Source of Compensation for
Labor or Personal Services

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-208254-90] RIN 1545-AO72

TITLE: Source of Compensation for Labor or Personal Services

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains a proposed Income Tax Regulation
describing the appropriate basis for determining the source of
income from labor or personal services performed partly within and
partly without the United States. This proposed regulation would
modify the existing final regulation under section 861 of the
Internal Revenue Code (Code). This regulation would affect foreign
and United States persons that perform services partly within and
partly without the United States during the taxable year. This
document also provides a notice of a public hearing on this proposed
regulation.

DATES: Written and electronic comments and outlines of topics to be
discussed at the public hearing scheduled for April 19, 2000, must
be received by March 29, 2000. ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG-208254-90), room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions
may be hand delivered. Monday through Friday between the hours of 8
a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG-208254-90), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC.

Alternatively, taxpayers may submit comments electronically via the
Internet by selecting the A Tax Reg @ option on the IRS Home Page,
or by submitting comments directly to the IRS Internet site at
http://www.irs.ustreas.gov/tax_regs/regslist.html. The public
hearing will be held at 10 a.m. in room 2615, Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulation,
David Bergkuist of the Office of Associate Chief Counsel
(International), within the Office of Chief Counsel, (202) 622-3850;
concerning submission of comments, the hearing, and/or to be placed
on the building access list to attend the hearing, LaNita Van Dyke
(202) 622-7180 (not toll free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to the Income Tax
Regulations (26 CFR Part 1) under section 861 of the Internal
Revenue Code (Code). These amendments modify the application of the
existing final regulation relating to the determination of the
source of income from the performance of labor or personal services
when such labor or personal services are performed partly within and
partly without the United States.

Explanation of Provisions

Section 861(a)(3) of the Code provides, in general, that
compensation for the performance of labor or personal services
within the United States is treated as gross income from sources
within the United States. Generally, under current §1.861- 4(b)(1)
(i) of the Income Tax Regulations, if a specific amount is paid for
labor or personal services performed in the United States, that
amount shall be included in United States source gross income. If no
accurate allocation or segregation of amounts paid as compensation
for labor or personal services performed in the United States can be
made, or when such compensation is paid for labor or personal
service performed partly within and partly without the United
States, this regulation provides that the amount to be included in
gross income from sources within the United States shall be
determined on the basis that most correctly reflects the proper
source of 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 will be acceptable; that is, the
amount to be included in gross income from sources within the United
States will be that amount that bears the same relation to the total
compensation as the number of days of performance of the labor or
service within the United States bears to the total number of days
of performance of labor or services for which the payment is made.
In other cases, the facts and circumstances will be such that
another method of apportionment will be acceptable. The IRS
understands that, under the current regulations, U.S. individuals
posted overseas and foreign individuals posted to the United States
generally apportion compensation on a time basis. However, the IRS
has become aware that under the facts and circumstances test of the
current regulations, U.S.

individuals are taking the position that certain fringe benefits
associated with an overseas posting by their employer should be
considered compensation for labor or personal services performed
outside the United States and treated entirely as foreign source
income even though some services are performed within the United
States during the time of the overseas posting. Conversely, foreign
individuals posted to the United States are taking the position that
fringe benefits associated with their U.S. posting should be
apportioned between compensation for labor or personal services
performed within and without the United States based upon the amount
of time spent in each jurisdiction and would be partly U.S. and
partly foreign source income. In addition, under the current
regulations, similarly situated taxpayers may be treated differently
depending upon how their employers account for any foreign posting
fringe benefits. Where an employer separately states the value of a
fringe benefit, a U.S.

individual posted overseas may argue that the fringe benefit is
entirely compensation for labor or personal services performed
outside the United States and foreign source. However, another
employee receiving the same amount of additional compensation as
part of a foreign posting, but where that benefit is not separately
stated, will often be required to apportion this benefit on the
basis of time. Finally, the current regulations may allow U.S.
individuals to take an inconsistent position for U.S. and foreign
tax purposes with respect to the source of fringe benefits
associated with an overseas posting and avoid all tax on such
compensation.

Treasury and the IRS have determined that an individual who performs
labor or personal services partly within and partly without the
United States during a specific time period should apportion the
services income, including any income in the nature of fringe
benefits, between compensation for labor or personal services
performed within and without the United States on a time basis. The
amount of compensation paid for labor or personal services performed
in the United States, as determined under proposed §1.861-4(b), will
constitute United States source income unless an exception applies
under §1.861-4(a). A time basis test for individuals will provide
certainty as well as ease of administration for both taxpayers and
the IRS. A time basis test will also prevent the possibility of in-
bound taxpayers taking a time basis apportionment position to
apportion a portion of their United States posting fringe benefits
back to their home country while similarly situated out-bound
taxpayers take a facts and circumstances position to allocate all of
their fringe benefits to foreign sources. This rule will also
eliminate any disparate treatment of similarly situated taxpayers
that might occur due to their employer's method of wage accounting.
Finally, Treasury and the IRS believe that this rule will limit the
potential for individuals to take inconsistent positions for U.S.
and foreign tax purposes with respect to the source of their fringe
benefits and avoid all tax.

Treasury and the IRS have further determined that, with respect to
persons other than an individual, an apportionment based upon all of
the facts and circumstances available, for example, an apportionment
based upon payroll expenses or capital and intangibles employed, may
better reflect the proper source of such compensation. In many
situations, an apportionment on a time basis may be acceptable.

The proposed regulation would delete as obsolete current §1.861-4(b)
(2), containing rules applicable to taxable years beginning before
January 1, 1976.

Proposed Effective Date

These regulations are proposed to be applicable for taxable years
beginning on or after the date they are published in the Federal
Register as final regulations.

Special Analyses

It has been determined that this proposed rulemaking is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. Chapter 5) does not apply to this regulation, and, because
this regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not
apply. Pursuant to section 7805(f) of the Internal Revenue Code,
this notice of proposed rulemaking will be submitted the Chief
Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.

Comments and Public Hearing

Before this proposed regulation is adopted as a final regulation,
consideration will be given to any written comments (a signed
original and eight (8) copies) and electronic comments that are
submitted timely to the IRS. The IRS and Treasury Department request
comments on the clarity of the proposed rule and how it may be made
easier to understand. All comments will be available for public
inspection and copying.

A public hearing has been scheduled for April 19, 2000, beginning at
10 a.m. in room 2615 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10 th Street entrance,
located between Constitution and Pennsylvania Avenues, NW. In
addition, all visitors must present photo identification to enter
the building. Because of access restrictions, visitors will not be
admitted beyond the immediate entrance area more than 15 minutes
before the hearing starts. For information about having your name
placed on the building access list to attend the hearing, see the A
FOR FURTHER INFORMATION CONTACT @ section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit written
comments and an outline of the topics to be discussed and the time
to be devoted to each topic (signed original and eight (8) copies)
by March 29, 2000. A period of 10 minutes will be allotted to each
person for making comments. An agenda showing the scheduling of the
speakers will be prepared after the deadline for receiving outlines
has passed. Copies of the agenda will be available free of charge at
the hearing.

Drafting Information

The principal author of this regulation is David Bergkuist of the
Office of Associate Chief Counsel (International), within the Office
of Chief Counsel, Internal Revenue Service. However, other personnel
from the IRS and Treasury Department participated in its
development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements. Proposed
Amendments to the Regulations Accordingly, 26 CFR part 1 is proposed
to be amended as follows:

PART 1--INCOME TAX

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: The heading for
paragraph (a)(1) is revised.

2. A new sentence is added at the beginning of paragraph (a)(1).

3. Paragraphs (b) and (d) are revised.

The addition and revisions read as follows: §1.861-4 Compensation
for labor or personal services.

(a) Compensation for labor or personal services performed within the
United States. (1) Generally, a specific amount paid for labor or
personal services performed in 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--(l) Persons other than
individuals. If a taxpayer other than an individual receives
compensation for a specific time period for labor or personal
services performed partly within and partly without the United
States, the amount of compensation for labor or personal services
performed in the United States shall be determined on the basis that
most correctly reflects the proper source of the income under the
facts and circumstances of the particular case.

To the extent that a determination is made on a time basis, the time
period to which the compensation for services relates is presumed to
be the taxable year of the taxpayer in which the services are
performed unless the taxpayer establishes to the satisfaction of the
Commissioner, or the Commissioner determines, a change in
circumstances that establishes a distinct, separate, and continuous
period of time.

(2) Individuals. If an individual receives compensation, including
fringe benefits, for a specific time period for labor or personal
services that are performed partly within and partly without the
United States, the amount of compensation for labor or personal
services performed within the United States shall be determined on a
time basis. An amount of compensation for labor or personal services
performed in the United States determined on a time basis is an
amount that bears the same relation to the total compensation as the
number of days of performance of the labor or services within the
United States bears to the total number of days of performance of
labor or services for which the compensation payment is made. The
time period to which the compensation for services relates is
presumed to be the calendar year in which the services are
performed, unless the taxpayer establishes to the satisfaction of
the Commissioner, or the Commissioner determines, a change in
circumstances that establishes a distinct, separate, and continuous
period of time.

For example, a transfer from a position in the United States to a
foreign posting during the year would generally establish two
separate time periods. However, a foreign posting that requires
short-term returns to the United States to perform services for the
employer would not be sufficient to establish a distinct, separate,
and continuous time period within the foreign posting time period.
Short-term returns to the United States during the separate time
period of the foreign posting would be relevant to the apportionment
of compensation relating to such time period.

(3) Examples. The following examples illustrate the application of
this paragraph (b):

Example 1. Corp X, a United States corporation, receives
compensation of $15,000 under a contract for services to be
performed concurrently in the United States and in several foreign
countries at differing rates of compensation by numerous Corp X
employees during the taxable year. The employees performing services
under this contract perform their services exclusively in one
jurisdiction and do not work both within and without the United
States during the taxable year. The payroll costs for employees
performing services in the United States associated with these
contract services is $2,000 out of a total contract payroll cost of
$3,000. Since the employees add relatively different amounts of
value to the product, a time basis test is not the best test under
the facts and circumstances of this particular case. An
apportionment of the income received under the contract based upon
relative payroll costs would be the basis that most correctly
reflects the proper source of the income. Thus, $10,000 of the
compensation received under this contract will be compensation for
labor or personal services performed in the United States ($15,000 x
$2,000/$3,000).

Example 2. Corp X, a United States corporation, receives
compensation of $15,000 under a contract for services. Corp X is
able to perform the services necessary to fulfill its obligation
under the contract by assigning only three of its employees, each
with the same rate of compensation, to render services both within
and without the United States during the taxable year.

Since the rate of compensation is the same, it can be assumed that
all employees are adding the same value to the product. The total
number of employee-days necessary to complete the contract is 30
days of which 10 days were spent performing services within the
United States. Under these facts and circumstances, an apportionment
on a time basis would be the basis that most correctly reflects the
proper source of the income. The amount of compensation for labor or
personal services performed in the United States will be that amount
that bears the same relation to the total compensation as the number
of days of performance of the labor or services within the United
States bears to the total number of days of performance of labor or
services for which the payment is made. Thus, $5,000 will be
compensation from labor or personal services performed in the United
States ($15,000 x 10/30).

Example 3. B, a nonresident alien individual, was employed by M, a
domestic corporation, from March 1 to June 12 of the taxable year, a
total of 104 days, for which B received compensation in the amount
of $12,240. Under the contract, B was subject to call at all times
by M and was in a payment status on a 7-day week basis. Pursuant to
the contract, B performed services within the United States for 59
days and performed services without the United States for 45 days.
Under subparagraph (b)(2) of this section, the amount of
compensation from labor or personal services performed in the United
States will be determined on a time basis and equal to $6,943.85
($12,240 x 59/104).

Example 4. (i) A, a United States citizen, is employed by a domestic
corporation. A earns an annual salary of $100,000. During the first
quarter of the calendar year, A's post of duty is in the United
States and A performs services entirely within the United States
during this period. A is transferred to Country X for the remaining
three-quarters of the year, and, in addition to A's annual salary,
receives $75,000 in fringe benefits that relate to the foreign
posting. These fringe benefits are paid separately from A's annual
salary and are specifically stated to be a housing allowance and an
allowance for family home leave. Under A's employment contract, A is
required to work on a 5-day week basis, Monday through Friday.

During the last three quarters of the year, A performs services 30
days in the United States and 150 days abroad.

(ii) A has $175,000 gross income for the taxable year from the
performance of services. A is able to clearly establish that A's
transfer created two distinct, separate, and continuous time periods
within the calendar year. Accordingly, $25,000 of the income
designated as salary is attributable to the first quarter of the
year (one quarter of $100,000). This amount is allocated entirely to
compensation for labor or personal services performed in the United
States. The balance of A's adjusted gross income, $150,000 (which
includes the $75,000 in fringe benefits that relate to the foreign
posting), is compensation allocated to services performed for the
final three quarters of his taxable year. During the last three
quarters of the year, A's periodic performance of services in the
United States does not constitute distinct, separate, and continuous
periods of time. Of this $150,000 amount, $125,000 (150/180 x
$150,000) is apportioned to compensation for labor or personal
services performed outside the United States, and $25,000 (30/180 x
$150,000) is apportioned to compensation for labor or personal
services performed in the United States.

* * * * *

(d) Effective date. Paragraphs (a) and (c) of this section apply
with respect to taxable years beginning after December 31, 1966,
however, the first sentence of paragraph (a)(1) applies to taxable
years beginning on or after final regulations are published in the
Federal Register. Paragraph (b) of this section applies to taxable
years beginning on or after final regulations are published in the
Federal Register. For paragraph (b) of this section and
corresponding rules applicable to taxable years beginning after
December 31, 1966, and before the date final regulations are
published in the Federal Register, see §1.861- 4(b) in effect prior
to the date final regulations are published in the Federal Register
(26 CFR part 1 revised April 1, 1999). For corresponding rules
applicable to taxable years beginning before January 1, 1967, see
§1.861-4 in effect prior to October 2, 1975 (26 CFR part 1 revised
April 1, 1975).

Robert E. Wenzel
Deputy Commissioner of Internal Revenue

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