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Irs gov 2. Irs gov   Possession Source Income Table of Contents Types of IncomeCompensation for Labor or Personal Services Investment Income Sales or Other Dispositions of Property Scholarships, Fellowships, Grants, Prizes, and Awards Effectively Connected Income In order to determine where to file your return and which form(s) you need to complete, you must determine the source of each item of income you received during the tax year. Irs gov Income you received from sources within, or that was effectively connected with the conduct of a trade or business within, the relevant possession must be identified separately from U. Irs gov S. Irs gov or foreign source income. Irs gov This chapter discusses the rules for determining if the source of your income is from: American Samoa, The Commonwealth of the Northern Mariana Islands (CNMI), The Commonwealth of Puerto Rico (Puerto Rico), Guam, or The U. Irs gov S. Irs gov Virgin Islands (USVI). Irs gov Generally, the same rules that apply for determining U. Irs gov S. Irs gov source income also apply for determining possession source income. Irs gov However, there are some important exceptions to these rules. Irs gov Both the general rules and the exceptions are discussed in this chapter. Irs gov U. Irs gov S. Irs gov income rule. Irs gov   This rule states that income is not possession source income if, under the rules of Internal Revenue Code sections 861–865, it is treated as income: From sources within the United States, or Effectively connected with the conduct of a trade or business within the United States. Irs gov Table 2-1 shows the general rules for determining whether income is from sources within the United States. Irs gov Table 2-1. Irs gov General Rules for Determining U. Irs gov S. Irs gov Source of Income Item of Income Factor Determining Source Salaries, wages, and other compensation for labor or personal services Where labor or services performed Pensions Contributions: Where services were performed that earned the pension Investment earnings: Where pension trust is located Interest Residence of payer Dividends Where corporation created or organized Rents Location of property Royalties:   Natural resources Location of property Patents, copyrights, etc. Irs gov Where property is used Sale of business inventory—purchased Where sold Sale of business inventory—produced Allocation if produced and sold in different locations Sale of real property Location of property Sale of personal property Seller's tax home (but see Special Rules for Gains From Dispositions of Certain Property , later, for exceptions) Sale of natural resources Allocation based on fair market value of product at export terminal. Irs gov For more information, see Regulations section 1. Irs gov 863-1(b). Irs gov Types of Income This section looks at the most common types of income received by individuals, and the rules for determining the source of the income. Irs gov Generally, the same rules shown in Table 2-1 are used to determine if you have possession source income. Irs gov Compensation for Labor or Personal Services Income from labor or personal services includes wages, salaries, commissions, fees, per diem allowances, employee allowances and bonuses, and fringe benefits. Irs gov It also includes income earned by sole proprietors and general partners from providing personal services in the course of their trade or business. Irs gov Services performed wholly within a relevant possession. Irs gov   Generally, all pay you receive for services performed in a relevant possession is considered to be from sources within that possession. Irs gov However, there is an exception for income earned as a member of the U. Irs gov S. Irs gov Armed Forces or a civilian spouse. Irs gov U. Irs gov S. Irs gov Armed Forces. Irs gov   If you are a bona fide resident of a relevant possession, your military service pay will be sourced in that possession even if you perform the services in the United States or another possession. Irs gov However, if you are not a bona fide resident of a possession, your military service pay will be income from the  United States even if you perform services in a possession. Irs gov Civilian spouse of active duty member of the U. Irs gov S. Irs gov Armed Forces. Irs gov   If you are a bona fide resident of a U. Irs gov S. Irs gov possession and choose to keep that possession as your tax residence under MSRRA when relocating with your servicemember spouse under military orders, the source of income for your labor or personal services is considered to be that possession. Irs gov Likewise, if your tax residence is in one of the 50 states or the District of Columbia before relocating and you choose to keep it as your tax residence, the source of income for services performed in any of the U. Irs gov S. Irs gov possessions is considered to be the United States and, specifically, your state of residence or the District of Columbia. Irs gov Services performed partly inside and partly outside a relevant possession. Irs gov   If you are an employee and receive compensation for labor or personal services performed both inside and outside the relevant possession, special rules apply in determining the source of the compensation. Irs gov Compensation (other than certain fringe benefits) is sourced on a time basis. Irs gov Certain fringe benefits (such as housing and education) are sourced on a geographical basis. Irs gov   Or, you may be permitted to use an alternative basis to determine the source of compensation. Irs gov See Alternative basis , later. Irs gov   If you are self-employed, determine the source of your income for labor or personal services from self-employment on the basis that most correctly reflects the proper source of that income under the facts and circumstances of your particular case. Irs gov In many cases, the facts and circumstances will call for an apportionment on a time basis as explained next. Irs gov Time basis. Irs gov   Use a time basis to figure your compensation for labor or personal services from the relevant possession (other than the fringe benefits discussed later). Irs gov Do this by multiplying your total compensation (other than the fringe benefits discussed later) by the following fraction:   Number of days you performed  services in the relevant  possession during the year     Total number of days you  performed services during the year           You can use a unit of time less than a day in the above fraction, if appropriate. Irs gov The time period for which the income is made does not have to be a year. Irs gov Instead, you can use another distinct, separate, and continuous time period if you can establish to the satisfaction of the IRS that this other period is more appropriate. Irs gov Example. Irs gov In 2013, you worked in your employer's office in the United States for 60 days and in the Puerto Rico office for 180 days, earning a total of $80,000 for the year. Irs gov Your Puerto Rico source income is $60,000, figured as follows. Irs gov       180 days 240 days × $80,000 = $60,000                 Multi-year compensation. Irs gov   The source of multi-year compensation is generally determined on a time basis over the period to which the compensation is attributable. Irs gov Multi-year compensation is compensation that is included in your income in 1 tax year but is attributable to a period that includes 2 or more tax years. Irs gov You determine the period to which the income is attributable based on the facts and circumstances of your case. Irs gov For more information on multi-year compensation, see Treasury Decision (T. Irs gov D. Irs gov ) 9212 and Regulations section 1. Irs gov 861-4, 2005-35 I. Irs gov R. Irs gov B. Irs gov 429, available at www. Irs gov irs. Irs gov gov/irb/2005-35_IRB/ar14. Irs gov html. Irs gov Certain fringe benefits sourced on a geographical basis. Irs gov   If you received any of the following fringe benefits as compensation for labor or services performed as an employee partly inside and partly outside a relevant possession, you must source that income on a geographical basis. Irs gov Housing. Irs gov Education. Irs gov Local transportation. Irs gov Tax reimbursement. Irs gov Hazardous or hardship duty pay. Irs gov Moving expense reimbursement. Irs gov For information on determining the source of the fringe benefits listed above, see Regulations section 1. Irs gov 861-4. Irs gov Alternative basis. Irs gov   You can determine the source of your compensation under an alternative basis if you establish to the satisfaction of the IRS that, under the facts and circumstances of your case, the alternative basis more properly determines the source of your income than the time or geographical basis. Irs gov If you use an alternative basis, you must keep (and have available for inspection) records to document why the alternative basis more properly determines the source of your income. Irs gov De minimis exception. Irs gov   There is an exception to the rule for determining the source of income earned in a possession. Irs gov Generally, you will not have income from a possession if during a tax year you: Are a U. Irs gov S. Irs gov citizen or resident, Are not a bona fide resident of that possession, Are not employed by or under contract with an individual, partnership, or corporation that is engaged in a trade or business in that possession, Temporarily perform services in that possession for 90 days or less, and Earned $3,000 or less from such services. Irs gov This exception began with income earned during your 2008 tax year. Irs gov Pensions. Irs gov   Generally, pension income has two components: contributions to the pension plan and the earnings accrued from investing those contributions. Irs gov The contribution portion is sourced according to where services were performed that earned the pension. Irs gov The investment earnings portion is sourced according to the location of the pension trust. Irs gov Example. Irs gov You are a U. Irs gov S. Irs gov citizen who worked in Puerto Rico for a U. Irs gov S. Irs gov company. Irs gov All services were performed in Puerto Rico. Irs gov Upon retirement you remained in Puerto Rico and began receiving your pension from the U. Irs gov S. Irs gov pension trust of your employer. Irs gov Distributions from the U. Irs gov S. Irs gov pension trust must be allocated between (1) contributions, which are Puerto Rico source income, and (2) investment earnings, which are U. Irs gov S. Irs gov source income. Irs gov Investment Income This category includes such income as interest, dividends, rents, and royalties. Irs gov Interest income. Irs gov   The source of interest income is generally determined by the residence of the payer. Irs gov Interest paid by corporations created or organized in a relevant possession (possession corporation) or by individuals who are bona fide residents of a relevant possession is considered income from sources within that possession. Irs gov   However, there is an exception to this rule if you are a bona fide resident of a relevant possession, receive interest from a corporation created or organized in that possession, and are a shareholder of that corporation who owns, directly or indirectly, at least 10% of the total voting stock of the corporation. Irs gov See Regulations section 1. Irs gov 937-2(i) for more information. Irs gov Dividends. Irs gov   Generally, dividends paid by a corporation created or organized in a relevant possession will be considered income from sources within that possession. Irs gov There are additional rules for bona fide residents of a relevant possession who receive dividend income from possession corporations, and who own, directly or indirectly, at least 10% of the voting stock of the corporation. Irs gov For more information, see Regulations section 1. Irs gov 937-2(g). Irs gov Rental income. Irs gov   Rents from property located in a relevant possession are treated as income from sources within that possession. Irs gov Royalties. Irs gov   Royalties from natural resources located in a relevant possession are considered income from sources within that possession. Irs gov   Also considered possession source income are royalties received for the use of, or for the privilege of using, in a relevant possession, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property. Irs gov Sales or Other Dispositions of Property The source rules for sales or other dispositions of property are varied. Irs gov The most common situations are discussed below. Irs gov Real property. Irs gov   Real property includes land and buildings, and generally anything built on, growing on, or attached to land. Irs gov The location of the property generally determines the source of income from the sale. Irs gov For example, if you are a bona fide resident of Guam and sell your home that is located in Guam, the gain on the sale is sourced in Guam. Irs gov If, however, the home you sold was located in the United States, the gain is U. Irs gov S. Irs gov source income. Irs gov Personal property. Irs gov   The term “personal property” refers to property (such as machinery, equipment, or furniture) that is not real property. Irs gov Generally, gain (or loss) from the sale or other disposition is sourced according to the seller's tax home. Irs gov If personal property is sold by a bona fide resident of a relevant possession, the gain (or loss) from the sale is treated as sourced within that possession. Irs gov   This rule does not apply to the sale of inventory, intangible property, depreciable personal property, or property sold through a foreign office or fixed place of business. Irs gov The rules applying to sales of inventory are discussed below. Irs gov For information on sales of the other types of property mentioned, see Internal Revenue Code section 865. Irs gov Inventory. Irs gov   Your inventory is personal property that is stock in trade or that is held primarily for sale to customers in the ordinary course of your trade or business. Irs gov The source of income from the sale of inventory depends on whether the inventory was purchased or produced. Irs gov Purchased. Irs gov   Income from the sale of inventory that you purchased is sourced where you sell the property. Irs gov Generally, this is where title to the property passes to the buyer. Irs gov Produced. Irs gov   Income from the sale of inventory that you produced in a relevant possession and sold outside that possession (or vice versa) is sourced based on an allocation. Irs gov For information on making the allocation, see Regulations section 1. Irs gov 863-3(f). Irs gov Special Rules for Gains From Dispositions of Certain Property There are special rules for gains from dispositions of certain investment property (for example, stocks, bonds, debt instruments, diamonds, and gold) owned by a U. Irs gov S. Irs gov citizen or resident alien prior to becoming a bona fide resident of a possession. Irs gov You are subject to these special rules if you meet both of the following conditions. Irs gov For the tax year for which the source of the gain must be determined, you are a bona fide resident of the relevant possession. Irs gov For any of the 10 years preceding that year, you were a citizen or resident alien of the United States (other than a bona fide resident of the relevant possession). Irs gov If you meet these conditions, gains from the disposition of this property will not be treated as income from sources within the relevant possession for purposes of the Internal Revenue Code. Irs gov Accordingly, bona fide residents of American Samoa and Puerto Rico, for example, may not exclude the gain on their U. Irs gov S. Irs gov tax return. Irs gov (See chapter 3 for additional filing information. Irs gov ) With respect to the CNMI, Guam, and the USVI, the gain from the disposition of this property will not meet the requirements for certain tax rules that may allow bona fide residents of those possessions to reduce or obtain a rebate of taxes on income from sources within the relevant possessions. Irs gov These rules apply to dispositions after April 11, 2005. Irs gov For details, see Regulations section 1. Irs gov 937-2(f)(1) and Examples 1 and 2 of section 1. Irs gov 937-2(k). Irs gov Example 1. Irs gov In 2007, Cheryl Jones, a U. Irs gov S. Irs gov citizen, lived in the United States and paid $1,000 for 100 shares of stock in the Rose Corporation, a U. Irs gov S. Irs gov corporation listed on the New York Stock Exchange. Irs gov On March 1, 2010, she moved to Puerto Rico and changed her tax home to Puerto Rico on the same date. Irs gov Cheryl satisfied the presence test in 2010 and, under the year-of-move exception, she was considered a bona fide resident of Puerto Rico for the rest of 2010. Irs gov On March 1, 2010, the closing value of Cheryl's stock in the Rose Corporation was $2,000. Irs gov On January 5, 2013, while still a bona fide resident of Puerto Rico, Cheryl sold all her Rose Corporation stock for $7,000. Irs gov Under the earlier rules, none of Cheryl's $6,000 gain will be treated as income from sources within Puerto Rico. Irs gov The source rules discussed in the preceding paragraphs supplement, and may apply in conjunction with, an existing special rule. Irs gov This existing special rule applies if you are a U. Irs gov S. Irs gov citizen or resident alien who becomes a bona fide resident of American Samoa, the CNMI, or Guam, and who has gain from the disposition of certain U. Irs gov S. Irs gov assets during the 10-year period beginning when you became a bona fide resident. Irs gov The gain is U. Irs gov S. Irs gov source income that generally is subject to U. Irs gov S. Irs gov tax if the property is either (1) located in the United States; (2) stock issued by a U. Irs gov S. Irs gov corporation or a debt obligation of a U. Irs gov S. Irs gov person or of the United States, a state (or political subdivision), or the District of Columbia; or (3) property that has a basis in whole or in part by reference to property described in (1) or (2). Irs gov See chapter 3 for filing information. Irs gov Special election. Irs gov   For dispositions after April 11, 2005, you can choose to treat the part of gain (or loss) attributable to the time you held the property while a bona fide resident of the relevant possession (the possession holding period) as gain (or loss) from sources within that possession. Irs gov Make the election by reporting the gain attributable to the possession holding period on your income tax return for the year of disposition. Irs gov This election overrides both of the special rules discussed earlier. Irs gov   There are two methods for figuring the gain for the possession holding period, one for marketable securities and another for other types of investment property. Irs gov Marketable securities. Irs gov   Marketable securities are those actively traded on an established financial market, such as stock in a publicly held corporation. Irs gov Under the special election, allocate the gain (or loss) by figuring the appreciation separately for your possession and U. Irs gov S. Irs gov holding periods. Irs gov   Your possession holding period begins on the first day you do not have a tax home outside the relevant possession. Irs gov The gain (or loss) attributable to the possession holding period is the difference in fair market value of the security at the close of the market on the first and last days of this holding period. Irs gov This is your gain (or loss) that is treated as being from sources within the relevant possession. Irs gov If you were a bona fide resident of the relevant possession for more than one continuous period, combine the gains (or losses) from each possession holding period. Irs gov Example 2. Irs gov Assume the same facts as in Example 1, except that Cheryl makes the special election to allocate the gain between her U. Irs gov S. Irs gov and possession holding periods. Irs gov Cheryl's possession holding period began March 1, 2010, the date her tax home changed to Puerto Rico. Irs gov Therefore, the portion of gain attributable to her possession holding period is $5,000 ($7,000 sale price – $2,000 closing value on first day of the possession holding period). Irs gov By reporting $5,000 of her $6,000 gain as Puerto Rico source income on her 2013 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income. Irs gov Other personal property. Irs gov   For personal property other than marketable securities, use a time-based allocation. Irs gov Figure the gain (or loss) attributable to the possession holding period by multiplying your total gain (or loss) by the following fraction. Irs gov      Number of days in the  possession holding period     Total number of days  in your holding period         The result is your gain (or loss) that is treated as being from sources within the relevant possession. Irs gov Example 3. Irs gov In addition to the stock in Rose Corporation, Cheryl acquired a 5% interest in the Alder Partnership on January 1, 2009. Irs gov On March 1, 2010, when she established bona fide residency in Puerto Rico, her partnership interest was not considered a marketable security. Irs gov On September 16, 2013, while still a bona fide resident of Puerto Rico, Cheryl sold her interest in Alder Partnership for a $100,000 gain. Irs gov She had owned the interest for a total of 1,720 days. Irs gov Cheryl's possession holding period (from March 1, 2010, through September 16, 2013) is 1,296 days. Irs gov The portion of her gain attributable to Puerto Rico is $75,349 ($100,000 x (1,296 Puerto Rico days ÷ 1,720 total days)). Irs gov By reporting $75,349 of her $100,000 gain as Puerto Rico source income on her 2013 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income. Irs gov Scholarships, Fellowships, Grants, Prizes, and Awards The source of these types of income is generally the residence of the payer, regardless of who actually disburses the funds. Irs gov Therefore, in order to be possession source income, the payer must be a resident of the relevant possession, such as an individual who is a bona fide resident or a corporation created or organized in that possession. Irs gov These rules do not apply to amounts paid as salary or other compensation for services. Irs gov See Compensation for Labor or Personal Services, earlier in this chapter, for the source rules that apply. Irs gov Effectively Connected Income In limited circumstances, some kinds of income from sources outside the relevant possession must be treated as effectively connected with a trade or business in that possession. Irs gov These circumstances are listed below. Irs gov You have an office or other fixed place of business in the relevant possession to which the income can be attributed. Irs gov That office or place of business is a material factor in producing the income. Irs gov The income is produced in the ordinary course of the trade or business carried on through that office or other fixed place of business. Irs gov An office or other fixed place of business is a material factor if it significantly contributes to, and is an essential economic element in, the earning of the income. Irs gov The three kinds of income from sources outside the relevant possession to which these rules apply are the following. Irs gov Rents and royalties for the use of, or for the privilege of using, intangible personal property located outside the relevant possession or from any interest in such property. Irs gov Included are rents or royalties for the use of, or for the privilege of using, outside the relevant possession, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and similar properties if the rents or royalties are from the active conduct of a trade or business in the relevant possession. Irs gov Dividends or interest from the active conduct of a banking, financing, or similar business in the relevant possession. Irs gov Income, gain, or loss from the sale or exchange outside the relevant possession, through the office or other fixed place of business in the relevant possession, of: Stock in trade, Property that would be included in inventory if on hand at the end of the tax year, or Property held primarily for sale to customers in the ordinary course of business. Irs gov Item (3) will not apply if you sold the property for use, consumption, or disposition outside the relevant possession and an office or other fixed place of business in a foreign country was a material factor in the sale. Irs gov Example. Irs gov Marcy Jackson is a bona fide resident of American Samoa. Irs gov Her business, which she conducts from an office in American Samoa, is developing and selling specialized computer software. Irs gov A software purchaser will frequently pay Marcy an additional amount to install the software on the purchaser's operating system and to ensure that the software is functioning properly. Irs gov Marcy installs the software at the purchaser's place of business, which may be in American Samoa, in the United States, or in another country. Irs gov The income from selling the software is effectively connected with the conduct of Marcy's business in American Samoa, even though the product's destination may be outside the possession. Irs gov However, the compensation she receives for installing the software (personal services) outside of American Samoa is not effectively connected with the conduct of her business in the possession—the income is sourced where she performs the services. Irs gov Prev  Up  Next   Home   More Online Publications