Td 9212

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[Federal Register: July 14, 2005 (Volume 70, Number 134)]
[Rules and Regulations]
[Page 40663-40669]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14jy05-6]
----------------------------------------------------------------------DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 9212]
RIN 1545-AO72

Source of Compensation for Labor or Personal Services
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulation.
----------------------------------------------------------------------SUMMARY: This document contains final regulations that describe the
proper basis for determining the source of compensation for labor or
personal services performed partly within and partly without the United
States. These final regulations will affect individuals who earn
compensation for labor or personal services performed partly within and
partly without the United States and are needed to provide appropriate
guidance regarding the determination of the proper source of that
compensation.
DATES: Effective Date: These regulations are effective July 14, 2005.
Applicability Date: For dates of applicability, see Sec. 1.8614(d).
FOR FURTHER INFORMATION CONTACT: David Bergkuist, (202) 622-3850 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
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Paperwork Reduction Act
The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)) under control number 1545-1900.
The collections of information in these final regulations are in
Sec. 1.861-4(b)(2) (ii)(C)(1)(i), (b)(2)(ii)(D), and (b)(2)(ii)(D)(6).
The information required in Sec. 1.861-4(b)(2) (ii)(C)(1)(i) will
enable an individual, where appropriate, to use an alternative basis
other than that described in Sec. 1.861-4(b)(2)(ii)(A) or (B) to
determine the source of his or her compensation as an employee for
labor or personal services performed partly within and partly without
the United States. The information required in Sec. 1.8614(b)(2)(ii)(D) and (D)(6) will enable an employee to source certain
fringe benefits on a geographical basis. The collections of information
will, likewise, allow the IRS to verify these determinations.
An agency may not conduct or sponsor, and a person is not required
to
[[Page 40664]]
respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents might become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document contains amendments to 26 CFR part 1. On August 6,
2004, proposed revisions to the regulations (REG-208254-90) under
section 861 of the Internal Revenue Code (Code) relating to the source
of compensation for labor or personal services were published in the
Federal Register (69 FR 47816). In the same document, a prior notice of
proposed rulemaking (REG-208254-90), published in the Federal Register
on January 21, 2000 (65 FR 3401), was withdrawn. A public hearing was
held on January 13, 2005. Two written comments were received. After
consideration of these comments, the August 6, 2004 proposed
regulations are adopted as amended by this Treasury decision.
Summary of Comments and Explanation of Revisions
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These final regulations, as proposed in the notice of proposed
rulemaking, retain the facts and circumstances basis as the general
rule for determining the source of compensation for labor or personal
services performed partly within and partly without the United States
received by persons other than individuals and by individuals who are
not employees. As proposed, the final regulations provide two general
bases for determining the proper source of compensation that an
individual receives as an employee for such labor or personal services.
Under the first general basis of Sec. 1.861-4(b)(2)(ii)(A), an
individual will source compensation, other than compensation in the
form of certain fringe benefits, on a time basis, as defined in Sec.
1.861-4(b)(2)(ii)(E).
Under the second general basis of Sec. 1.861-4(b)(2)(ii)(B) and
(D), an individual will source compensation in the form of fringe
benefits, as described in Sec. 1.861-4(b)(2) (ii)(D)(1) through (6),
on a geographical basis (e.g., at the employee's principal place of
work, as defined in section 217 and Sec. 1.217-2(c)(3)). The fringe
benefits to which this general basis applies are housing, education,
local transportation, tax reimbursement, hazardous or hardship duty
pay, and moving expense reimbursement fringe benefits. This general
basis will apply only if the amount of the fringe benefit is reasonable
and is substantiated by adequate contemporaneous records or sufficient
evidence under rules similar to those set forth in Sec. 1.274-5T(c) or
(h) or Sec. 1.132-5.
Comments were received that proposed several changes with regard to
the fringe benefits described in Sec. 1.861-4(b)(2)(ii)(D)(1) through
(6). Under one suggestion, the specific definitions of the identified
fringe benefits would be replaced with broad categories. The comment
further suggested that the housing fringe benefit, education fringe
benefit, and local transportation fringe benefit include employerprovided allowances that are based on estimated, rather than actual,
expenses. The comment also requested that the definition of education
fringe benefit be expanded to include payments for the education of the
employee's spouse for studies that relate to the foreign location of
the employment, such as language courses and job training at the
foreign location, and to include pre-school and post-secondary
education, home schooling costs, and language courses of the employee's
dependents. With respect to the transportation fringe benefit, the
comment requested that automobile purchase assistance in the host
country be included. The comment also requested that the amount of
compensation qualifying for the hazardous or hardship duty pay fringe
benefit not be limited to government-provided amounts. The comment
suggested that the definition of moving expense reimbursement fringe
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benefit be expanded to include a list of specific expenses, such as
moving allowances, home sale/purchase assistance, temporary living, car
loss reimbursement, utility setup, appliance installation, auto
registration, driver's license fees, power converters, and other
related expenses. The comment also suggested three additional fringe
benefits: home leave allowances, cost-of-living allowances, and
exchange rate differential allowances.
The Treasury Department and the IRS considered the various comments
regarding the approach, scope, and detail of the identified fringe
benefits under the proposed regulations. In response to the comments,
the final regulations modify the definition of education fringe benefit
to include education expenses of the type described in section
530(b)(4)(A)(i) regardless of whether the education expenses are
incurred in connection with enrollment or attendance at a school. The
final regulations do not incorporate the suggestion for allowances
based on estimated expenses because the Treasury Department and the IRS
continue to believe that substantiation of relevant items is the more
appropriate approach. Regarding the other proposed changes to the
identified fringe benefits, the Treasury Department and the IRS believe
that the regulations provide an appropriate scope of benefits, a
reasonable manner of determining the appropriate amount of fringe
benefit to be sourced geographically, and a reasonable limit to the
amount of an individual's compensation that may be sourced under the
exception to the general time basis rule of Sec. 1.861-4(b)(2)(ii)(E).
As noted in the preamble to the proposed regulations, the Treasury
Department and the IRS intend to keep the list and descriptions of
identified fringe benefits current and continue to invite comments on
whether the identified fringe benefits are appropriately defined and
whether other fringe benefits should be identified and sourced on a
specific geographic basis.
Furthermore, the final regulations retain the proposed provision
that permits an employee to use an alternative basis, based upon the
facts and circumstances, to source such compensation if he or she
establishes to the satisfaction of the Commissioner that such an
alternative basis more properly determines the source of the
compensation. An individual seeking to use an alternative basis need
not obtain the satisfaction of the Commissioner prior to filing his or
her return. To obtain the satisfaction of the Commissioner, an
individual who uses an alternative basis must retain in his or her
records documentation setting forth why the alternative basis more
properly determines the source of the compensation than the basis for
determining source of compensation described in Sec. 1.8614(b)(2)(ii)(A) or (B). One comment requested that substantiation by the
individual's employer be accepted as substantiation by the employee,
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particularly where the alternative method is used by a group of
employees. Whether an alternative basis more properly determines the
source of an individual's compensation is based on the facts and
circumstances of the individual's specific case. As a result, it is the
individual employee, rather than the employer, who must demonstrate
that the alternative basis more properly determines the source of the
compensation than the basis for determining source of compensation
described in Sec. 1.861-4(b)(2)(ii)(A) or (B). It is expected,
however, that the
[[Page 40665]]
individual employee would use, among other documentation, documentation
provided by the employer for such substantiation.
Another comment requested relief from any penalties that might
arise from inaccurate reporting or withholding if an alternative method
is determined not to be acceptable or if the Commissioner determines
that a method other than the two general methods determines the source
of compensation in a more reasonable manner. The Treasury Department
and the IRS believe that the existing standards of penalty
administration, including applicable justifications, adequately address
this matter.
Section 1.861-4(b)(2)(ii)(C)(1)(i) of the proposed regulations
provided that to assert an alternative basis the individual must comply
with the requirements set forth in any administrative pronouncement
issued by the Commissioner. The final regulations require that to
assert an alternative basis, the individual must provide the
information related to the alternative basis required by applicable
Federal tax forms and accompanying instructions. It is expected that
the applicable Federal tax forms and accompanying instructions will
require individuals with $250,000 or more in compensation for the tax
year that use an alternative basis to respond to questions on the tax
form and to attach to their income tax returns a written statement that
sets forth: (1) The specific compensation income, or the specific
fringe benefit, for which an alternative method is used; (2) for each
such item, the alternative method of allocation of source used; (3) for
each such item, a computation showing how the alternative allocation
was computed; and (4) a comparison of the dollar amount of the
compensation sourced within and without the United States under both
the individual's alternative basis and the basis for determining source
of compensation described in Sec. 1.861-4(b)(2)(ii)(A) or (B).
The proposed regulations at Sec. 1.861-4(b)(2)(ii)(C)(3) were
reserved with respect to artists and athletes who are employees.
Although requested, no comments were received on the definition of
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artists and athletes. The reservation is retained in these final
regulations. As noted in the preamble to the proposed regulation, it is
intended that the specific rules for artists and athletes who are
employees, when issued, will require such individuals to determine the
proper source of compensation for labor or personal services on the
basis that most correctly reflects the proper source of that income
under the facts and circumstances of the particular case, consistent
with current law.
Proposed Sec. 1.861-4(b)(2)(ii)(F) provided that the source of
multi-year compensation of an employee is generally determined on a
time basis over the applicable period to which the compensation is
attributable. Determination of the applicable period to which the
compensation is attributable (including whether the compensation
relates to more than one taxable year) is based upon the facts and
circumstances of the particular case. Comments requested additional
guidance in the area of equity based compensation, particularly with
respect to stock options, that relate to services performed over a
period of more than one year. These comments requested guidance related
to pre-grant sourcing, sourcing based upon exercise date, and nonconventional equity compensation awards. Because under the regulations
the applicable period is determined based on the facts and
circumstances of the particular case, and a taxpayer may assert an
alternative method to source such compensation income pursuant to Sec.
1.861-4(b)(2)(ii)(C)(1)(i), the Treasury Department and the IRS
concluded that Sec. 1.861-4(b)(2)(ii)(F), as proposed, was reasonable
in its scope and the rules were not modified in the final regulations.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It is hereby
certified that the collections of information contained in these
regulations will not have a significant economic impact on a
substantial number of small entities. Accordingly, a regulatory
flexibility analysis is not required. This certification is based upon
that fact that the Treasury Department and the IRS believe that a time
basis generally is the most appropriate method for determining the
source of an individual employee's compensation for labor or personal
services performed partly within and partly without the United States.
The information necessary to apply the time basis should be readily
available to employers and employees. For example, Form 2555, ``Foreign
Earned Income'', requires an individual who claims the foreign earned
income exclusion to provide the IRS with information relating to the
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number of business days spent within the United States and any fringe
benefits received. In addition, if an employee wishes to use an
alternative method to source compensation, it is the employee that must
document such alternative method. Pursuant to section 7805(f) of the
Code, the notice of proposed rulemaking preceding these regulations was
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Drafting Information
The principal author of these final regulations is David Bergkuist
of the Office of Associate Chief Counsel (International). However,
other personnel from the IRS and the Treasury Department participated
in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.861-4 is amended as follows:
0
1. The heading for paragraph (a) is revised.
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0
2. A sentence is added at the beginning of paragraph (a)(1)
introductory text.
0
3. Paragraph (b) is revised.
0
4. A sentence is added at the end of paragraph (d).
The revisions and addition read as follows:

Sec.

1.861-4

Compensation for labor or personal services.

(a) Compensation for labor or personal services performed wholly
within the United States. (1) Generally, compensation for labor or
personal services, including fees, commissions, fringe benefits, and
similar items, performed wholly within the United States is gross
income from sources within the United States. * * *
* * * * *
(b) Compensation for labor or personal services performed partly
within and partly without the United States--(1) Compensation for labor
or
[[Page 40666]]
personal services performed by persons other than individuals--(i) In
general. In the case of compensation for labor or personal services
performed partly within and partly without the United States by a
person other than an individual, the part of that compensation that is
attributable to the labor or personal services performed within the
United States, and that is therefore included in gross income as income
from sources within the United States, is determined on the basis that
most correctly reflects the proper source of the income under the facts
and circumstances of the particular case. In many cases, the facts and
circumstances will be such that an apportionment on the time basis, as
defined in paragraph (b)(2)(ii)(E) of this section, will be acceptable.
(ii) Example. The application of paragraph (b)(1)(i) is illustrated
by the following example.
Example. Corp X, a domestic corporation, receives compensation
of $150,000 under a contract for services to be performed
concurrently in the United States and in several foreign countries
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by numerous Corp X employees. Each Corp X employee performing
services under this contract performs his or her services
exclusively in one jurisdiction. Although the number of employees
(and hours spent by employees) performing services under the
contract within the United States equals the number of employees
(and hours spent by employees) performing services under the
contract without the United States, the compensation paid to
employees performing services under the contract within the United
States is higher because of the more sophisticated nature of the
services performed by the employees within the United States.
Accordingly, the payroll cost for employees performing services
under the contract within the United States is $20,000 out of a
total contract payroll cost of $30,000. Under these facts and
circumstances, a determination based upon relative payroll costs
would be the basis that most correctly reflects the proper source of
the income received under the contract. Thus, of the $150,000 of
compensation included in Corp X's gross income, $100,000 ($150,000 x
$20,000/$30,000) is attributable to the labor or personal services
performed within the United States and $50,000 ($150,000 x $10,000/
$30,000) is attributable to the labor or personal services performed
without the United States.
(2) Compensation for labor or personal services performed by an
individual--(i) In general. Except as provided in paragraph (b)(2)(ii)
of this section, in the case of compensation for labor or personal
services performed partly within and partly without the United States
by an individual, the part of such compensation that is attributable to
the labor or personal services performed within the United States, and
that is therefore included in gross income as income from sources
within the United States, is determined on the basis that most
correctly reflects the proper source of that income under the facts and
circumstances of the particular case. In many cases, the facts and
circumstances will be such that an apportionment on a time basis, as
defined in paragraph (b)(2)(ii)(E) of this section, will be acceptable.
(ii) Employee compensation--(A) In general. Except as provided in
paragraph (b)(2)(ii)(B) or (C) of this section, in the case of
compensation for labor or personal services performed partly within and
partly without the United States by an individual as an employee, the
part of such compensation that is attributable to the labor or personal
services performed within the United States, and that is therefore
included in gross income as income from sources within the United
States, is determined on a time basis, as defined in paragraph
(b)(2)(ii)(E) of this section.
(B) Certain fringe benefits sourced on a geographical basis. Except
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as provided in paragraph (b)(2)(ii)(C) of this section, items of
compensation of an individual as an employee for labor or personal
services performed partly within and partly without the United States
that are described in paragraphs (b)(2)(ii)(D)(1) through (6) of this
section are sourced on a geographical basis in accordance with those
paragraphs.
(C) Exceptions and special rules--(1) Alternative basis--(i)
Individual as an employee generally. An individual may determine the
source of his or her compensation as an employee for labor or personal
services performed partly within and partly without the United States
under an alternative basis if the individual establishes to the
satisfaction of the Commissioner that, under the facts and
circumstances of the particular case, the alternative basis more
properly determines the source of the compensation than a basis
described in paragraph (b)(2)(ii)(A) or (B), whichever is applicable,
of this section. An individual that uses an alternative basis must
retain in his or her records documentation setting forth why the
alternative basis more properly determines the source of the
compensation. In addition, the individual must provide the information
related to the alternative basis required by applicable Federal tax
forms and accompanying instructions.
(ii) Determination by Commissioner. The Commissioner may, under the
facts and circumstances of the particular case, determine the source of
compensation that is received by an individual as an employee for labor
or personal services performed partly within and partly without the
United States under an alternative basis other than a basis described
in paragraph (b)(2)(ii)(A) or (B) of this section if such compensation
either is not for a specific time period or constitutes in substance a
fringe benefit described in paragraph (b)(2)(ii)(D) of this section
notwithstanding a failure to meet any requirement of paragraph
(b)(2)(ii)(D) of this section. The Commissioner may make this
determination only if such alternative basis determines the source of
compensation in a more reasonable manner than the basis used by the
individual pursuant to paragraph (b)(2)(ii)(A) or (B) of this section.
(2) Ruling or other administrative pronouncement with respect to
groups of taxpayers. The Commissioner may, by ruling or other
administrative pronouncement applying to similarly situated taxpayers
generally, permit individuals to determine the source of their
compensation as an employee for labor or personal services performed
partly within and partly without the United States under an alternative
basis. Any such individual shall be treated as having met the
requirement to establish such alternative basis to the satisfaction of
the Commissioner under the facts and circumstances of the particular
case, provided that the individual meets the other requirements of
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paragraph (b)(2)(ii)(C)(1)(i) of this section. The Commissioner also
may, by ruling or other administrative pronouncement, indicate the
circumstances in which he will require individuals to determine the
source of certain compensation as an employee for labor or personal
services performed partly within and partly without the United States
under an alternative basis pursuant to the authority under paragraph
(b)(2)(ii)(C)(1)(ii) of this section.
(3) Artists and athletes. [Reserved.]
(D) Fringe benefits sourced on a geographical basis. Except as
provided in paragraph (b)(2)(ii)(C) of this section, compensation of an
individual as an employee for labor or personal services performed
partly within and partly without the United States in the form of the
following fringe benefits is sourced on a geographical basis as
indicated in this paragraph (b)(2)(ii)(D). The amount of the
compensation in the form of the fringe benefit must be reasonable, and
the individual must substantiate such amounts by adequate records or by
sufficient evidence under rules similar to those set forth in Sec.
1.274-5T(c) or (h) or Sec. 1.132-5. For purposes of this paragraph
(b)(2)(ii)(D), the term principal place of work has the same
[[Page 40667]]
meaning that it has for purposes of section 217 and Sec. 1.2172(c)(3).
(1) Housing fringe benefit. The source of compensation in the form
of a housing fringe benefit is determined based on the location of the
individual's principal place of work. For purposes of this paragraph
(b)(2)(ii)(D)(1), a housing fringe benefit includes payments to or on
behalf of an individual (and the individual's family if the family
resides with the individual) only for rent, utilities (other than
telephone charges), real and personal property insurance, occupancy
taxes not deductible under section 164 or 216(a), nonrefundable fees
paid for securing a leasehold, rental of furniture and accessories,
household repairs, residential parking, and the fair rental value of
housing provided in kind by the individual's employer. A housing fringe
benefit does not include payments for expenses or items set forth in
Sec. 1.911-4(b)(2).
(2) Education fringe benefit. The source of compensation in the
form of an education fringe benefit for the education expenses of the
individual's dependents is determined based on the location of the
individual's principal place of work. For purposes of this paragraph
(b)(2)(ii)(D)(2), an education fringe benefit includes payments only
for qualified tuition and expenses of the type described in section
530(b)(4)(A)(i) (regardless of whether incurred in connection with
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enrollment or attendance at a school) and expenditures for room and
board and uniforms as described in section 530(b)(4)(A)(ii) with
respect to education at an elementary or secondary educational
institution.
(3) Local transportation fringe benefit. The source of compensation
in the form of a local transportation fringe benefit is determined
based on the location of the individual's principal place of work. For
purposes of this paragraph (b)(2)(ii)(D)(3), an individual's local
transportation fringe benefit is the amount that the individual
receives as compensation for local transportation of the individual or
the individual's spouse or dependents at the location of the
individual's principal place of work. The amount treated as a local
transportation fringe benefit is limited to the actual expenses
incurred for local transportation and the fair rental value of any
vehicle provided by the employer and used predominantly by the
individual or the individual's spouse or dependents for local
transportation. For this purpose, actual expenses incurred for local
transportation do not include the cost (including interest) of the
purchase by the individual, or on behalf of the individual, of an
automobile or other vehicle.
(4) Tax reimbursement fringe benefit. The source of compensation in
the form of a foreign tax reimbursement fringe benefit is determined
based on the location of the jurisdiction that imposed the tax for
which the individual is reimbursed.
(5) Hazardous or hardship duty pay fringe benefit. The source of
compensation in the form of a hazardous or hardship duty pay fringe
benefit is determined based on the location of the hazardous or
hardship duty zone for which the hazardous or hardship duty pay fringe
benefit is paid. For purposes of this paragraph (b)(2)(ii)(D)(5), a
hazardous or hardship duty zone is any place in a foreign country which
is either designated by the Secretary of State as a place where living
conditions are extraordinarily difficult, notably unhealthy, or where
excessive physical hardships exist, and for which a post differential
of 15 percent or more would be provided under section 5925(b) of Title
5 of the U.S. Code to any officer or employee of the U.S. Government
present at that place, or where a civil insurrection, civil war,
terrorism, or wartime conditions threatens physical harm or imminent
danger to the health and well-being of the individual. Compensation
provided an employee during the period that the employee performs labor
or personal services in a hazardous or hardship duty zone may be
treated as a hazardous or hardship duty pay fringe benefit only if the
employer provides the hazardous or hardship duty pay fringe benefit
only to employees performing labor or personal services in a hazardous
or hardship duty zone. The amount of compensation treated as a
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hazardous or hardship duty pay fringe benefit may not exceed the
maximum amount that the U.S. government would allow its officers or
employees present at that location.
(6) Moving expense reimbursement fringe benefit. Except as
otherwise provided in this paragraph (b)(2)(ii)(D)(6), the source of
compensation in the form of a moving expense reimbursement is
determined based on the location of the employee's new principal place
of work. The source of such compensation is determined based on the
location of the employee's former principal place of work, however, if
the individual provides sufficient evidence that such determination of
source is more appropriate under the facts and circumstances of the
particular case. For purposes of this paragraph (b)(2)(ii)(D)(6),
sufficient evidence generally requires an agreement, between the
employer and the employee, or a written statement of company policy,
which is reduced to writing before the move and which is entered into
or established to induce the employee or employees to move to another
country. Such written statement or agreement must state that the
employer will reimburse the employee for moving expenses that the
employee incurs to return to the employee's former principal place of
work regardless of whether he or she continues to work for the employer
after returning to that location. The writing may contain certain
conditions upon which the right to reimbursement is determined as long
as those conditions set forth standards that are definitely
ascertainable and can only be fulfilled prior to, or through completion
of, the employee's return move to the employee's former principal place
of work.
(E) Time basis. The amount of compensation for labor or personal
services performed within the United States determined on a time basis
is the amount that bears the same relation to the individual's total
compensation as the number of days of performance of the labor or
personal services by the individual within the United States bears to
his or her total number of days of performance of labor or personal
services. A unit of time less than a day may be appropriate for
purposes of this calculation. The time period for which the
compensation for labor or personal services is made is presumed to be
the calendar year in which the labor or personal services are
performed, unless the taxpayer establishes to the satisfaction of the
Commissioner, or the Commissioner determines, that another distinct,
separate, and continuous period of time is more appropriate. For
example, a transfer during a year from a position in the United States
to a foreign posting that lasted through the end of that year would
generally establish two separate time periods within that taxable year.
The first of these time periods would be the portion of the year
preceding the start of the foreign posting, and the second of these
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time periods would be the portion of the year following the start of
the foreign posting. However, in the case of a foreign posting that
requires short-term returns to the United States to perform services
for the employer, such short-term returns would not be sufficient to
establish distinct, separate, and continuous time periods within the
foreign posting time period but would be relevant to the allocation of
compensation relating to the overall
[[Page 40668]]
time period. In each case, the source of the compensation on a time
basis is based upon the number of days (or unit of time less than a
day, if appropriate) in that separate time period.
(F) Multi-year compensation arrangements. The source of multi-year
compensation is determined generally on a time basis, as defined in
paragraph (b)(2)(ii)(E) of this section, over the period to which such
compensation is attributable. For purposes of this paragraph
(b)(2)(ii)(F), multi-year compensation means compensation that is
included in the income of an individual in one taxable year but that is
attributable to a period that includes two or more taxable years. The
determination of the period to which such compensation is attributable,
for purposes of determining its source, is based upon the facts and
circumstances of the particular case. For example, an amount of
compensation that specifically relates to a period of time that
includes several calendar years is attributable to the entirety of that
multi-year period. The amount of such compensation that is treated as
from sources within the United States is the amount that bears the same
relationship to the total multi-year compensation as the number of days
(or unit of time less than a day, if appropriate) that labor or
personal services were performed within the United States in connection
with the project bears to the total number of days (or unit of time
less than a day, if appropriate) that labor or personal services were
performed in connection with the project. In the case of stock options,
the facts and circumstances generally will be such that the applicable
period to which the compensation is attributable is the period between
the grant of an option and the date on which all employment-related
conditions for its exercise have been satisfied (the vesting of the
option).
(G) Examples. The following examples illustrate the application of
this paragraph (b)(2)(ii):
Example 1. B, a nonresident alien individual, was employed by
Corp M, a domestic corporation, from March 1 to December 25 of the
taxable year, a total of 300 days, for which B received compensation
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in the amount of $80,000. Under B's employment contract with Corp M,
B was subject to call at all times by Corp M and was in a payment
status on a 7-day week basis. Pursuant to that contract, B performed
services (or was available to perform services) within the United
States for 180 days and performed services (or was available to
perform services) without the United States for 120 days. None of
B's $80,000 compensation was for fringe benefits as identified in
paragraph (b)(2)(ii)(D) of this section. B determined the amount of
compensation that is attributable to his labor or personal services
performed within the United States on a time basis under paragraph
(b)(2)(ii)(A) and (E) of this section. B did not assert, pursuant to
paragraph (b)(2)(ii)(C)(1)(i) of this section, that, under the
particular facts and circumstances, an alternative basis more
properly determines the source of that compensation than the time
basis. Therefore, B must include in income from sources within the
United States $48,000 ($80,000 x 180/300) of his compensation from
Corporation M.
Example 2. (i) Same facts as in Example 1 except that Corp M had
a company-wide arrangement with its employees, including B, that
they would receive an education fringe benefit, as described in
paragraph (b)(2)(ii)(D)(2) of this section, while working in the
United States. During the taxable year, B incurred education
expenses for his dependent daughter that qualified for the education
fringe benefit in the amount of $10,000, for which B received a
reimbursement from Corp M. B did not maintain adequate records or
sufficient evidence of this fringe benefit as required by paragraph
(b)(2)(ii)(D) of this section. When B filed his Federal income tax
return for the taxable year, B did not apply paragraphs
(b)(2)(ii)(B) and (D)(2) of this section to treat the compensation
in the form of the education fringe benefit as income from sources
within the United States, the location of his principal place of
work during the 300-day period. Rather, B combined the $10,000
reimbursement with his base compensation of $80,000 and applied the
time basis of paragraph (b)(2)(ii)(A) of this section to determine
the source of his gross income.
(ii) On audit, B argues that because he failed to substantiate
the education fringe benefit in accordance with paragraph
(b)(2)(ii)(D) of this section, his entire employment compensation
from Corp M is sourced on a time basis pursuant to paragraph
(b)(2)(ii)(A) of this section. The Commissioner, after reviewing
Corp M's fringe benefit arrangement, determines, pursuant to
paragraph (b)(2)(ii)(C)(1)(ii) of this section, that the $10,000
educational expense reimbursement constitutes in substance a fringe
benefit described in paragraph (b)(2)(ii)(D)(2) of this section,
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notwithstanding a failure to meet all of the requirements of
paragraph (b)(2)(ii)(D) of this section, and that an alternative
geographic source basis, under the facts and circumstances of this
particular case, is a more reasonable manner to determine the source
of the compensation than the time basis used by B.
Example 3. (i) A, a United States citizen, is employed by Corp
N, a domestic corporation. A's principal place of work is in the
United States. A earns an annual salary of $100,000. During the
first quarter of the calendar year (which is also A's taxable year),
A performed services entirely within the United States. At the
beginning of the second quarter of the calendar year, A was
transferred to Country X for the remainder of the year and received,
in addition to her annual salary, $30,000 in fringe benefits that
are attributable to her new principal place of work in Country X.
Corp N paid these fringe benefits separately from A's annual salary.
Corp N supplied A with a statement detailing that $25,000 of the
fringe benefit was paid for housing, as defined in paragraph
(b)(2)(ii)(D)(1) of this section, and $5,000 of the fringe benefit
was paid for local transportation, as defined in paragraph
(b)(2)(ii)(D)(3) of this section. None of the local transportation
fringe benefit is excluded from the employee's gross income as a
qualified transportation fringe benefit under section 132(a)(5).
Under A's employment contract, A was required to work on a 5-day
week basis, Monday through Friday. During the last three quarters of
the year, A performed services 30 days in the United States and 150
days in Country X and other foreign countries.
(ii) A determined the source of all of her compensation from
Corp N pursuant to paragraphs (b)(2)(ii)(A), (B), and (D)(1) and (3)
of this section. A did not assert, pursuant to paragraph
(b)(2)(ii)(C)(1)(i) of this section, that, under the particular
facts and circumstances, an alternative basis more properly
determines the source of that compensation than the bases set forth
in paragraphs (b)(2)(ii)(A), (B), and (D)(1) and (3) of this
section. However, in applying the time basis set forth in paragraph
(b)(2)(ii)(E) of this section, A establishes to the satisfaction of
the Commissioner that the first quarter of the calendar year and the
last three quarters of the calendar year are two separate, distinct,
and continuous periods of time. Accordingly, $25,000 of A's annual
salary is attributable to the first quarter of the year (25 percent
of $100,000). This amount is entirely compensation that was
attributable to the labor or personal services performed within the
United States and is, therefore, included in gross income as income
from sources within the United States. The balance of A's
compensation as an employee of Corp N, $105,000 (which includes the
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$30,000 in fringe benefits that are attributable to the location of
A's principal place of work in Country X), is compensation
attributable to the final three quarters of her taxable year. During
those three quarters, A's periodic performance of services in the
United States does not result in distinct, separate, and continuous
periods of time. Of the $75,000 paid for annual salary, $12,500 (30/
180 x $75,000) is compensation that was attributable to the labor or
personal services performed within the United States and $62,500
(150/180 x $75,000) is compensation that was attributable to the
labor or personal services performed outside the United States.
Pursuant to paragraphs (b)(2)(ii)(B) and (D)(1) and (3) of this
section, A sourced the $25,000 received for the housing fringe
benefit and the $5,000 received for the local transportation fringe
benefit based on the location of her principal place of work,
Country X. Accordingly, A included the $30,000 in fringe benefits in
her gross income as income from sources without the United States.
Example 4. Same facts as in Example 3. Of the 150 days during
which A performed services in Country X and in other foreign
countries (during the final three quarters of A's taxable year), she
performed 30 days of those services in Country Y. Country Y is a
[[Page 40669]]
country designated by the Secretary of State as a place where living
conditions are extremely difficult, notably unhealthy, or where
excessive physical hardships exist and for which a post differential
of 15 percent or more would be provided under section 5925(b) of
Title 5 of the U.S. Code to any officer or employee of the U.S.
government present at that place. Corp N has a policy of paying its
employees a $65 premium per day for each day worked in countries so
designated. The $65 premium per day does not exceed the maximum
amount that the U. S. government would pay its officers or employees
stationed in Country Y. Because A performed services in Country Y
for 30 days, she earned additional compensation of $1,950. The
$1,950 is considered a hazardous duty or hardship pay fringe benefit
and is sourced under paragraphs (b)(2)(ii)(B) and (D)(5) of this
section based on the location of the hazardous or hardship duty
zone, Country Y. Accordingly, A included the amount of the hazardous
duty or hardship pay fringe benefit ($1,950) in her gross income as
income from sources without the United States.
Example 5. (i) During 2006 and 2007, Corp P, a domestic
corporation, employed four United States citizens, E, F, G, and H to
work in its manufacturing plant in Country V. As part of his or her
compensation package, each employee arranged for local
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transportation unrelated to Corp P's business needs. None of the
local transportation fringe benefit is excluded from the employee's
gross income as a qualified transportation fringe benefit under
section 132(a)(5) and (f).
(ii) Under the terms of the compensation package that E
negotiated with Corp P, Corp P permitted E to use an automobile
owned by Corp P. In addition, Corp P agreed to reimburse E for all
expenses incurred by E in maintaining and operating the automobile,
including gas and parking. Provided that the local transportation
fringe benefit meets the requirements of paragraph (b)(2)(ii)(D)(3)
of this section, E's compensation with respect to the fair rental
value of the automobile and reimbursement for the expenses E
incurred is sourced under paragraphs (b)(2)(ii)(B) and (D)(3) of
this section based on E's principal place of work in Country V.
Thus, the local transportation fringe benefit will be included in
E's gross income as income from sources without the United States.
(iii) Under the terms of the compensation package that F
negotiated with Corp P, Corp P let F use an automobile owned by Corp
P. However, Corp P did not agree to reimburse F for any expenses
incurred by F in maintaining and operating the automobile. Provided
that the local transportation fringe benefit meets the requirements
of paragraph (b)(2)(ii)(D)(3) of this section, F's compensation with
respect to the fair rental value of the automobile is sourced under
paragraphs (b)(2)(ii)(B) and (D)(3) of this section based on F's
principal place of work in Country V. Thus, the local transportation
fringe benefit will be included in F's gross income as income from
sources without the United States.
(iv) Under the terms of the compensation package that G
negotiated with Corp P, Corp P agreed to reimburse G for the
purchase price of an automobile that G purchased in Country V. Corp
P did not agree to reimburse G for any expenses incurred by G in
maintaining and operating the automobile. Because the cost to
purchase an automobile is not a local transportation fringe benefit
as defined in paragraph (b)(2)(ii)(D)(3) of this section, the source
of the compensation to G will be determined pursuant to paragraph
(b)(2)(ii)(A) or (C) of this section.
(v) Under the terms of the compensation package that H
negotiated with Corp P, Corp P agreed to reimburse H for the
expenses that H incurred in maintaining and operating an automobile,
including gas and parking, which H purchased in Country V. Provided
that the local transportation fringe benefit meets the requirements
of paragraph (b)(2)(ii)(D)(3) of this section, H's compensation with
respect to the reimbursement for the expenses H incurred is sourced
under paragraphs (b)(2)(ii)(B) and (D)(3) of this section based on
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H's principal place of work in Country V. Thus, the local
transportation fringe benefit will be included in H's gross income
as income from sources without the United States.
Example 6. (i) On January 1, 2006, Company Q compensates
employee J with a grant of options to which section 421 does not
apply that do not have a readily ascertainable fair market value
when granted. The stock options permit J to purchase 100 shares of
Company Q stock for $5 per share. The stock options do not become
exercisable unless and until J performs services for Company Q (or a
related company) for 5 years. J works for Company Q for the 5 years
required by the stock option grant. In years 2006-08, J performs all
of his services for Company Q within the United States. In 2009, J
performs \1/2\ of his services for Company Q within the United
States and \1/2\ of his services for Company Q without the United
States. In year 2010, J performs his services entirely without the
United States. On December 31, 2012, J exercises the options when
the stock is worth $10 per share. J recognizes $500 in taxable
compensation (($10-$5) x 100) in 2012.
(ii) Under the facts and circumstances, the applicable period is
the 5-year period between the date of grant (January 1, 2006) and
the date the stock options become exercisable (December 31, 2010).
On the date the stock options become exercisable, J performs all
services necessary to obtain the compensation from Company Q.
Accordingly, the services performed after the date the stock options
become exercisable are not taken into account in sourcing the
compensation from the stock options. Therefore, pursuant to
paragraph (b)(2)(ii)(A), since J performs 3\1/2\ years of services
for Company Q within the United States and 1\1/2\ years of services
for Company Q without the United States during the 5-year period, 7/
10 of the $500 of compensation (or $350) recognized in 2012 is
income from sources within the United States and the remaining 3/10
of the compensation (or $150) is income from sources without the
United States.
* * * * *
(d) Effective date. * * * Paragraph (b) and the first sentence of
paragraph (a)(1) of this section apply to taxable years beginning on or
after July 14, 2005.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
0
Par. 3. The authority citation for part 602 continues to read as
follows:

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Authority: 26 U.S.C. 7805.
0
Par. 4. In Sec. 602.101, paragraph (b) is amended by adding an entry
for Sec. 1.861-4 in numerical order to the table to read as follows:

Sec.

602.101

OMB Control numbers.

* * * * *
(b) * * *
-----------------------------------------------------------------------Current OMB
CFR part or section where Identified and described
control No.
-----------------------------------------------------------------------* * * * *
1.861-4....................................................

1545-1900

* * * * *
------------------------------------------------------------------------

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Approved: July 5, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary for Tax Policy.
[FR Doc. 05-13681 Filed 7-13-05; 8:45 am]
BILLING CODE 4830-01-P

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