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Www. Www.taxact.com taxact. Www.taxact.com com 2. Www.taxact.com   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. Www.taxact.com 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. Www.taxact.com S. Www.taxact.com or foreign source income. Www.taxact.com 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. Www.taxact.com S. Www.taxact.com Virgin Islands (USVI). Www.taxact.com Generally, the same rules that apply for determining U. Www.taxact.com S. Www.taxact.com source income also apply for determining possession source income. Www.taxact.com However, there are some important exceptions to these rules. Www.taxact.com Both the general rules and the exceptions are discussed in this chapter. Www.taxact.com U. Www.taxact.com S. Www.taxact.com income rule. Www.taxact.com   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. Www.taxact.com Table 2-1 shows the general rules for determining whether income is from sources within the United States. Www.taxact.com Table 2-1. Www.taxact.com General Rules for Determining U. Www.taxact.com S. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com For more information, see Regulations section 1. Www.taxact.com 863-1(b). Www.taxact.com 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. Www.taxact.com Generally, the same rules shown in Table 2-1 are used to determine if you have possession source income. Www.taxact.com 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. Www.taxact.com It also includes income earned by sole proprietors and general partners from providing personal services in the course of their trade or business. Www.taxact.com Services performed wholly within a relevant possession. Www.taxact.com   Generally, all pay you receive for services performed in a relevant possession is considered to be from sources within that possession. Www.taxact.com However, there is an exception for income earned as a member of the U. Www.taxact.com S. Www.taxact.com Armed Forces or a civilian spouse. Www.taxact.com U. Www.taxact.com S. Www.taxact.com Armed Forces. Www.taxact.com   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. Www.taxact.com 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. Www.taxact.com Civilian spouse of active duty member of the U. Www.taxact.com S. Www.taxact.com Armed Forces. Www.taxact.com   If you are a bona fide resident of a U. Www.taxact.com S. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com S. Www.taxact.com possessions is considered to be the United States and, specifically, your state of residence or the District of Columbia. Www.taxact.com Services performed partly inside and partly outside a relevant possession. Www.taxact.com   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. Www.taxact.com Compensation (other than certain fringe benefits) is sourced on a time basis. Www.taxact.com Certain fringe benefits (such as housing and education) are sourced on a geographical basis. Www.taxact.com   Or, you may be permitted to use an alternative basis to determine the source of compensation. Www.taxact.com See Alternative basis , later. Www.taxact.com   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. Www.taxact.com In many cases, the facts and circumstances will call for an apportionment on a time basis as explained next. Www.taxact.com Time basis. Www.taxact.com   Use a time basis to figure your compensation for labor or personal services from the relevant possession (other than the fringe benefits discussed later). Www.taxact.com 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. Www.taxact.com The time period for which the income is made does not have to be a year. Www.taxact.com 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. Www.taxact.com Example. Www.taxact.com 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. Www.taxact.com Your Puerto Rico source income is $60,000, figured as follows. Www.taxact.com       180 days 240 days × $80,000 = $60,000                 Multi-year compensation. Www.taxact.com   The source of multi-year compensation is generally determined on a time basis over the period to which the compensation is attributable. Www.taxact.com 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. Www.taxact.com You determine the period to which the income is attributable based on the facts and circumstances of your case. Www.taxact.com For more information on multi-year compensation, see Treasury Decision (T. Www.taxact.com D. Www.taxact.com ) 9212 and Regulations section 1. Www.taxact.com 861-4, 2005-35 I. Www.taxact.com R. Www.taxact.com B. Www.taxact.com 429, available at www. Www.taxact.com irs. Www.taxact.com gov/irb/2005-35_IRB/ar14. Www.taxact.com html. Www.taxact.com Certain fringe benefits sourced on a geographical basis. Www.taxact.com   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. Www.taxact.com Housing. Www.taxact.com Education. Www.taxact.com Local transportation. Www.taxact.com Tax reimbursement. Www.taxact.com Hazardous or hardship duty pay. Www.taxact.com Moving expense reimbursement. Www.taxact.com For information on determining the source of the fringe benefits listed above, see Regulations section 1. Www.taxact.com 861-4. Www.taxact.com Alternative basis. Www.taxact.com   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. Www.taxact.com 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. Www.taxact.com De minimis exception. Www.taxact.com   There is an exception to the rule for determining the source of income earned in a possession. Www.taxact.com Generally, you will not have income from a possession if during a tax year you: Are a U. Www.taxact.com S. Www.taxact.com 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. Www.taxact.com This exception began with income earned during your 2008 tax year. Www.taxact.com Pensions. Www.taxact.com   Generally, pension income has two components: contributions to the pension plan and the earnings accrued from investing those contributions. Www.taxact.com The contribution portion is sourced according to where services were performed that earned the pension. Www.taxact.com The investment earnings portion is sourced according to the location of the pension trust. Www.taxact.com Example. Www.taxact.com You are a U. Www.taxact.com S. Www.taxact.com citizen who worked in Puerto Rico for a U. Www.taxact.com S. Www.taxact.com company. Www.taxact.com All services were performed in Puerto Rico. Www.taxact.com Upon retirement you remained in Puerto Rico and began receiving your pension from the U. Www.taxact.com S. Www.taxact.com pension trust of your employer. Www.taxact.com Distributions from the U. Www.taxact.com S. Www.taxact.com pension trust must be allocated between (1) contributions, which are Puerto Rico source income, and (2) investment earnings, which are U. Www.taxact.com S. Www.taxact.com source income. Www.taxact.com Investment Income This category includes such income as interest, dividends, rents, and royalties. Www.taxact.com Interest income. Www.taxact.com   The source of interest income is generally determined by the residence of the payer. Www.taxact.com 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. Www.taxact.com   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. Www.taxact.com See Regulations section 1. Www.taxact.com 937-2(i) for more information. Www.taxact.com Dividends. Www.taxact.com   Generally, dividends paid by a corporation created or organized in a relevant possession will be considered income from sources within that possession. Www.taxact.com 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. Www.taxact.com For more information, see Regulations section 1. Www.taxact.com 937-2(g). Www.taxact.com Rental income. Www.taxact.com   Rents from property located in a relevant possession are treated as income from sources within that possession. Www.taxact.com Royalties. Www.taxact.com   Royalties from natural resources located in a relevant possession are considered income from sources within that possession. Www.taxact.com   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. Www.taxact.com Sales or Other Dispositions of Property The source rules for sales or other dispositions of property are varied. Www.taxact.com The most common situations are discussed below. Www.taxact.com Real property. Www.taxact.com   Real property includes land and buildings, and generally anything built on, growing on, or attached to land. Www.taxact.com The location of the property generally determines the source of income from the sale. Www.taxact.com 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. Www.taxact.com If, however, the home you sold was located in the United States, the gain is U. Www.taxact.com S. Www.taxact.com source income. Www.taxact.com Personal property. Www.taxact.com   The term “personal property” refers to property (such as machinery, equipment, or furniture) that is not real property. Www.taxact.com Generally, gain (or loss) from the sale or other disposition is sourced according to the seller's tax home. Www.taxact.com 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. Www.taxact.com   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. Www.taxact.com The rules applying to sales of inventory are discussed below. Www.taxact.com For information on sales of the other types of property mentioned, see Internal Revenue Code section 865. Www.taxact.com Inventory. Www.taxact.com   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. Www.taxact.com The source of income from the sale of inventory depends on whether the inventory was purchased or produced. Www.taxact.com Purchased. Www.taxact.com   Income from the sale of inventory that you purchased is sourced where you sell the property. Www.taxact.com Generally, this is where title to the property passes to the buyer. Www.taxact.com Produced. Www.taxact.com   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. Www.taxact.com For information on making the allocation, see Regulations section 1. Www.taxact.com 863-3(f). Www.taxact.com 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. Www.taxact.com S. Www.taxact.com citizen or resident alien prior to becoming a bona fide resident of a possession. Www.taxact.com You are subject to these special rules if you meet both of the following conditions. Www.taxact.com For the tax year for which the source of the gain must be determined, you are a bona fide resident of the relevant possession. Www.taxact.com 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). Www.taxact.com 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. Www.taxact.com Accordingly, bona fide residents of American Samoa and Puerto Rico, for example, may not exclude the gain on their U. Www.taxact.com S. Www.taxact.com tax return. Www.taxact.com (See chapter 3 for additional filing information. Www.taxact.com ) 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. Www.taxact.com These rules apply to dispositions after April 11, 2005. Www.taxact.com For details, see Regulations section 1. Www.taxact.com 937-2(f)(1) and Examples 1 and 2 of section 1. Www.taxact.com 937-2(k). Www.taxact.com Example 1. Www.taxact.com In 2007, Cheryl Jones, a U. Www.taxact.com S. Www.taxact.com citizen, lived in the United States and paid $1,000 for 100 shares of stock in the Rose Corporation, a U. Www.taxact.com S. Www.taxact.com corporation listed on the New York Stock Exchange. Www.taxact.com On March 1, 2010, she moved to Puerto Rico and changed her tax home to Puerto Rico on the same date. Www.taxact.com 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. Www.taxact.com On March 1, 2010, the closing value of Cheryl's stock in the Rose Corporation was $2,000. Www.taxact.com On January 5, 2013, while still a bona fide resident of Puerto Rico, Cheryl sold all her Rose Corporation stock for $7,000. Www.taxact.com Under the earlier rules, none of Cheryl's $6,000 gain will be treated as income from sources within Puerto Rico. Www.taxact.com The source rules discussed in the preceding paragraphs supplement, and may apply in conjunction with, an existing special rule. Www.taxact.com This existing special rule applies if you are a U. Www.taxact.com S. Www.taxact.com 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. Www.taxact.com S. Www.taxact.com assets during the 10-year period beginning when you became a bona fide resident. Www.taxact.com The gain is U. Www.taxact.com S. Www.taxact.com source income that generally is subject to U. Www.taxact.com S. Www.taxact.com tax if the property is either (1) located in the United States; (2) stock issued by a U. Www.taxact.com S. Www.taxact.com corporation or a debt obligation of a U. Www.taxact.com S. Www.taxact.com 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). Www.taxact.com See chapter 3 for filing information. Www.taxact.com Special election. Www.taxact.com   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. Www.taxact.com Make the election by reporting the gain attributable to the possession holding period on your income tax return for the year of disposition. Www.taxact.com This election overrides both of the special rules discussed earlier. Www.taxact.com   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. Www.taxact.com Marketable securities. Www.taxact.com   Marketable securities are those actively traded on an established financial market, such as stock in a publicly held corporation. Www.taxact.com Under the special election, allocate the gain (or loss) by figuring the appreciation separately for your possession and U. Www.taxact.com S. Www.taxact.com holding periods. Www.taxact.com   Your possession holding period begins on the first day you do not have a tax home outside the relevant possession. Www.taxact.com 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. Www.taxact.com This is your gain (or loss) that is treated as being from sources within the relevant possession. Www.taxact.com 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. Www.taxact.com Example 2. Www.taxact.com Assume the same facts as in Example 1, except that Cheryl makes the special election to allocate the gain between her U. Www.taxact.com S. Www.taxact.com and possession holding periods. Www.taxact.com Cheryl's possession holding period began March 1, 2010, the date her tax home changed to Puerto Rico. Www.taxact.com 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). Www.taxact.com 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. Www.taxact.com Other personal property. Www.taxact.com   For personal property other than marketable securities, use a time-based allocation. Www.taxact.com Figure the gain (or loss) attributable to the possession holding period by multiplying your total gain (or loss) by the following fraction. Www.taxact.com      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. Www.taxact.com Example 3. Www.taxact.com In addition to the stock in Rose Corporation, Cheryl acquired a 5% interest in the Alder Partnership on January 1, 2009. Www.taxact.com On March 1, 2010, when she established bona fide residency in Puerto Rico, her partnership interest was not considered a marketable security. Www.taxact.com 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. Www.taxact.com She had owned the interest for a total of 1,720 days. Www.taxact.com Cheryl's possession holding period (from March 1, 2010, through September 16, 2013) is 1,296 days. Www.taxact.com The portion of her gain attributable to Puerto Rico is $75,349 ($100,000 x (1,296 Puerto Rico days ÷ 1,720 total days)). Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com These rules do not apply to amounts paid as salary or other compensation for services. Www.taxact.com See Compensation for Labor or Personal Services, earlier in this chapter, for the source rules that apply. Www.taxact.com 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. Www.taxact.com These circumstances are listed below. Www.taxact.com You have an office or other fixed place of business in the relevant possession to which the income can be attributed. Www.taxact.com That office or place of business is a material factor in producing the income. Www.taxact.com The income is produced in the ordinary course of the trade or business carried on through that office or other fixed place of business. Www.taxact.com 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. Www.taxact.com The three kinds of income from sources outside the relevant possession to which these rules apply are the following. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com Dividends or interest from the active conduct of a banking, financing, or similar business in the relevant possession. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com Example. Www.taxact.com Marcy Jackson is a bona fide resident of American Samoa. Www.taxact.com Her business, which she conducts from an office in American Samoa, is developing and selling specialized computer software. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com 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. Www.taxact.com Prev  Up  Next   Home   More Online Publications