and outside the United States) that is not Virgin 
Islands ECI. S's tax liability incurred to the Virgin Islands 
pursuant to the Internal Revenue Code as applicable in the Virgin 
Islands (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 Virgin Islands 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 Virgin 
Islands. 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 ($60,000 / $120,000)] - [$10,000 x ($15,000 
/ $37,500)] = ($30,000 x 0.5) - ($10,000 x 0.4) = $15,000 - $4,000 = 
$11,000
    (iv) Accordingly, S's net tax liability incurred to the Virgin 
Islands 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 Virgin Islands a copy of 
his Federal income tax return and pays to the Virgin Islands 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 Virgin Islands law relating to business activities like his in 
the Virgin Islands to reduce any of his tax liability payable to the 
Virgin Islands under section 932(b).
    Example 3. (i) Z is a nonresident alien who resides in Country 
FC. In 2008, Z receives dividends from a corporation organized under 
the law of the Virgin Islands in the amount of $90x. Z's tax 
liability incurred to the Virgin Islands pursuant to section 871(a)

[[Page 19367]]

of the Code as applicable in the Virgin Islands (mirror code) is 
$27x.
    (ii) Pursuant to a Virgin Islands 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 
Virgin Islands. 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 x ($90x/$90x) = $27x.
    (iii) Accordingly, depending on the terms of the exemption as 
provided under Virgin Islands law, Z's net tax liability incurred to 
the Virgin Islands may be reduced or eliminated entirely.
    Example 4. (i) A Corp is organized under the laws of the Virgin 
Islands 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 Virgin 
Islands. During 2008, A Corp had $50x in gross income from sources 
within the Virgin Islands (as determined under section 937(b) and 
Sec.  1.937-2) 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 Virgin Islands to reduce or 
remit the income tax liability of a qualified foreign corporation 
arising under the Code as applicable in the Virgin Islands (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 Virgin Islands 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 Virgin 
Islands.
    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 Virgin Islands--5%
U.S. citizens who are not bona fide residents of the Virgin 
Islands--3%
Nonresident aliens who are bona fide residents of the Virgin 
Islands--42%
Nonresident aliens who are not bona fide residents of the Virgin 
Islands--50%

    (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 Virgin Islands may reduce or remit A 
Corp's mirror code income tax liability with respect to its $50x in 
gross income from sources within the Virgin Islands 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 Virgin Islands 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/applicability date. This section applies for taxable 
years ending after April 9, 2008.


Sec.  1.934-1T  [Removed]

0
Par. 24. Section 1.934-1T is removed.
0
Par. 25. Section 1.935-1 is amended by revising paragraphs (a), (b)(1), 
(b)(3), (b)(5), (b)(6), (b)(7), (c), (d), (e), (f), and (g) to read as 
follows:


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

    (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 applies 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, the following 
definitions apply:
    (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, Public Law 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; and
    (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.  1.937-1 will apply for determining whether 
an individual is a bona fide resident of a section 935 possession.
    (iv) The rules of Sec.  1.937-2 generally will apply for 
determining whether income is from sources within a section 935 
possession. Pursuant to Sec.  1.937-2(a), however, the rules of Sec.  
1.937-2(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 must file an income tax 
return for the taxable year--
    (i) With the United States if such individual is a resident of the 
United States;

[[Page 19368]]

    (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.
* * * * *
    (3) Place for filing returns--(i) U.S. returns. A return required 
under this paragraph (b) to be filed with the United States must 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 must 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 must be filed as directed in 
the applicable forms and instructions.
* * * * *
    (5) Tax payments. The tax shown on the return must be paid to the 
jurisdiction with which such return is required to be filed and must 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 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) [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 (Code), the United States 
generally will 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 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 (for example, 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 will 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 will be treated as a domestic corporation 
and a U.S. taxpayer shareholder will not be treated as a nonresident 
alien individual with respect to such corporation. While such an 
election is in effect, the corporation will be treated as a domestic 
corporation for all purposes of the 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 taxable 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; and
    (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 (for example, sections 931 through 937, 7651, and 7654);
    (B) The determination of any aspect of an individual's residency 
(for example, 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 (for example, sections 935, 937, and 7654). 
Thus, for example, income determined to be derived from sources within 
the relevant possession under section 937(b) will 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 (CNMI)'';
    (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); and
    (E) The characterization of a corporation for purposes other than 
subchapter S (for example, 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

[[Page 19369]]

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 will 
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 Guam 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 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 must 
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 must 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, will 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 (IRS) 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 IRS, the Commissioner, at his discretion, 
may deem the election also to have been made for Federal tax purposes; 
and
    (iii) If inconsistent entity status elections are filed with the 
relevant possession and the IRS, 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. 2006-23 (2006-1 C.B. 900) (see Sec.  601.601(d)(2)(ii)(b) of 
this chapter) for procedures for requesting the assistance of the IRS 
when a taxpayer is or may be subject to inconsistent tax treatment by 
the IRS 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 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; and
    (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) of this 
chapter and under that section as mirrored in the relevant possession, 
an eligible entity subject to this paragraph (e) will be classified for 
both 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 will 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

[[Page 19370]]

paragraph (e)(1)(iii) of this section 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 will 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 will take effect for 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.  (i) B, a United States citizen, files returns on a 
calendar year basis. In November 2008, B moves to Possession G, a 
section 935 possession; purchases a house; and accepts a permanent 
position with a local employer. For the remainder of the year and 
throughout 2009, B continues to live and work in Possession G and 
has a closer connection to Possession G than to the United States or 
any foreign country. As a consequence of his employment in 
Possession G, B earns income from the performance of services in 
Possession G during 2008 and 2009.
    (ii) For 2008, B does not qualify as a bona fide resident of 
Possession G under section 937(a) and Sec.  1.937-1(b) and (f)(1). 
Therefore, B is subject to the rules applicable to individuals 
described in paragraph (a)(2)(iii) of this section for 2008 because 
he has income derived from sources within Possession G as determined 
under the rules of section 937(b) and Sec.  1.937-2.
    (iii) For 2009, assuming that B otherwise satisfies the 
requirements of section 937(a) and Sec.  1.937-1(b), B qualifies as 
a bona fide resident of Possession G. Therefore, section 
935(b)(1)(B) and paragraph (b)(1)(ii) of this section apply to B for 
2009, and he must file his income tax return with Possession G under 
paragraph (b)(1) of this section. Provided that B properly files 
such return and pays his income tax liability to Possession G, B is 
relieved of liability to file an income tax return with, and to pay 
an income tax to, the United States for 2009 under paragraph (b)(6) 
of this section.
    Example 2. (i) The facts are the same as in Example 1 except 
that B's employment terminates in June 2011. B properly pays his 
April 2008 estimated tax to the United States, continues to pay 
estimated tax for the 2008 taxable year to the United States under 
paragraph (d) of this section, and properly files his 2008 return 
with the United States.
    (ii)(A) On the date of each payment of estimated tax in 2009, B 
reasonably believes that he would be required to file his return for 
2009 with Possession G under paragraph (b)(1) of this section.
    (B) In August 2009, 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 2009, subtracting the $1000 
overpayment from his estimated tax payments pursuant to section 
6402(b), and properly files his tax return with Possession G.
    (iii) In April 2010, B reasonably believes that he would be 
returning to the United States in the Fall of 2010, and properly 
pays estimated tax to the United States. By June 2010, 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 
2010 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.
    (iv) In April 2011, B reasonably believes that he would be a 
bona fide resident of Possession G for the entire taxable year 2011 
and properly pays estimated taxes to Possession G. By the time B 
pays his estimated taxes for June 2011, 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 2011, properly 
filed with the United States, B determines that he has underpaid 
estimated taxes throughout 2011 in an amount subject to penalty 
under section 6654. B owes the United States an estimated tax 
penalty under section 6654.

    (g) Effective/applicability date. Paragraphs (a), (b)(1), (b)(3), 
(b)(5) through (b)(7), and (c) through (f) of this section apply to 
taxable years ending after April 9, 2008.


Sec.  1.935-1T  [Removed]

0
Par. 26. Section 1.935-1T is removed.

0
Par. 27. Section 1.937-1 is amended by revising paragraph (h)(3) and 
the heading of paragraph (i) to read as follows:


Sec.  1.937-1  Bona fide residency in a possession.

* * * * *
    (h)(3) Bona fide residents of Puerto Rico or a section 931 
possession (as defined in Sec.  1.931-1(c)(1)) who take a position for 
U.S. tax reporting purposes that they qualify as bona fide residents of 
that 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 
U.S. Virgin Islands or a section 935 possession (as defined in Sec.  
1.935-1(a)(3)(i)).
    (i) Effective/applicability date. * * *

0
Par. 28. Section 1.937-2 is added to read as follows:


Sec.  1.937-2  Income from sources within a possession.

    (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 under those provisions (relating to the determination of 
the gross and the taxable income from sources within and without the 
United States) generally will be applied in determining the gross and 
the taxable income from sources within and without the relevant 
possession. In the application of such principles, it generally will be 
sufficient to substitute, where appropriate, the name of the relevant 
possession for the term ``United States,'' and to substitute, where 
appropriate, the term ``bona fide resident of'' followed by the name of 
the relevant possession for the term ``United States resident.'' 
Furthermore, the term domestic will be construed to mean created or 
organized in the relevant possession. In applying these principles, 
additional substitutions may be necessary to accomplish the intent of 
section 937(b) and this section. For example, in applying the 
principles of sections 863(d) and (e) to individuals under this 
paragraph (b), the term ``bona fide resident of a possession'' will be 
used instead of the term ``United States person.'' In no case, however, 
will a

[[Page 19371]]

bona fide resident or other person have, as a result of the application 
of these principles, more income from sources within the relevant 
possession than the amount of income from sources within the United 
States that a similarly situated U.S. person who is not a bona fide 
resident would have under sections 861 through 865.
    (c) U.S. income--(1) In general. Except as provided in paragraph 
(d) of this section, income from sources within the relevant possession 
will not include any item of income determined under the rules of 
sections 861 through 865 and the regulations under those provisions 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 will 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) Service in the Armed Forces. In the case of a member of the 
Armed Forces of the United States, the following rules will apply for 
determining the source of compensation for services performed in 
compliance with military orders:
    (1) 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).
    (2) 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) Except to the extent an election is made 
under paragraph (f)(1)(vi) of this section, income from sources within 
the relevant possession will 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 the Tax Reform Act of 1986, Public Law 99-514 (100 
Stat. 2085) (providing that gains from the disposition of certain 
property by individuals who acquired residency in certain possessions 
will 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 will 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 will 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.
    (vi) Notwithstanding the general rule of paragraph (f)(1)(i) of 
this section and section 1277(e) of the Tax Reform Act of 1986, Public 
Law 99-514 (100 Stat. 2085), an individual described in paragraph 
(f)(1)(iii) of this section may elect to treat as gain from sources 
within the relevant possession the portion of the gain attributable to 
the individual's possession holding period. The election under this 
paragraph (f)(1)(vi) will be considered made if the individual's income 
tax return for the year of disposition of the property reports the 
portion of gain attributable to the taxpayer's possession holding 
period as determined in accordance with paragraph (f)(1)(vi)(A) or 
paragraph (f)(1)(vi)(B) of this section, as the case may be.
    (A) In the case of marketable securities, the portion of gain 
attributable to the possession holding period will be determined by 
reference to the fair market value of the marketable security at the 
close of the market on the first day of the individual's possession 
holding period. In the event that the individual is a bona fide 
resident of the relevant possession for more than a single continuous 
period, the portion of gain described in this paragraph (f)(1)(vi)(A) 
will be the aggregate of the portions of gain (or offsetting loss) 
attributable to each possession holding period.
    (B) In the case of property other than marketable securities, the 
portion of gain attributable to the possession holding period in the 
relevant possession will be determined by multiplying the total gain on 
disposition of the property by a fraction, the numerator of which is 
the number of days in the possession holding period and the denominator 
of which is the total number of days in the individual's holding period 
for the property. For purposes of the preceding sentence, in the event 
that the individual is a bona fide resident of the relevant possession 
for more than a single continuous period, the number of days in the 
numerator will be the aggregate of the number of days in each 
possession holding period. For purposes of this paragraph 
(f)(1)(vi)(B), the denominator will include days that are required to 
be included in an individual's holding period under section 735(b), 
section 1223, and any other applicable holding period rule in the 
Internal Revenue Code.
    (vii) For purposes of paragraph (f)(1)(vi) of this section--
    (A) The term marketable securities means property described in 
paragraph (f)(1)(ii) of this section that is, throughout the 
individual's holding period, actively traded within the meaning of 
Sec.  1.1092(d)-1(a); and
    (B) The term possession holding period means the part of the 
individual's holding period for the

[[Page 19372]]

property during which the individual is a bona fide resident of the 
relevant possession. However, for this purpose, the possession holding 
period will be considered to commence in all cases on the first day 
during such period that the individual does not have a tax home outside 
the relevant possession. In the event that the individual is a bona 
fide resident of the relevant possession for more than a single 
continuous period, each possession holding period prior to the one 
ending on the date of sale or other disposition will be considered to 
end on the first day that the individual has a tax home outside the 
relevant possession. With respect to the determination of tax home, see 
Sec.  1.937-1(d).
    (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) will 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) will 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 
under that section pursuant to paragraph (b) of this section, the rules 
of section 865(g) will not apply, but the special rule of section 
865(h)(2)(B) will 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) will be treated as income from sources within 
such possession. For purposes of this paragraph (g)--
    (A) The possessions source ratio will be a fraction, the numerator 
of which is 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 is 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 will 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.  1.937-3); 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 will 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 under that section pursuant to 
paragraph (b) of this section, the special rules relating to dividends 
for which deductions are allowable under section 243 or 245 will 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) will 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 will 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 will 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 will 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.  1.937-3). For purposes of the 
preceding sentence, the principles of Sec. Sec.  1.861-9 through 1.861-
12 will apply.
    (ii) Interest from corporations engaged in the active conduct of a 
trade or business in the relevant possession. The entire amount of any 
interest paid or accrued by a possessions corporation will 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 will 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 will 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) will apply except that the language ``5 percent'' 
will 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. (i) X, a U.S. citizen, resides in State N and 
acquires stock of Corporation C, a domestic corporation, in 2008 for 
$10x. X moves to the Northern Mariana Islands (NMI) on March 1, 2009 
and changes his principal place of business to NMI on that same 
date.

[[Page 19373]]

Assume for purposes of this example that, under Sec.  1.937-1(b) and 
(f)(1) (year-of-move exception), X is considered a bona fide 
resident of NMI for 2009 through 2012. On March 1, 2009, the closing 
value of X's stock in Corporation C, a marketable security (within 
the meaning of paragraph (f)(1)(vii)(A) of this section), is $20x. 
On January 3, 2012, X sells all his Corporation C stock for $70x.
    (ii) Pursuant to section 1277(e) of the Tax Reform Act of 1986, 
and absent an election under paragraph (f)(1)(vi) of this section, 
all of X's gain ($60x) will be 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 
(under paragraph (f)(1)(i) of this section) not as income from 
sources in the NMI. However, pursuant to paragraph (f)(1)(vi) of 
this section, X may elect on his 2012 income tax return filed with 
NMI to treat the portion of this gain attributable to X's possession 
holding period with respect to NMI as gain from sources within NMI. 
X's possession holding period with respect to NMI begins on March 1, 
2009, the date his tax home changes to the NMI. Under paragraph 
(f)(1)(vi)(A) of this section, the portion of X's gain attributable 
to this possession holding period is $50x, the excess of the sale 
price of the stock ($70x) over its closing value ($20x) on the first 
day of the possession holding period. By reporting $50x of gain on 
his 2012 NMI return, X will elect under paragraph (f)(1)(vi) of this 
section to treat that amount as NMI source income.
    Example 2. (i) R, a U.S. citizen, resides in State F and 
acquires a 5 percent interest in Partnership P on January 1, 2009. R 
moves to Puerto Rico on June 1, 2010 and changes her principal place 
of business to Puerto Rico on that same date. Assume for purposes of 
this example that under Sec.  1.937-1(b) and (f)(1) (year-of-move 
exception), R is considered a bona fide resident of Puerto Rico for 
2010 through 2012. On June 1, 2010, R's interest in Partnership P is 
not a marketable security within the meaning of section 731(c)(2). 
On December 31, 2012, having owned the interest in Partnership P for 
a period of 4 years (1461 days), R sells it, recognizing gain of 
$100x.
    (ii) Pursuant to paragraph (f)(1) of this section, and absent an 
election under paragraph (f)(1)(vi) of this section, the gain will 
not be treated as income from sources within Puerto Rico for 
purposes of the Internal Revenue Code (including section 933(1)). 
However, pursuant to paragraph (f)(1)(vi) of this section, R may 
elect on her 2012 return filed with the IRS to treat the portion of 
this gain attributable to R's possession holding period with respect 
to Puerto Rico as gain from sources within Puerto Rico. R's 
possession holding period with respect to Puerto Rico is the 945-day 
period from June 1, 2010, the date her tax home changes to Puerto 
Rico, through December 31, 2012, the date of sale. Under paragraph 
(f)(1)(vi)(B) of this section, the portion of R's gain attributable 
to this possession holding period is $64.68x, computed as follows:
[GRAPHIC] [TIFF OMITTED] TR09AP08.000

    (iii) By reporting $64.68x of gain on her 2012 Federal return, R 
will elect under paragraph (f)(1)(vi) of this section to treat that 
amount as Puerto Rico source income.
    Example 3. X, a bona fide resident of Possession S, a section 
931 possession (as defined in Sec.  1.931-1(c)(1)), is engaged in a 
trade or business in the United States through an office in State H. 
In 2008, this office materially participates in the sale of 
inventory property in Possession S, 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 will not be treated as income from sources within Possession 
S for purposes of section 931(a)(1) pursuant to paragraph (c)(1)(ii) 
of this section, but nonetheless will 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 2010, X receives a dividend of 
$70x from A Corp. During 2008 through 2010, A Corp has gross income 
from the following sources:

------------------------------------------------------------------------
                                                               Sources
                                                 Possession    outside
                                                 I sources    possession
                                                                  I
------------------------------------------------------------------------
2008..........................................         $10x         $20x
2009..........................................          20x          10x
2010..........................................          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 2008 
through 2010, B Corp has gross income from the following sources:

------------------------------------------------------------------------
                                                               Sources
                                                 Possession    outside
                                                 I sources    possession
                                                                  I
------------------------------------------------------------------------
2008..........................................         $10x          $6x
2009..........................................          14x           8x
2010..........................................          10x           4x
------------------------------------------------------------------------

    (iii) A Corp is treated as having received 50 percent of the 
gross income of B Corp. Therefore, for 2008 through 2010, the gross 
income of A Corp is from the following sources:

------------------------------------------------------------------------
                                                               Sources
                                                 Possession    outside
                                                 I sources    possession
                                                                  I
------------------------------------------------------------------------
2008..........................................         $15x         $23x
2009..........................................          27x          14x
2010..........................................          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 2010 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 2008, 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. 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. Under the principles 
of section 863(d)(1)(A) as applied pursuant to paragraph (b) of this 
section, the compensation that X receives for services performed in 
international waters is treated as income from sources within the 
NMI for purposes of the Internal Revenue Code (including section 
7654, as in effect with respect to the NMI). Thus, all of X's 
compensation for services during 2008 is treated as income from 
sources within the NMI.
    Example 6. X, a U.S. citizen, resides in State L and receives 
$2,500 of compensation for services performed in Possession J during 
2008 for Y, X's employer. X is temporarily present in Possession J 
in 2008 for a period (or periods) not exceeding a total of 90 days. 
Y, a U.S. citizen, is not a bona fide resident of Possession J and 
is not engaged in a trade or business within Possession J. 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 Possession J during 2008 is not treated as income from 
sources within Possession J.
    Example 7. (i) Company Y, a corporation organized in State C, 
produces, markets, and distributes music products. Y enters into a 
recording contract with Z, a recording artist who is a bona fide 
resident of the U.S. Virgin Islands (USVI). Pursuant to the contract 
between Y and Z, Z agrees to perform services as writer, musician, 
and vocalist on the recording of a new musical composition and 
related music video. Under the contract, all songs, recordings and 
related artwork, packaging copy, and liner notes, together with 
copyrights and other intellectual property in those works, are the 
sole property of Y, and Z obtains no proprietary rights in that 
property. As compensation for Z's services, all of which are 
performed at a recording studio or other locations in the USVI, Y 
agrees to pay amounts designated as

[[Page 19374]]

the ``writer's share'' to Z based on a percentage of the music 
products sold. Y also agrees to make an upfront payment to Z as an 
advance against future portions of Z's writer's share.
    (ii) To the extent that Z performs personal services within the 
USVI, the compensation that Z receives for his services is sourced 
to the USVI under the principles of section 861(a)(3) and Sec.  
1.861-4 as applied pursuant to Sec.  1.937-2(b). If all of Z's 
services are performed in the USVI, none of the writer's share is 
derived from sources within the United States under section 
861(a)(3) and Sec.  1.861-4, nor is it effectively connected with 
the conduct of a trade or business in the United States under 
section 864(c)(3). Accordingly, the U.S. income rule of section 
937(b)(2) and paragraph (c)(1) of this section would not operate to 
prevent Z's services income from being USVI source or USVI 
effectively connected income within the meaning of section 
937(b)(1). If Z also performs services in the United States, 
however, then the U.S. income rule would apply to the part of Z's 
compensation that is sourced to the United States under section 
861(a)(3) and Sec.  1.861-4. In the event that Y and Z are 
controlled taxpayers within the meaning of Sec.  1.482-1(i)(5), 
section 482 and the regulations under that section, including Sec.  
1.482-9T(i), would apply to evaluate the arm's length amount charged 
for Z's controlled services.

    (l) Effective/applicability dates. Except as otherwise provided in 
this paragraph (l), this section applies to income earned in taxable 
years ending after April 9, 2008. Taxpayers may choose to apply 
paragraph (b) of this section to income earned in open taxable years 
ending after October 22, 2004. Taxpayers may choose to apply paragraph 
(f)(1) of this section to dispositions made after April 11, 2005.


Sec.  1.937-2T  [Removed]

0
Par. 29. Section 1.937-2T is removed.

0
Par. 30. Section 1.937-3 is added to read as follows:


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

    (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 
under that section (relating to the determination of income, gain or 
loss that is effectively connected with the conduct of a trade or 
business within the United States) generally will be applied in 
determining whether income is effectively connected with the conduct of 
a trade or business within the relevant possession, without regard to 
whether the taxpayer qualifies as a nonresident alien individual or a 
foreign corporation with respect to such possession. Subject to the 
rules of this section, the principles of section 864(c)(4) will apply 
for purposes of determining whether income from sources without the 
relevant possession is effectively connected with the conduct of a 
trade or business in the relevant possession. For purposes of the 
preceding sentence, all income other than income from sources within 
the relevant possession (as determined under the rules of Sec.  1.937-
2) will be considered income from sources without the relevant 
possession in the application of the principles of section 864(c) under 
this paragraph (b), it generally will be sufficient to substitute the 
name of the relevant possession for the term ``United States'' where 
appropriate, but additional substitutions may be necessary to 
accomplish the intent of section 937(b) and this section. In no case, 
however, will a bona fide resident or other person have, as a result of 
the application of these principles, more income effectively connected 
with the conduct of a trade or business in the relevant possession than 
the amount of U.S. effectively connected income that a similarly 
situated U.S. person who is not a bona fide resident would have under 
section 864(c).
    (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 will 
not include any item of income determined under the rules of sections 
861 through 865 and the regulations under those provisions 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 will 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 will 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.  1.931-1(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.  1.937-2(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 will 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

[[Page 19375]]

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 will 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.
    Example 4. (i) Corporation A, a corporation organized in 
Possession X, is engaged in a business consisting of the development 
of computer software and the sale of that software. Corporation A 
has its sole place of business in Possession X and is not engaged in 
the conduct of a trade or business in the United States. Corporation 
A receives orders for its software from customers in the United 
States and around the world. After orders are accepted, Corporation 
A's software is either loaded onto compact discs at Corporation A's 
Possession X facility and shipped via common carrier, or downloaded 
from Corporation A's server in Possession X. The sales contract 
provides that the rights, title, and interest in the product will 
pass from Corporation A to the customer either at Corporation A's 
place of business in Possession X (if shipped in compact disc form) 
or at Corporation A's server in Possession X (if electronically 
downloaded). Assume for purposes of this example that each 
transaction is classified as a sale of a copyrighted article under 
Sec.  1.861-18(c)(1)(ii) and (f)(2).
    (ii) Under the principles of section 863(a), as applied pursuant 
to Sec.  1.937-2(b), because Corporation A passes the rights, title, 
and interest to the copyrighted articles in Possession X, 
Corporation A's sales income is sourced to Possession X. Corporation 
A's sales income is also effectively connected with the conduct of a 
trade or business in Possession X, under the principles of section 
864(c)(3) as applied pursuant to Sec.  1.937-3(b). Corporation A's 
income is not from sources within the United States, nor is it 
effectively connected with the conduct of a trade or business in the 
United States. Accordingly, the U.S. income rule of section 
937(b)(2), Sec.  1.937-2(c)(1), and paragraph (c)(1) of this section 
does not operate to prevent Corporation A's sales income from being 
Possession X source and Possession X effectively connected income 
under section 937(b)(1).
    Example 5. (i) Corporation B, a corporation organized in 
Possession X, has its sole place of business in Possession X and is 
not engaged in the conduct of a trade or business in the United 
States. Corporation B employs a software business model generally 
referred to as an application service provider. Employees of 
Corporation B in Possession X develop software and maintain it on 
Corporation B's server in Possession X. Corporation B's customers in 
the United States and around the world transmit detailed data about 
their own customers to Corporation B's server and electronic storage 
facility in Possession X. The customers pay a monthly fee to 
Corporation B under a Subscription Agreement, and they can use the 
software to generate reports analyzing the data at any time but do 
not receive a copy of the software. Corporation B's software allows 
its customers to generate the reports from their location and to 
keep track of their relationships with their own customers. Assume 
for purposes of this example that Corporation B's income from these 
transactions is derived from the provision of services.
    (ii) Under the principles of section 861(a)(3) and Sec.  1.861-
4(a), as applied pursuant to Sec.  1.937-2(b), because Corporation B 
performs personal services wholly within Possession X, the 
compensation Corporation B receives for services is sourced to 
Possession X. Corporation B's services income is also effectively 
connected with the conduct of a trade or business in Possession X, 
under the principles of section 864(c)(3) as applied pursuant to 
Sec.  1.937-3(b). Corporation B's income is not from sources within 
the United States, nor is it effectively connected with the conduct 
of a trade or business in the United States. Accordingly, the U.S. 
income rule of section 937(b)(2), Sec.  1.937-2(c)(1), and paragraph 
(c)(1) of this section does not operate to prevent Corporation B's 
services income from being Territory X source or Possession X 
effectively connected income within the meaning of section 
937(b)(1).

    (f) Effective/applicability date. Except as otherwise provided in 
this paragraph (f), this section applies to income earned in taxable 
years ending after April 9, 2008. Taxpayers may choose to apply 
paragraph (b) of this section to income earned in open taxable years 
ending after October 22, 2004.


Sec.  1.937-3T  [Removed]

0
Par. 31. Section 1.937-3T is removed.

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


Sec.  1.957-3  United States person defined.

    (a) Basic rule--(1) In general. The term United States person has 
the same meaning for purposes of sections 951 through 965 that it has 
under section 7701(a)(30) and the regulations under that section, 
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 Puerto Rico or 
any section 931 possession;
    (ii) The term section 931 possession has the same meaning that it 
has under Sec.  1.931-1(c)(1);
    (iii) The rules of Sec.  1.937-1 will apply for determining whether 
an individual is a bona fide resident of a possession of the United 
States;
    (iv) Except as provided in paragraph (b)(2) of this section, the 
rules of Sec.  1.937-2 will apply for determining whether income is 
from sources within a possession of the United States; and
    (v) The rules of Sec.  1.937-3 will 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

[[Page 19376]]

regard to this paragraph (b), is a United States person) will 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 that 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. For purposes of this paragraph (b)(2), the rules of Sec.  1.937-
2(g)(1) will not apply.
    (c) Section 931 possession corporation and resident. An individual 
(who, without regard to this paragraph (c), is a United States person) 
will 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 that 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/applicability date. This section applies to taxable 
years ending after April 9, 2008.


Sec.  1.957-3T  [Removed]

0
Par. 33. Section 1.957-3T is removed.

0
Par. 34. 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.

    (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) will 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/applicability date. This section applies to taxable 
years ending after April 9, 2008.


Sec.  1.1402(a)-12T  [Removed]

0
Par. 35. Section 1.1402(a)-12T is removed.

0
Par. 36. Section 1.6012-1 is amended by revising paragraph (a)(1)(iii) 
to read as follows:


Sec.  1.6012-1  Individuals required to make returns of information.

    (a) * * *
    (1) * * *
    (iii) An alien bona fide resident of Puerto Rico or any section 931 
possession, as defined in Sec.  1.931-1(c)(1), during the entire 
taxable year.
* * * * *

0
Par. 37. Section 1.6038-2 is amended by revising paragraph (d) and 
adding a new sentence at the end of the paragraph (m) 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) 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.--
(i) With respect to an individual who is a bona fide resident of Puerto 
Rico, the term United States person has the meaning assigned to it by 
Sec.  1.957-3 except that the rules of Sec.  1.937-2(g)(1) will apply.
    (ii) With respect to an individual who is a bona fide resident of 
any section 931 possession, as defined in Sec.  1.931-1(c)(1), the term 
United States person has the meaning assigned to it by Sec.  1.957-3.
    (3) Special rule for certain nonresident aliens. An individual for 
whom an election under section 6013(g) or (h) is in effect will, 
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.
* * * * *
    (m) * * * Paragraph (d) of this section applies to taxable years 
ending after April 9, 2008.


Sec.  1.6038-2T  [Removed]

0
Par. 38. Section 1.6038-2T, is removed.

0
Par. 39. Section 1.6046-1 is amended by revising paragraph (f)(3) and 
adding a new paragraph (l) to read as follows:


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

* * * * *
    (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.--(A) With respect to an individual who is a bona fide 
resident of Puerto Rico, the term United States person has the meaning 
assigned to it by Sec.  1.957-3 except that the rules of Sec.  1.937-
2(g)(1) will apply.
    (B) With respect to individuals who are bona fide residents of any 
section 931 possession, as defined in Sec.  1.931-1(c)(1), the term 
United States person has the meaning assigned to it by Sec.  1.957-3.
    (iii) Special rule for certain nonresident aliens. An individual 
for whom an election under section 6013(g) or (h) is in effect will, 
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.
* * * * *
    (l) Effective/applicability date. Paragraph (f)(3) of this section 
applies to taxable years ending after April 9, 2008.


Sec.  1.6046-1T  [Removed]

0
Par. 40. Section 1.6046-1T is removed.

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 41. The authority citation for part 301 continues to read, in 
part, as follows:

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


0
Par. 42. Section 301.6688-1 is revised to read as follows:

[[Page 19377]]

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

    (a) In general. Each individual described in section 7654(a) 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 
must, 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 requirement for an individual to file Form 8898, 
``Statement for Individuals who Begin or End Bona Fide Residence in a 
U.S. Possession,'' under Sec.  1.937-1(h) of this chapter, to report 
that he or she became or ceased to be a bona fide resident of a 
possession.
    (b) Manner of payment. The penalty set forth in paragraph (a) of 
this section must be paid in the same manner as tax upon the issuance 
of a notice and demand for the penalty.
    (c) Reasonable cause--(1) In general. The penalty set forth in 
paragraph (a) of this section will 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. This statement must be filed with 
Internal Revenue Service Center where Form 8898 must be filed. 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.
    (d) Effective/applicability date. This section applies to taxable 
years ending after April 9, 2008.


Sec.  301.6688-1T  [Removed]

0
Par. 43. Section 301.6688-1T is removed.

0
Par. 44. Section 301.7701(b)-1 is amended by revising paragraph (d) to 
read as follows:


Sec.  301.7701(b)-1  Resident alien.

* * * * *
    (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 Federal income tax purposes. 
For the applicable rules for making this determination, see section 
937(a) and Sec.  1.937-1 of this chapter.
* * * * *


Sec.  301.7701(b)-1T  [Removed]

0
Par. 45. Section 301.7701(b)-1T is removed.

0
Par. 46. Section 301.7701(b)-9 is amended by revising the section 
heading and adding new paragraph (b)(5) to read as follows:


Sec.  301.7701(b)-9  Effective/applicability dates of Sec. Sec.  
301.7701(b)-1 through 301.7701(b)-7.

* * * * *
    (b) * * *
    (5) Possessions and territories. For purposes of applying section 
7701(b) and the regulations under that section, Sec.  301.7701(b)-1(d) 
applies to taxable years ending after April 9, 2008.

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
    Approved: April 1, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 08-1105 Filed 4-4-08; 8:45 am]
BILLING CODE 4830-01-P