Chapter 16: U'S' Taxation of ForeignRelated Transactions

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Chapter 16U.S. Taxation ofForeign-Related
Transactions
Chapter 16 U.S. Taxation of Forteign-Related Tran
sactions
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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

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Jurisdiction to Tax

• Taxpayers country of citizenship
• Taxpayers country of residence
• Type of income earned
• Location where the income is earned

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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

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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

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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

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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

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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

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Foreign Earned Income Exclusion (FEI) (3 of 4)

• Amount of exclusion
• Lesser of
• 80,000, OR
• Foreign earned income for current year, OR
• 219.18 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)

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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

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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

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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

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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 lt 183 days during year

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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

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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

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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

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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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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

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Foreign Corporations(2 of 2)

• ? 10 domestic corp owner can also claim
  dividends received deduction
• U.S. tax on foreign subs income deferred until
  dividends received

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Deemed PaidForeign Tax Credit

• Deemed paid credit calculation

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Controlled ForeignCorporations (CFC) (1 of 3)

• Typical tax-avoidance scenario of a CFC

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Controlled ForeignCorporations (CFC) (2 of 3)

• CFC definition
• gt 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.

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Controlled ForeignCorporations (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.

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Foreign SalesCorporations (FSC) (1 of 3)

• FSC is a special export entity
• Must meet certain mandated administrative and
  economic activity requirements.
• Part or all of FSCs foreign trade income exempt
  from U.S. taxation
• Exempt amount based on transfer pricing method
  used.
• May use other-than-arms-length pricing.

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Foreign SalesCorporations (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.

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Foreign SalesCorporations (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

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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

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End of Chapter 16