The IRS has published a tax practice unit on source of income for nonresident aliens. The summary is as follows:
NOTE: This Practice Unit was updated to incorporate changes due to the Tax Cuts and Jobs Act for tax years beginning after 12/31/2017 and supersedes the 05/12/16 Unit with the same title.
Source of income is a fundamental concept in international taxation. Identifying the country in which taxpayers earn income is an important step in determining the taxability of a transaction. In general, the U.S. source rules are based on the location of the underlying income-producing property or activity that generated the income. However, the source of certain income is based on residency.
Although sourcing rules apply to U.S. and foreign persons, this Practice Unit focuses on how the sourcing rules apply to nonresident aliens (NRA). The source rules are used in determining the U.S. income tax liability of foreign persons. With few exceptions, the United States can only tax income from U.S. sources that is effectively connected to a U.S. trade or business. In most cases, effectively connected income (ECI) is limited to U.S. source income. In the case of nonbusiness income, such as fixed or determinable annual or periodical (FDAP) income, a 30 percent withholding tax is applicable only to U.S. source income.
Most of the source rules are found in IRC 861 through 865 as follows:
IRC 861: Identifies U.S. source income.
IRC 862: Identifies foreign source income.
IRC 863: Deals with categories of income that are partially U.S. and partially foreign sourced.
IRC 864: Provides definitions for a number of relevant terms and prescribes rules for allocation of certain expenses to U.S. and foreign source income.
IRC 865: Provides rules for determining the source of income derived from the sale of various types of personal property.
Posted by Lewis J. Saret, Co-General Editor, Wealth Strategies Journal.