Td 9212

Page 1

Treasury Decisions
Copyright 2007 LexisNexis Group, All Rights Reserved
Rules and Regulations
DEPARTMENT OF THE TREASURY
Internal Revenue Service (IRS)
26 CFR Parts 1 and 602
70 FR 40663; Treas. Dec. Int. Rev. 9212; RIN 1545-AO72
Source of Compensation for Labor or Personal Services
T.D. 9212
DATE: July 14, 2005
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.
EFFECTIVE DATE: Effective Date: These regulations are effective July 14, 2005.
Applicability Date: For dates of applicability, see § 1.861-4(d).
FOR FURTHER INFORMATION CONTACT: David Bergkuist, (202) 622-3850 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 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 § 1.861-4(b)(2) (ii)(C)(1)(i), (b)(2)(ii)(D), and
(b)(2)(ii)(D)(6). The information required in § 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 § 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 § 1.861-4(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

Page 2
T.D. 9212

determinations.
An agency may not conduct or sponsor, and a person is not required to 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
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 § 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 § 1.861-4(b)(2)(ii)(E).
Under the second general basis of § 1.861-4(b)(2)(ii)(B) and (D), an individual will source compensation in the
form of fringe benefits, as described in § 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 § 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 § 1.274-5T(c) or (h) or § 1.132-5.
Comments were received that proposed several changes with regard to the fringe benefits described in §
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 employer-provided 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 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

Page 3
T.D. 9212

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 §
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 § 1.861-4(b)(2)(ii)(A) or (B). One
comment requested that substantiation by the individual's employer be accepted as substantiation by the employee,
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 § 1.861-4(b)(2)(ii)(A) or (B). It is expected, however, that the 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 § 1.861-4(b)(2)(ii)(A) or
(B).

Page 4
T.D. 9212

The proposed regulations at § 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 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 § 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 non-conventional 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 § 1.861-4(b)(2)(ii)(C)(1)(i), the Treasury
Department and the IRS concluded that § 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 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

Page 5
T.D. 9212

Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.861-4 is amended as follows:
1. The heading for paragraph (a) is revised.
2. A sentence is added at the beginning of paragraph (a)(1) introductory text.
3. Paragraph (b) is revised.
4. A sentence is added at the end of paragraph (d).
The revisions and addition read as follows:
§ 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 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 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.

Page 6
T.D. 9212

(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 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 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.]

Page 7
T.D. 9212

(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 § 1.274-5T(c) or (h) or § 1.132-5. For purposes of this paragraph (b)(2)(ii)(D), the term principal place of work
has the same meaning that it has for purposes of section 217 and § 1.217-2(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 §
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 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 hazardous or hardship
duty pay fringe benefit may not exceed the maximum amount that the U.S. government would allow its officers or

Page 8
T.D. 9212

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 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
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.

Page 9
T.D. 9212

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 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,
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

Page 10
T.D. 9212

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 $ 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 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 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

Page 11
T.D. 9212

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 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 31/2 years of services for
Company Q within the United States and 11/2 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
Par. 3. The authority citation for part 602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 4. In § 602.101, paragraph (b) is amended by adding an entry for § 1.861-4 in numerical order to the table to
read as follows:
§ 602.101 OMB Control numbers.
*

*

*

*

*

(b) * * *
CFR part or section
where Identified and described

Current OMB control No.

Page 12
T.D. 9212

*****
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