Generally, income from the sale of personal property is “sourced” to the residence of the seller. If the seller is a U.S. tax resident the source of the income is deemed to be the United States. On the other hand, if the seller is a nonresident, the income is generally foreign-sourced.
The Congressional policy behind this residence rule provides as follows:
Source rules for sales of personal property should reflect the location of the economic activity generating the income at issue or the place of utilization of the assets generating that income. In addition, source rules should operate clearly without the necessity for burdensome factual determinations, limit erosion of the U.S. tax base and, in connection with the foreign tax credit limitation, generally not treat as foreign income any income that foreign countries do not or should not tax.
Because the residence of the seller generally is the location of much of the underlying activity that generates income derived from sales of personal property, the committee believes that sales income generally should be sourced there.
Rept. 99–426, at 360 (1985), 1986–3 C.B. (Vol.2) 1, 360. Courts have likewise recognized the policy behind the residence rule, acknowledging that “Congress determined that ‘the residence of the seller generally is the location of much of the underlying activity that generates income derived from sales of personal property.’” See Int’l Multifoods Corp. v. Comm’r of Internal Revenue, 108 T.C. 579, 589 (U.S.T.C. 1997). In this regard, the term “sale” includes any exchange or other disposition.
For income-sourcing purposes, the concept of residency is modified from the general tax definition of residency and is based on the location of the seller’s “tax home.” A U.S. citizen or resident alien is deemed to be a U.S. resident for purposes of determining the source of personal property if they do not have a tax home outside the United States. Likewise, a nonresident alien is deemed to be a United States resident if he has a tax home within the United States. For these purposes, the concept of “tax home” is defined as the individual’s home for purposes of section § 162(a)(2). However, an individual may not be treated as having a tax home in a foreign country for any period for which he has an abode in the United States.
In applying the sourcing rule based on the residence of the seller, for example, the Courts have ruled that a stock loss realized by a U.S. resident on the sale of stock of a foreign corporation was a U.S.-source loss based on the residence of the seller.
Exceptions to the General Sourcing Rule
The general rule for sourcing income from the sale of personal property is subject to several exceptions. The following list, while not an exhaustive list of those exceptions, contains several of the most common exceptions to the income sourcing rules:
- 10% Foreign Income. If a U.S. citizen or resident alien pays foreign income tax equal to or greater than 10 percent on the gain from the sale of personal property, that individual will be treated as a nonresident of the United States and the gain on the sale will be foreign source.
- Sales of inventory. Sales of inventory are subject to additional rules that may vary based upon several factors.
- Sales of depreciable property. If there is a gain on the sale of depreciable or amortizable tangible personal property, any depreciation or amortization deductions that were allocated against U.S.-source income must be recaptured and treated as U.S.-source income. The remaining portion of such gain (not in excess of the depreciation deductions) is treated as foreign source. Any gain in excess of the depreciation deductions is sourced as if the property were “inventory property” under IRC 861 through 863. This rule stops a taxpayer from taking deductions against U.S.-source income (which reduces his or her basis in the property) and later avoiding tax on the sale of the property through sourcing rules.
- Sales of personal property through a U.S. or foreign office or fixed place of business. If a United States resident maintains an office or other fixed place of business in a foreign country, income from sales of personal property attributable to such office or other fixed place of business are sourced outside the United States. If a nonresident maintains an office or other fixed place of business in the United States, income from any sale of personal property (including inventory property) attributable to the office or other fixed place of business is sourced in the United States. This does not apply, however, for certain purposes, such as relating to an export trade corporation.
- Sales of personal property by a partnership. In the case of a partnership or trust, the source of income usually is determined at the entity level and the characterization carries over to the partner or beneficiary’s distributive share of income. An exception is the sale of personal property by the partnership, in which case the applicable source rule is applied at the partner level rather than the partnership level.
- Sales of Intellectual Property. The source of gain realized from the sale of intangible property is generally determined by the residence of the taxpayer if there is a fixed price. If payments are contingent on the productivity, use or disposition of the intangible property, the source of income is determined using the source rules for royalties under IRC 861(a)(4) and 862(a)(4). To the extent that amortization deductions have been taken against U.S.- or foreign-source income from intangible property (not including goodwill), the gain that does not exceed the deductions taken is treated as U.S.- or foreign-source income under IRC 865(c). Gain realized from the sale of goodwill is generally deemed to be from sources in the country where the goodwill was generated.
Remember that other exceptions to the general may apply, depending on the circumstances and income type.
The United States is a signatory to more than 60 income tax treaties. Tax treaties often change the otherwise applicable income sourcing rules.
Our Freeman Law interactive tax treaty map provides a link to tax treaty materials for each U.S. treaty partner:
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