Prior to TCJA, taxpayers were typically incentivized to treat as much income as possible as a foreign source to maximize available FTCs as a way to offset residual U.S. income taxation. However, QBI does not generally include foreign-source income. Therefore, for taxpayers who are able to and want to maximize the domestic pass-through deduction, it would make sense to maximize U.S. source ECI within and through the respective pass-through business.
Interest income
The term interest includes any payment for the use of borrowed funds, including unstated interest that is part of a deferred payment on the sale of property and original issue discount. Any payment of interest by the U.S. government, a U.S. territory, or any subdivision of a U.S. territory (not including U.S. possessions) is U.S.-source income. Note that the source of interest does not depend on such factors as where funds are borrowed or spent, the place where principal is paid, or the place where a debt obligation is issued.
In general, the source of interest income is determined by the residence of the debtor.
Sections 861(a)(1) and 862(a)(1) generally source interest income by reference to the debtor’s residence (in the case of a “noncorporate” debtor, such as an individual, partnership, trust, or estate) or the debtor’s place of incorporation (in the case of a corporation). The general rule of Sections 861(a)(1) and 862(a)(1) treats interest income as U.S.-source income if the debtor is a U.S. resident or a domestic corporation, and as foreign-source income if the debtor is neither a U.S. resident nor a domestic corporation.
Generally, U.S. source interest income includes the following items:
Interest on bonds, notes, or other interest-bearing obligations of U.S. residents or domestic corporations
Interest paid by a domestic or foreign partnership or foreign corporation engaged in a U.S. trade or business at any time during the tax year
Original issue discount
Interest from a state, the District of Columbia, or the U.S. government
The place or manner of payment is immaterial in determining the source of the income.
A substitute interest payment made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction is sourced in the same manner as the interest on the transferred security.
U.S. source interest income does not include the following items:
1 Interest paid by a resident alien or a domestic corporation on obligations issued before August 10, 2010, if for the three-year period ending with the close of the payer’s tax year preceding the interest payment, at least 80% of the payer’s total gross income:Is from sources outside the United States, andIs attributable to the active conduct of a trade or business by the individual or corporation in a foreign country or a U.S. possession.However, the interest will be considered U.S. source interest income if either of the following apply.The recipient of the interest is related to the resident alien or domestic corporation. See Section 954(d)(3) for the definition of related person.The terms of the obligation are significantly modified after August 9, 2010. Any extension of the term of the obligation is considered a significant modification.
2 Interest paid by a foreign branch of a domestic corporation or a domestic partnership on deposits or withdrawable accounts with mutual savings banks, cooperative banks, credit unions, domestic building and loan associations, and other savings institutions chartered and supervised as savings and loan or similar associations under federal or state law if the interest paid or credited can be deducted by the association.
3 Interest on deposits with a foreign branch of a domestic corporation or domestic partnership, but only if the branch is in the commercial banking business.
Dividends
In most cases, dividend income received from domestic corporations is U.S. source income. Dividend income from foreign corporations is usually foreign-source income. Exceptions to both of these rules are discussed in the following material.
A substitute dividend payment made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction is sourced in the same manner as a distribution on the transferred security.
Dividend equivalent payments
U.S. source dividends also include all dividend equivalent payments. Dividend equivalent payments include substitute dividends, payments made pursuant to a specified notional principal contract, and all similar payments that, directly or indirectly, are contingent on or determined by reference to, the payment of a dividend from U.S. sources. The IRS has issued final regulations on this topic.
Guarantee of indebtedness
Certain amounts received directly or indirectly, for the provision of a guarantee of indebtedness issued after September 27, 2010, are U.S. source income. They must be paid by a noncorporate resident or U.S. corporation or by any foreign person if the amounts are effectively connected with the conduct of a U.S. trade or business. For more information, see Internal Revenue Code Sections 861(a)(9) and 862(a)(9).
Personal services
All wages and any other compensation for services performed in the United States are considered to be from sources in the United States subject to very specific exceptions for employees of foreign persons, organizations, or offices, and crew members.
If you are an employee and receive compensation for labor or personal services performed both inside and outside the United States, special rules apply in determining the source of the compensation. Compensation (other than certain fringe benefits) is sourced on a time basis. Certain fringe benefits (such as housing and education) are sourced on a geographical basis, or, you may be permitted to use an alternative [time] basis to determine the source of compensation.
Transportation income
Transportation income is income from the use of a vessel or aircraft or for the performance of services directly related to the use