Taxation of Foreign Income

Question 1

What do treaties do?

Answer 1

Override tax provisions in US tax law or foreign tax law.

Question 2

What foreign TPs are usually taxed on? US persons?

Answer 2

Foreign: Only on US source income.
US: Taxed on all income earned anywhere in the world.

Question 3

Who does “US persons” include?

Answer 3

A citizen or resident of the US, a domestic partnership, corporation, estate, or trust.

Question 4

When is earned income foreign source? US source? Employee benefits?

Answer 4

F: if earned in a foreign county.
U: if earned domestically.
This rule include employee benefits.

Question 5

Wen is unearned income foreign source?

Answer 5

When received from a foreign resident or for property that is used in a foreign country.

Question 6

Source of gain from sales: how is it determined? Exception?

Answer 6

Based on the residence of the seller.
Except:
*Inventory is sourced where title transfers.
*For depreciable property, recapture is sourced where depreciation was claimed; remaining gain is sourced where title transfers.

Question 7

Source of gain from sales: income from the sale of intangible?

Answer 7

Sourced where the amortization was claimed.

Question 8

Source of gain from sales: Income from the sale or exchange of real property?

Answer 8

Sourced based on the location of the property.

Question 9

When is interest income US source?

Answer 9

If received from:

• US government
• Noncorporate US residents
• Domestic corporations

Question 10

When does active business income of a US corporation become foreign source

Answer 10

If the corporation receives 80% or more of its active business income from foreign sources over the previous 3 yrs.

Question 11

Source of dividends? Exception?

Answer 11

• Dividends from US corporations are US source.
• From foreign corporations are foreign source.
• Exception: if a foreign corporation receives 25% or more of gross income from income connected with a US business for 3 previous tax years, the dividends is US source.

Question 12

Source of income from the use of tangible property? Intangible property?

Answer 12

T: The country in which the property is located.
I: The country in which the property is used.

Question 13

When would IRS exercise its authority to change allocation of income and deductions?

Answer 13

If it determines that TP’s methods do not clearly reflect income.

Question 14

What is the tax result when assets are transferred from US to a foreign country?

Answer 14

May trigger income, gain, and depreciation recapture applies.

Question 15

Outbound transactions: when is gain deferred? Exceptions?

Answer 15

Gain is deferred if assets are used in a trade or business outside the US.
Exceptions: If the property is:
*Inventory or unrealized receivables.
*Installments obligations
*Foreign currency

Question 16

What is controlled foreign corporations (CFC)?

Answer 16

A foreign corporation for which more than 50% of the voting power or value of stock is owned by US shareholders (limited to those who own, direct, and indirect, 10% or more of the foreign corporation) on any day of the tax year of the foreign corporation.

Question 17

CFC: tax consequences of CFC income for US shareholders?

Answer 17

Taxed on CFC income as a constructive dividend.

Question 18

CFC: Is all income taxed as constructive dividend?

Answer 18

No, only certain ones.

Question 19

CFC: what is the main type of income?

Answer 19

• Not connected economically to the country in which it is organized.
• Income from insuring the risk of loss from outside the county in which it is organized.

Question 20

Question:
B Corp is CFC for the entire tax year.
T is a US based corporation, owns 75% of B for the entire year. Both are calendar year corporations. Subpart F income is $50,000 and no distributions have been made. What is T’s constructive dividend for the tax year?

Answer 20

$50,000x75%=37,500

Question 21

World wide income has potential of double taxation. What are 3 provisions to avoid this?

Answer 21

• Foreign income taxes paid are an itemized deduction for individuals.
• Alternatively, a credit may be claimed for foreign taxes paid.
• Certain individuals can elect to exclude foreign-earned income.

Question 22

Foreign tax credit: when is credit for foreign taxes paid limited? Formula?

Answer 22

When the US effective tax rate exceeds the foreign effective rate.
Limit = US tax on worldwide income x (Foreign source taxable income/worldwide taxable income).

Question 23

Foreign tax credit computation: what must individuals add?

Answer 23

Personal exemptions to worldwide income.

Question 24

Foreign tax credit: what happens to excess foreign tax credits?

Answer 24

Can be carried back 1 yr and forward 10 yrs.

Question 25

Foreign tax credit: how is individual’s passive income treated?

Answer 25

If it does not exceed $300 ($600 for joint returns), can elect to be exempt from the foreign tax credit limitation.

Question 26

Which one is better; a foreign tax credit or a deduction?

Answer 26

Credit is generally better.

Question 27

When is deduction preferable compared to foreign tax credit?

Answer 27

When the foreign effective tax rate is high and foreign income, as compared to worldwide income, is small.

Question 28

What are 2 tests that must be met for individuals to exclude foreign income?

Answer 28

• During a continuous period that includes an entire tax year, the individual is a bona fide resident of at least one foreign country, OR
• The individual has a tax home in a foreign country and was present in one or more foreign countries for at least 330 days during any 12 consecutive months.

Question 29

Foreign income exclusion: what can qualifying individuals exclude?

Answer 29

• Foreign-earned income from personal services (wages).

* Employer provided foreign housing income.

Question 30

Foreign income exclusion: any limit?

Answer 30

Yes, indexed for inflation.

Question 31

Foreign income exclusion: what must TP do to get this benefit?

Answer 31

File an election to take the exclusion.

Question 32

Foreign income exclusion: must TP file exclusion election every year?

Answer 32

No, once it’s submitted, it’s binding for future years until revoked.

Question 33

Foreign currency gains and losses: what is the nature of these gains and losses?

Answer 33

If G/L are resulted from the normal course of business operation, ordinary.
If from investment or personal transactions, capital.

Question 34

What are 2 categories of income nonresident foreign persons are subject to US tax?

Answer 34

1. Income that is effectively connected with a US trade or business (ECI).
2. Certain passive types of US source income commonly referred to as fixed and determinable annual or periodical income (FDAP).

Question 35

When computing foreign tax credit limitation, what is other category that must be considered separately?

Answer 35

Foreign passive category income