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2. U.S. TAX OF FOREIGN- RELATED TRANSACTIONS (1 of 2)
Jurisdiction to tax
Taxation of U.S. citizens & resident aliens
Taxation of nonresident aliens
Taxation of U.S. businesses operating abroad
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3. U.S. TAX OF FOREIGN- RELATED TRANSACTIONS (2 of 2)
Tax planning considerations
Compliance and procedural Considerations
Financial statement implications
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4. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Jurisdiction to Tax
U.S. authority to tax foreign-related transactions based on three factors
Taxpayer’s country of citizenship
Taxpayer’s country of residence
Location where the income is earned
©2010 Pearson Education, Inc. Publishing as Prentice Hall

5. Taxation of U.S. Citizens and Resident Aliens
U.S. citizens and resident aliens taxed on worldwide income
Income earned in foreign countries or U.S. possessions receives special treatment
Foreign tax credit
Foreign earned exclusion
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6. Foreign Tax Credit (FTC) (1 of 5)
FTC permits U.S. citizens and residents to avoid double taxation
FTC directly reduces U.S. tax liability
Creditable taxes
Taxes paid or accrued in foreign country
U.S. citizens and residents eligible
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7. Foreign Tax Credit (FTC) (2 of 5)
Translation of foreign tax payments
Cash basis taxpayers use exchange rate on date of payment
Accrual taxpayers use average exchange rate for the year
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8. Foreign Tax Credit (FTC) (3 of 5)
FTC limited to lesser of
Foreign tax actually paid OR
foreign taxable income U.S. tax
worldwide taxable income x liability
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9. Foreign Tax Credit (FTC) (4 of 5)
FTC deducted after nonrefundable credits
Unused FTC carried back one year and forward ten years on a FIFO basis to a year where taxpayer has an excess credit limitation
Source of income rules on p. 6
Used to determine numerator of FTC formula
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10. Foreign Tax Credit (FTC) (5 of 5)
Special FTC limitation
Nine separate baskets of income
Foreign tax credit calculated for each basket of income
See pages 5 and 6 for partial list of baskets
Excess FTC from one basket cannot offset excess limitation amounts in another basket
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11. Foreign Earned Income Exclusion (FEI) (1 of 5)
FEI available to U.S. citizens and resident aliens working abroad
Eligibility
Bona fide resident test
Resident of foreign country uninterrupted for entire tax year and maintain tax home in foreign country
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12. Foreign Earned Income Exclusion (FEI) (2 of 5)
Eligibility (continued)
Physical presence test
Taxpayer must be physically present in a foreign country for 330 full days during a 12-month period, AND
Maintain a tax home in a foreign country during that period
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13. Foreign Earned Income Exclusion (FEI) (3 of 5)
Wages, salaries, & fees as compensation for personal services actually rendered
Amount of exclusion
Lesser of
$91,400, OR
Foreign earned income for current year, OR
$ ($91,400/365 days) x # of qualifying days in current year
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14. Foreign Earned Income Exclusion (FEI) (4 of 5)
Additional exclusion for taxable housing allowance
Limitation lesser of
[Actual housing cost] – [16% x $91,400], OR
($40.065/day) x (qualifying days/365), OR
(14% x $91,400) = $12,796
Housing costs incurred in excess of $12,796 are a for AGI deduction if not provided by employer
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15. Foreign Earned Income Exclusion (FEI) (5 of 5)
Housing allowance exclusion (continued)
Allowance limited to lesser of employer-provided amount or the individual’s FEI
Housing allowance exclusion reduces amount eligible for FEI exclusion
You can claim either the FTC or FEI exclusion on foreign earned income, but not both
©2010 Pearson Education, Inc. Publishing as Prentice Hall

16. Taxation of Nonresident Aliens
Resident/nonresident definitions
Investment income
Trade or business income
Calculating US income tax
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17. Resident/Nonresident Definitions (1 of 2)
Resident aliens are taxed same as U.S. citizens
Nonresident aliens generally taxed only on U.S. source income
Taxpayer is a resident alien if they meet one of the two tests
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18. Resident/Nonresident Definitions (2 of 2)
Green-card test
Permanent resident w/ “green card” visa
Physical presence test
Present  31 days during current calendar year AND present  183 weighted average days during a three year period
Current year: 1 day counted as 1 day
Prior year: 1 day counted as 1/3 day
2nd prior year: 1 day counted as 1/6 day
©2010 Pearson Education, Inc. Publishing as Prentice Hall

19. Investment Income (1 of 2)
Most U.S. source passive or investment income is taxed at 30%
30% applied to gross amount
U.S. payer must withhold tax
U.S. payer responsible for tax if not withheld
Tax rate often reduced by tax treaties
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20. Investment Income (2 of 2)
Income exempt from U.S. taxation
Non-USToB capital gains if individual physically present < 183 days during year
Non-USToB interest from banks or other financial institutions not taxed
Portfolio interest
Income from casual sale of personal property
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21. Trade or Business Income
U.S. Trade or business (USToB)
Conducting business in US on regular basis with intent to make a profit
Income exempt from US tax if
In U.S. <90 days/yr, employed by nonresident entity, and earn <$3,000
Real estate income may be treated as USToB instead of passive income
©2010 Pearson Education, Inc. Publishing as Prentice Hall

22. Calculating U.S. Income Tax
Individuals must itemize deductions
Cannot claim standard deduction
Normal deductions apply for items “effectively connected” to a USToB
Gains from real property considered “effected connected” to a USToB
Tax treaties often reduce or eliminate U.S. for many types of income
©2010 Pearson Education, Inc. Publishing as Prentice Hall

23. Taxation of U.S. Businesses Operating Abroad
Domestic corps & Foreign branches
Foreign corporations
Deemed paid foreign tax credit
Controlled foreign corporations
Inversions
§482 rules and tax avoidance
Foreign Sales Corporations & Extra-territorial Income Exclusion
©2010 Pearson Education, Inc. Publishing as Prentice Hall

24. Domestic Corporations
Domestic subsidiary corporations
Can file consolidated return w/parent
Parent protected from foreign creditors of subsidiary
Foreign branches
Income and losses taxed currently
Eligible for direct FTC (described earlier)
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25. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Foreign Corporations
If domestic corp owns  10% of foreign corp, domestic corp eligible for “deemed paid credit” for dividends received from foreign corp
 10% domestic corp owner cannot claim DRD on non-USToB earnings
U.S. tax on foreign sub’s income deferred until dividends received
©2010 Pearson Education, Inc. Publishing as Prentice Hall

26. Deemed Paid Foreign Tax Credit
Separate basket if own ≥ 10% & ≤ 50%
Called Sec. 902 or 10/50 dividends
Div paid to domestic corp from undistrib earnings
All undistributed earnings X
Creditable taxes paid or accrued by foreign corp =
Deemed paid foreign tax credit
__________________
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27. Controlled Foreign Corporations (CFC) (1 of 3)
Typical tax-avoidance scenario of a CFC
U.S.
Manufacturing
Corporation
(Chicago)
Foreign Sales
Subsidiary
(Island Corporation)
Foreign
Purchasers
of U.S.
Manufacturer’s
Products
Physical flow of goods
Billing of tax haven sales subsidiary by U.S. manufacturer
Billing of foreign purchasers by tax haven sales subsidiary
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28. Controlled Foreign Corporations (CFC) (2 of 3)
CFC definition
> 50% of foreign corp stock owned by U.S. shareholders
U.S. shareholder defined if owns 10% of stock
Some income forms (Subpart F income) of the CFC are taxed in the year in which they are earned
See Figure 2
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29. Controlled Foreign Corporations (CFC) (3 of 3)
Tax-deferred earnings can be taxed under Subpart F when invested in U.S. property
Previously taxed income distributed tax-free
Special rules apply to the sale or exchange of CFC stock
©2010 Pearson Education, Inc. Publishing as Prentice Hall

30. §482 Rules & Tax Avoidance (1 of 3)
Tax avoidance opportunity high for domestic parent and 100% owned subsidiary (see slide 16-26)
U.S. parent sells goods/services at less than FMV to 100% foreign sub, OR
Foreign sub pays less than FMV for use of U.S. parent’s intangibles (e.g., patents)
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31. §482 Rules & Tax Avoidance (2 of 3)
§482 authorizes IRS to distribute, apportion, or allocate gross income, deductions, credits or allowances between or among controlled entities
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32. §482 Rules & Tax Avoidance (3 of 3)
§482 Regs hold that transactions between entities must meet arm’s-length standard
Consistent w/ transactions between uncontrolled entities
Comparable transaction under comparable circumstances
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33. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Inversions (1 of 3)
U.S. corps subject to U.S. tax on world- wide (WW) income, while foreign corps only taxed on U.S. source income
This encourages U.S. corps with substantial foreign-source income to reorganize in a foreign country through an inversion
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34. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Inversions (2 of 3)
Basics of inversions
U.S. corp merges into a foreign entity or transfers its assets to a foreign entity
Owners of U.S. corp exchange U.S. corp’s stock for equity in foreign entity
Same owners continue to conduct both U.S. and foreign business through the new foreign entity, but only U.S. source business subject to U.S. taxation
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35. ©2010 Pearson Education, Inc. Publishing as Prentice Hall
Inversions (3 of 3)
§§367 & 7874 added to prevent erosion of U.S. tax base
Under §367 a foreign corp (FC) will be deemed to be a U.S. corp if
FC acquired all assets of U.S. corp
Former U.S. corp s/hs own ≥80% of FC &
FC does not conduct much business in foreign country of incorporation
©2010 Pearson Education, Inc. Publishing as Prentice Hall

36. Tax Planning Considerations (1 of 2)
Deduction vs. credit for foreign taxes
Deduction may be beneficial when taxpayer has foreign losses or when credit is limited
Election to accrue foreign taxes
Cash method taxpayers can elect to accrue foreign taxes
Binding for all tax years and can only be revoked with IRS consent
©2010 Pearson Education, Inc. Publishing as Prentice Hall

37. Tax Planning Considerations (2 of 2)
Special earned income elections
Taxpayers may revoke election to exclude foreign-earned income when
Employed in foreign country where foreign tax rate > U.S. tax rate OR
Taxpayer incurs substantial loss from overseas employment
©2010 Pearson Education, Inc. Publishing as Prentice Hall

38. Compliance and Procedural Considerations (1 of 2)
Foreign operations of U.S. corp
Form 1120 Schedule N
Foreign tax credit
Form 1118 (corp), Form 1116 (individual)
Foreign earned income exclusion
Form 2555 or 2555-EZ
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39. Compliance and Procedural Considerations (2 of 2)
Nonresident aliens
Form 1040-NR
Foreign corporations
Form 1120-F
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40. Financial Statement Implications (1 of 2)
Foreign tax credit
Excess FTC creates deferred tax asset
Deferred foreign earnings
Normally would create a deferred tax asset
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41. Financial Statement Implications (2 of 2)
Deferred foreign earnings (continued)
SFAS No. 109 adopts APB No. 23 exception for indefinite reinvestment
No deferred tax asset unless temporary difference expected to reverse in forseable future
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42. ©2010 Pearson Education, Inc. Publishing as Prentice Hall