1. Chapter 16: U.S. Taxation of Foreign-Related Transactions
Forteign-Related
Transactions
Chapter 16: U.S. Taxation of Foreign-Related Transactions

2. U.S. TAX OF FOREIGN- RELATED TRANSACTIONS
Jurisdiction to tax
Taxation of U.S. citizens & residents
Taxation of nonresidents
U.S. taxation of foreign activity

3. Jurisdiction to Tax Taxpayer’s country of citizenship
Taxpayer’s country of residence
Type of income earned
Location where the income is earned

4. Taxation of U.S. Citizens and Residents
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

5. Foreign Tax Credit (FTC) (1 of 2)
FTC permits U.S. citizens and residents to avoid double taxation
Directly reduces U.S. tax liability
FTC limited to lesser of
Foreign tax actually paid OR
foreign taxable income_ U.S. tax
worldwide taxable income x liability
Source of income rules (used to determine numerator) listed on page C16-6

6. Foreign Tax Credit (FTC) (2 of 2)
Unused FTC carried back two years and forward five years on a FIFO basis to a year where taxpayer has an excess credit limitation
Special FTC limitation
Ten separate baskets of income
Foreign tax credit calculated for each basket of income
See page C16-7 for partial list of baskets

7. Foreign Earned Income Exclusion (FEI) (1 of 4)
FEI available to U.S. citizens and resident aliens working abroad
Eligibility
Bona fide resident test
Present in foreign country uninterrupted for entire tax year and maintain tax home in foreign country

8. Foreign Earned Income Exclusion (FEI) (2 of 4)
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 during that period
Foreign earned income
Wages, salaries, & fees as compensation for personal services actually rendered

9. Foreign Earned Income Exclusion (FEI) (3 of 4)
Amount of exclusion
Lesser of
$80,000, OR
Foreign earned income for current year, OR
$ x no. of qualifying days in current year
Exclusion for taxable housing allowance
Limitation lesser of
Actual housing amount included in income, OR
$10,842 (2002) x (qualifying days/365)

10. Foreign Earned Income Exclusion (FEI) (4 of 4)
Housing allowance (continued)
Housing costs incurred in excess of $10,842 are a for AGI deduction
Housing allowance exclusion reduces amount eligible for FEI
FTC and FEI are mutually exclusive
Claim either the FTC or the FEI on foreign earned income, but not both

11. Taxation of Nonresidents (1 of 5)
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

12. Taxation of Nonresidents (2 of 5)
Resident alien tests
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

13. Taxation of Nonresidents (3 of 5)
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
Income exempt from U.S. taxation
Non-USToB capital gains if individual physically present < 183 days during year

14. Taxation of Nonresidents (4 of 5)
Exempt income (continued)
Non-USToB interest from banks or other financial institutions not taxed
Portfolio interest
Income from casual sale of personal property
Individuals must itemize deductions

15. Taxation of Nonresidents (5 of 5)
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

16. U.S. Taxation of Foreign Activity
Domestic corporations
Foreign corporations
Deemed paid foreign tax credit
Controlled foreign corporations
Foreign Sales Corporations
Puerto Rico and U.S. possessions corporations

17. 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)

18. Foreign Corporations (1 of 2)
If domestic corp owns  10% of foreign corp, domestic corp eligible for “deemed paid credit” for dividends received from foreign corp

19. Foreign Corporations (2 of 2)
 10% domestic corp owner can also claim dividends received deduction
U.S. tax on foreign sub’s income deferred until dividends received

20. Deemed Paid Foreign Tax Credit
Deemed paid credit calculation
Div paid to domestic corp (from post 1986 undist earnings
All post 1986 undistributed earnings X
Creditable taxes paid or accrued by foreign corp
(post 1986) =
Deemed paid foreign tax credit

21. Controlled Foreign Corporations (CFC) (1 of 3)
Typical tax-avoidance scenario of a CFC

22. Controlled Foreign Corporations (CFC) (2 of 3)
CFC definition
> 50% of foreign corp stock owned by U.S. shareholders
U.S. shareholder defined as owning 10% of stock
Some income forms (Subpart F income) of the CFC are taxed in the year in which they are earned.

23. 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 is distributed tax-free.
Special rules apply to the sale or exchange of CFC stock.

24. Foreign Sales Corporations (FSC) (1 of 3)
FSC is a special export entity
Must meet certain mandated administrative and economic activity requirements.
Part or all of FSC’s foreign trade income exempt from U.S. taxation
Exempt amount based on transfer pricing method used.
May use other-than-arm’s-length pricing.

25. Foreign Sales Corporations (FSC) (2 of 3)
Dividend distributions may be eligible for a 100% dividends-received deduction.
Foreign tax credit also available for taxes withheld on dividends.
FSC status restricted to foreign corps having made FSC election before 10/1/2000.

26. Foreign Sales Corporations (FSC) (3 of 3)
In July 1999, the World Trade Organization determined that FSC export incentive is an illegal export subsidy
FSC rules replaced with extraterritorial income rules
WTO considers extraterritorial income rules an illegal export subsidy

27. Puerto Rico and U.S. Possessions Corporations
Some corps operated in Puerto Rico or U.S. possession prior to 1/1/96 can qualify for tax credit that can exempt part or all of their non-U.S. income from U.S. taxation
A new Puerto Rico Economic Activity Credit applies for tax years beginning after 12/31/1995 and before 1/1/2006

28. End of Chapter 16
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