Prop. Regs. Clarify Source of Compensation Rules

By James Beavers, J.D., LL.M., CPA

The IRS has issued proposed regulations that would clarify the determination of the source of compensation for a person, including an artist or athlete, who is compensated for labor or personal services performed at a specific event or events.

Current Rules

Compensation for labor or personal services performed in the United States is treated as gross income from sources within the United States, and compensation for labor or personal services performed outside the United States is treated as gross income from sources without the United States (Secs. 861(a)(3) and 862(a)(3)). Compensation for labor or personal services performed partly within and partly outside the United States is apportioned among the countries in which the services were performed (Regs. Sec. 1.861-4(b)).

If an individual performs labor or personal services partly within and partly outside the United States other than as an employee, the compensation’s source is determined on the basis that most correctly reflects the proper source of that income under the facts and circumstances of the particular case. If an individual performs labor or personal services within and outside the United States as an employee, the compensation’s source is generally determined on a time basis, with certain fringe benefits sourced on a geographic basis. However, an employee may determine the compensation’s source under an alternative basis if the employee establishes to the Service’s satisfaction that, under the facts and circumstances, the alternative basis more properly determines the compensation’s source than the general rules. In addition, the IRS may determine the source of an individual’s compensation under an alternative basis if the compensation is not for a specific time period, provided that the alternative basis determines the compensation’s source in a more reasonable manner than the basis used by the individual. (See Regs. Sec. 1.861-4(b)(2)(ii).)

Proposed Regulations

The Service has proposed regulations that would create a new “event basis” rule for sourcing compensation received by a person, including an artist or athlete. Using the event basis, the amount of income that is properly treated as a person’s compensation is the amount of compensation that, based on the facts and circumstances, is attributable to the labor or personal services a person performs at the location of a specific event. The compensation’s source is the location of the event. The event basis would apply both when a person is paid for labor or personal services performed entirely in the United States and when a person is paid for labor or personal services performed partly within and partly outside the United States.

While the proposed regulations do not rule out the use of an alternative basis for apportioning compensation attributable to specific events, they state that “a basis that purports to determine the source of compensation from the performance of labor or personal services at a specific event, whether on a time basis or otherwise, by taking into account the location of labor or personal services performed in preparation for the performance of labor or personal services at the specific event will generally not be the basis that most correctly determines the source of the compensation.” If a taxpayer uses a basis other than the event basis to determine the source of compensation, the IRS can redetermine the compensation’s source using the event basis if its use determines the source of compensation in a more reasonable manner.

Example 1: P, a citizen and resident of country A, is paid by Company Z to make a presentation in the United States in 2009. In 2010, Z pays P to make 10 presentations, four of which are in the United States and six of which are outside the United States. Z compensates P separately for each presentation. For some presentations P receives a flat fee from Z. For the remaining presentations P receives compensation based on a formula. Under the facts and circumstances of the particular case, the source of the compensation for each presentation is most correctly reflected on an event basis. Because P is compensated separately for each presentation, the source of P’s compensation from Z for the 2009 presentation within the United States and the four 2010 presentations in the United States will be from sources in the United States. The amounts will be determined based on the flat fee or the formula as contractually determined.

Example 2: A, a citizen and resident of country M, is an employee of X Corp., a country M corporation. During 2008, X is contractually obligated to provide A’s services to perform in a specific athletic event in the United States. Under A’s employment contract with X, A is required to perform at a professional level that requires training and other preparation prior to the event. A undertakes all of this preparation in country M. Solely as a result of A’s performance at the U.S. athletic event, A receives $2 million from X. The entire $2 million is income from sources within the United States on an event basis. A’s compensation is attributable entirely to labor or personal services performed within the United States at the athletic event. It is inappropriate to conclude that the sourceof A’s compensation is performed partly within and partly outside the United States simply because A’s preparation for the athletic event involved activities in country M.

Reflections

In addition to the language the proposed regulations would add to Regs. Sec. 1.861-4, they would also remove the reservation for artists and athletes currently at Regs. Sec. 1.861-4(c)(3), making it clear (along with the discussion in the preamble to the proposed regulations) that the event basis in the proposed regulations should apply to artists and athletes. Although the examples in the regulations indicate that the intent of these rules is to ensure that foreign persons include the maximum amountof compensation or income from events in the United States in their U.S. income, the rules would apply equally to U.S. citizens that work within and outside the United States. The new rules are proposed to be effective for tax years beginning after the date the final regulations are published.

REG-114125-07 (10/17/2007)

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