Td 9194

of § 1014, the contract is an annuity described in § 72 (as then in effect), and
therefore receives no basis adjustment
by reason of the owner’s death because
it is governed by the annuity exception
of § 1014(b)(9)(A). If the beneficiary
elects a lump-sum payment, the excess
of the amount received over the amount
of consideration paid by the decedent is
includable in the beneficiary’s gross income. Rev. Rul. 79–335 prospectively
revokes Rev. Rul. 70–143, 1970–1 C.B.
167, which had concluded on substantially identical facts that such a contract,
if surrendered by the beneficiary prior to
the annuity starting date, is not an annuity described in § 72 and therefore is not
governed by the rule of § 1014(b)(9)(A),
and that the beneficiary receives the date
of death value as the basis in the contract.
Although Rev. Rul. 79–335 concludes that the annuity exception in
§ 1014(b)(9)(A) applies to the contract
described in that ruling, it does not specifically address whether amounts received
by a beneficiary under a deferred annuity
contract in excess of the owner-annuitant’s investment in the contract would be
subject to §§ 691 and 1014(c). However,
had the owner-annuitant surrendered the
contract and received the amounts in excess of the owner-annuitant’s investment
in the contract, those amounts would have
been income to the owner-annuitant under
§ 72(e). Because those amounts would
have been income to the owner-annuitant
if the contract had been surrendered during
life, those amounts are IRD under § 691.
Likewise, in the present case, had A
surrendered the contract and received the
amounts at issue, those amounts would
have been income to A under § 72(e) to
the extent they exceeded A’s investment in
the contract. Accordingly, amounts that B
receives that exceed A’s investment in the
contract are IRD under § 691(a). As provided in Rev. Rul. 79–335, those amounts
are includible in B’s gross income and B
does not receive a basis adjustment in the
contract. However, B will be entitled to a
deduction under § 691(c) if estate tax was
due by reason of A’s death. The result
would be the same whether B receives the
death benefit in a lump sum or as periodic
payments.

May 16, 2005

HOLDING
If the owner-annuitant of a deferred annuity contract dies before the annuity starting date, and the beneficiary receives a
death benefit under the annuity contract,
the amount received by the beneficiary in
a lump sum in excess of the owner-annuitant’s investment in the contract is includible in the beneficiary’s gross income
as IRD within the meaning of § 691. If
the death benefit is instead received in the
form of a series of periodic payments in
accordance with § 72(s), the amounts received are likewise includible in the beneficiary’s gross income (in an amount determined under § 72) as IRD within the meaning of § 691.
EFFECT ON OTHER DOCUMENTS
Rev. Rul. 79–335 is modified and
superseded for deferred annuity contracts
purchased on or after October 21, 1979.
The holding of Rev. Rul. 70–143 (which
was revoked by Rev. Rul. 79–335) will
continue to apply for deferred annuity
contracts purchased before October 21,
1979, including any contributions applied
to those contracts pursuant to a binding
commitment entered into before that date.
DRAFTING INFORMATION
The principal author of this revenue ruling is Bradford R. Poston of the Office of
Associate Chief Counsel (Passthroughs &
Special Industries). For further information regarding this revenue ruling, contact
Bradford R. Poston at (202) 622–3060 (not
a toll-free call).

1016

Section 937.—Residence
and Source Rules Involving
Possessions
26 CFR 1.937–1T: Bona fide residency in a possession (temporary).

T.D. 9194
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 301, and 602
Residence and Source Rules
Involving U.S. Possessions and
Other Conforming Changes
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regulations.
SUMMARY: This document contains temporary regulations that provide rules under section 937(a) of the Internal Revenue Code (Code) for determining whether
an individual is a bona fide resident of
the following U.S. possessions: American
Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the United States
Virgin Islands. The temporary regulations
also provide rules under section 937(b)
for determining whether income is derived
from sources within a U.S. possession and
whether income is effectively connected
with the conduct of a trade or business
within a U.S. possession. Section 937 was
added to the Code by section 908 of the
American Jobs Creation Act (2004 Act).
The temporary regulations also provide
updated guidance under sections 876, 881,
884, 931, 932, 933, 934, 935, 957, and
6688 of the Code to reflect amendments
made by the Tax Reform Act of 1986
(1986 Act) and the 2004 Act. Conforming changes are also made to regulations
under sections 170A, 243, 702, 861, 863,
871, 901, 1402, 6038, 6046, and 7701
of the Code. The text of the temporary
regulations also serves as the text of the
proposed regulations (REG–159243–03)
set forth in the cross-referenced notice of
proposed rulemaking on this subject in
this issue of the Bulletin.

2005–20 I.R.B.

DATES: Effective Date: These regulations
are effective April 11, 2005.
FOR
FURTHER
INFORMATION
CONTACT: J. David Varley (202)
435–5165 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
These temporary regulations are being
issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason,
the collection of information contained in
these regulations has been reviewed and
pending receipt and evaluation of public
comments, approved by the Office of Management and Budget under control number
1545–1930. Responses to this collection
of information are mandatory.
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless the
collection of information displays a valid
control number.
For further information concerning this
collection of information, and where to
submit comments on the collection of information and the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross-referencing notice of proposed rulemaking published in this issue of
the Bulletin.
Books and records relating to a collection of information must be retained as
long as their contents may become material in the administration of any internal
revenue law. Generally, tax returns and tax
return information are confidential, as required by 26 U.S.C. 6103.
Background
The income tax laws of the United
States have always contained special provisions concerning the income taxation of
individuals residing in U.S. possessions
and corporations created or organized in
U.S. possessions. See e.g., sections 260
and 261 of Public Law 65–254 (40 Stat.
1057). The current rules for residents
of the Commonwealth of Puerto Rico
(Puerto Rico) were first enacted in 1950.
See sections 220 and 221 of Public Law
81–814 (64 Stat. 906) (enacting the predecessors to sections 876 and 933 of the

2005–20 I.R.B.

Code). Special rules for residents of the
United States Virgin Islands (USVI) were
added in 1960. See section 4 of Public
Law 86–779 (74 Stat. 998) (enacting section 934 of the Code). Special rules for
residents of Guam were added in 1972.
See Public Law 92–606 (86 Stat. 1494)
(1972 Act) (enacting sections 935 and
7654 of the Code). These special rules for
residents of Guam were made applicable
to residents of the Commonwealth of the
Northern Mariana Islands (NMI) for tax
years beginning after December 31, 1978.
See section 601 of Public Law 94–241 (90
Stat. 263) and Presidential Proclamation
4534.
The 1986 Act substantially revised the
provisions governing the income taxation
of individuals residing in U.S. possessions.
See sections 1271 through 1277 of Public Law 99–514 (amending sections 876,
931 through 935, 957(c), and 7654 of the
Code). The 2004 Act restated and supplemented certain aspects of these provisions.
See section 908 of Public Law 108–357
(enacting section 937 of the Code). These
regulations conform the existing regulations to the amended statutes and provide
additional guidance on the proper application of the statutory provisions.
This document contains amendments to
26 CFR parts 1, 301, and 602. The crossreferenced notice of proposed rulemaking
is published elsewhere in this issue of the
Bulletin.

U.S. Federal income tax on their worldwide income under section 1.
Under section 933, income from
sources within Puerto Rico is excluded
from gross income of bona fide residents
of Puerto Rico (whether U.S. citizens or
alien individuals) for U.S. Federal income
tax purposes. Consequently, such individuals have a U.S. Federal income tax return
filing obligation only if their income from
sources outside Puerto Rico exceeds their
deductions under section 151 relating to
personal exemptions. To the extent such
income constitutes income from sources
outside the United States, such individuals
generally may claim a foreign tax credit
under section 901(b) for income taxes paid
to foreign countries and U.S. possessions
(including Puerto Rico) to offset their U.S.
Federal income tax liability, subject to
certain limitations.
Deductions (other than the deduction
under section 151, relating to personal exemptions) properly allocable to or chargeable against amounts excluded from gross
income under section 933 generally have
been disallowed since the statute was enacted in 1950. The 1986 Act amended
section 933 to provide for a similar disallowance of credits. These regulations
amend the existing regulations under section 933 to reflect this statutory change.

Explanation of Provisions

Section 931, as enacted in the 1986 Act,
operates in a similar fashion to section 933.
For U.S. citizens and alien individuals who
are bona fide residents of possessions to
which it applies (section 931 possessions),
income from sources within such possessions or effectively connected with the
conduct of a trade or business in such possessions is excluded from gross income
for U.S. Federal income tax purposes.
Consequently, such individuals have a
U.S. Federal income tax return filing obligation only if their income from sources
outside section 931 possessions and not
effectively connected with the conduct of
a trade or business in such possessions
exceeds their deductions under section
151 relating to personal exemptions. To
the extent such income constitutes income
from sources outside the United States,
U.S. citizens who are bona fide residents
of section 931 possessions generally may

I. Operative Provisions
Many of the substantive and procedural
provisions of the Code specifically relating
to the possessions were amended by the
1986 Act. The 2004 Act further amended
certain of these provisions. These regulations implement the statutory changes
by modifying or replacing existing regulations as discussed below.
A. Puerto Rico
Individuals who are U.S. citizens generally are subject to U.S. Federal income
tax on their worldwide income, regardless
of source, under section 1 of the Code. As
discussed in section I.F. of this explanation, alien individuals who qualify as bona
fide residents of Puerto Rico (and certain
other possessions) likewise are subject to

1017

B. American Samoa, Guam, and the
Northern Mariana Islands

May 16, 2005

claim a foreign tax credit under section
901(b) for income taxes paid to foreign
countries and U.S. possessions (including
section 931 possessions) to offset their
U.S. Federal income tax liability, subject
to certain limitations. As under section
933, any deductions (other than the deduction under section 151, relating to personal
exemptions) and credits properly allocable
or chargeable against amounts excluded
from gross income under section 931 are
disallowed.
Although section 931 by its terms applies to bona fide residents of American
Samoa, Guam, and the NMI (collectively,
the Pacific possessions), the statute takes
effect with respect to any such possession
only when the possession enters into an
implementing agreement with the Internal
Revenue Service as required under the relevant effective date provisions of the 1986
Act. See sections 1271(b) and 1277(b)
of Public Law 99–514. To date, only
American Samoa has entered into such an
agreement. Consequently, section 931 currently applies only to bona fide residents of
American Samoa.
Although section 935 was repealed by
the 1986 Act, the effective date of its repeal is contingent on the entry into force
of implementing agreements, as described
above, by the possessions to which section
935 historically has applied (section 935
possessions), namely, Guam and the NMI.
Given that neither has agreed to the entry
into force of such agreements, section 935
remains in force with respect to bona fide
residents of Guam and the NMI.
Section 935, as in effect prior to its repeal, refers only to Guam. Pursuant to section 601 of the Covenant to Establish a
Commonwealth of the Northern Mariana
Islands in Political Union with the United
States, Public Law 94–241, however, the
income tax laws of the United States entered into force in the NMI in the same
manner as those laws are in force in Guam,
and references in the Code to Guam generally are deemed also to refer to the NMI.
Consequently, section 935 currently applies to bona fide residents of Guam and
of the NMI.
These regulations amend the existing
regulations under section 935 to reflect the
fact that the section currently applies not
only to bona fide residents of Guam but
also to bona fide residents of the NMI, and
may in the future apply only to bona fide

May 16, 2005

residents of one or the other and will not
apply to bona fide residents of either possession if both enter into the implementing agreements contemplated in the 1986
Act. Similarly, these regulations set forth
the post-1986 Act statutory framework for
residents of section 931 possessions in a
manner that reflects the potential for bona
fide residents of Guam and the NMI to be
covered by its provisions upon entry into
force of such implementing agreements.
C. United States Virgin Islands
Section 932, as enacted in the 1986 Act,
provides two sets of operative rules: one
for bona fide residents of the USVI, and
one for U.S. citizens and resident alien
individuals who are not bona fide residents of the USVI but have income from
sources within the USVI or income effectively connected with the conduct of a
trade or business in the USVI.
With respect to individuals who are
bona fide residents of the USVI (whether
U.S. citizens or alien individuals), section
932(c) generally provides that an income
tax return must be filed with the USVI
tax authorities. If the individual properly
reports on this return his or her income
from all sources and identifies the source
of each item of income, and pays all of the
tax properly due with respect to such income, then such income is excluded from
gross income for U.S. Federal income tax
purposes. Consequently, such individuals
have a U.S. Federal income tax return
filing obligation only if they fail to report
or properly identify the source of some
of their income on their USVI income tax
return, or if they fail to pay all of the tax
properly due with respect to their income
(for example, by improperly claiming the
benefit of a tax credit or exemption provided under USVI law but subject to the
limitations of section 934(b)).
With respect to U.S. citizens and resident alien individuals who are not bona
fide residents of the USVI but have income from sources within the USVI or income effectively connected with the conduct of a trade or business in the USVI,
section 932(a) generally provides that each
such individual must file his or her income
tax return with both the IRS and with the
USVI Bureau of Internal Revenue. In addition, under section 932(b), such an individual must pay to the USVI the “ap-

1018

plicable percentage” of the taxes imposed
under Chapter 1 of the Code. For this
purpose, the term applicable percentage
means the percentage which the individual’s Virgin Islands adjusted gross income
bears to the individual’s adjusted gross income; the term Virgin Islands adjusted
gross income means the individual’s adjusted gross income determined by taking into account only income derived from
sources within the Virgin Islands and deductions properly apportioned or allocable
thereto. On the individual’s U.S. Federal
income tax return, he or she may claim a
credit for the tax required to be paid to the
USVI, so that only the remainder is due to
the United States.
In general, the USVI administers income tax laws that are identical (except for
the substitution of the name of the USVI
for the term United States where appropriate) to those in force in the United States
(commonly referred to as the mirror code).
However, subject to the limitations of section 934(b), as amended by the 1986 Act,
the USVI has the authority to reduce or remit tax liabilities under the mirror code in
certain situations.
First, under section 934(b)(1), the
USVI may reduce or remit the tax otherwise imposed on the income of any person
(other than a U.S. citizen or resident alien
individual who is not a bona fide resident of the USVI) from sources within the
USVI or effectively connected with the
conduct of a trade or business in the USVI.
Second, under section 934(b)(3), the
USVI may reduce or remit the tax otherwise imposed on the income (other than
income from sources within the United
States or effectively connected with the
conduct of a trade or business in the United
States) of a foreign corporation, provided
that less than ten percent of its stock (by
vote and value) is owned by United States
persons. Given that a corporation created
or organized outside of the USVI can only
have a mirror code tax liability with respect to income from sources within the
USVI or effectively connected with the
conduct of a trade or business within the
USVI (all of which is within the scope of
section 934(b)(1)), the additional waiver of
the limitations of section 934(a) provided
by section 934(b)(3) generally will have no
practical effect for such corporations. Instead, section 934(b)(3) generally is relevant only to corporations created or orga-

2005–20 I.R.B.

nized in the USVI (which are treated as
“foreign” corporations for U.S. Federal income tax purposes).
These regulations amend the existing
regulations under section 934 and provide
new regulations under section 932 to reflect this post-1986 Act statutory framework.
D. U.S. tax liabilities of certain
possessions corporations
Section 881(a) generally imposes a 30
percent tax on U.S.-source fixed or determinable annual or periodical income of
foreign corporations. Section 884 imposes
certain branch-level taxes on foreign corporations that are engaged in a trade or
business in the United States. Section
881(b) provides for the reduction or elimination of the taxes otherwise imposed under sections 881(a) and 884 on corporations created or organized in U.S. possessions (possessions corporations) under certain circumstances.
Section 881(b), as enacted by the 1972
Act, provides the rules currently in effect for corporations created or organized
in section 935 possessions. Under these
rules, such corporations effectively are exempt from tax under section 881(a), provided that the following conditions are satisfied—
(1) At all times during the taxable year,
less than 25 percent in value of the stock
of such corporation is owned (directly or
indirectly) by foreign persons; and
(2) At least 20 percent of the gross income of such corporation is shown to the
satisfaction of the Secretary to have been
derived from sources within such possession for the 3-year period ending with the
close of the preceding taxable year of such
corporation (or for such part of such period
as the corporation has been in existence).
Section 881(b), as enacted by the 1972
Act, also provides the rules currently in effect for corporations created or organized
in the United States that otherwise might
incur a tax liability to a section 935 possession under a mirrored version of section
881(a). Under these rules, such corporations effectively are exempt from tax in the
section 935 possession in all cases.
Section 881(b), as amended by the 1986
Act, provides the rules currently in effect
for corporations created or organized in
section 931 possessions and in the USVI.

2005–20 I.R.B.

Under these rules, such corporations effectively are exempt from tax under section
881(a) and section 884, provided that the
following conditions (1986 conditions) are
satisfied—
(1) At all times during the taxable year,
less than 25 percent in value of the stock
of such corporation is beneficially owned
(directly or indirectly) by foreign persons;
(2) At least 65 percent of the gross
income of such corporation is shown to
the satisfaction of the Secretary to be effectively connected with the conduct of a
trade or business in such a possession or
the United States for the 3-year period ending with the close of the taxable year of
such corporation (or for such part of such
period as the corporation or any predecessor has been in existence); and
(3) No substantial part of the income
of such corporation is used (directly or indirectly) to satisfy obligations to persons
who are not bona fide residents of such a
possession or the United States.
Corporations that are created or organized in section 935 possessions and
satisfy the 1986 conditions also are exempt from the U.S. tax imposed under
section 884. Similarly, corporations that
are created or organized in the United
States and satisfy the 1986 conditions are
exempt from the tax imposed under mirrored versions of section 884 in section
935 possessions.
Section 881(b), as amended by the 2004
Act, provides a special rule for corporations created or organized in Puerto Rico.
Under this rule, such corporations are subject to tax under section 881(a) at a rate
of 10 percent (rather than the generally applicable rate of 30 percent) on their U.S.source dividend income, provided that the
1986 conditions are satisfied. However, if,
on or after October 22, 2004, there is an
increase in the rate of Puerto Rico’s withholding tax which is generally applicable
to dividends paid to United States corporations not engaged in a trade or business
in Puerto Rico to a rate greater than 10
percent, this special rule shall not apply to
dividends received on or after the effective
date of the increase.
These regulations amend the existing
regulations under sections 881 and 884 to
reflect this post-1986 Act and post-2004
Act statutory framework. These regulations also provide rules similar to the 1972
Act rules applicable to section 935 posses-

1019

sions for purposes of determining tax liability incurred to the USVI by corporations created or organized in the United
States, pursuant to section 1274(c) of the
1986 Act.
E. Application of subpart F to bona fide
residents of a possession
With respect to bona fide residents of
section 935 possessions and the USVI
(mirror code possessions), corporations
created or organized in the possession in
which they reside are treated as domestic
corporations for mirror code tax purposes.
Thus, provisions such as subpart F of part
III of subchapter N of chapter 1 of the
Code (relating to controlled foreign corporations) as mirrored do not apply with
respect to their ownership of such corporations.
With respect to bona fide residents of
section 931 possessions and Puerto Rico,
corporations created or organized in the
possession in which they reside are treated
as foreign corporations for U.S. Federal income tax purposes. Thus, in cases where,
after the application of section 931 or 933
as the case may be, such individuals are required to file U.S. Federal income tax returns, they generally must treat such corporations as foreign corporations for purposes of applying provisions, such as subpart F, to determine their U.S. Federal income tax liability.
Section 957(c), however, provides a
significant exception for bona fide residents of section 931 possessions and
Puerto Rico. In cases where it applies, the
individual is not treated as a United States
person for purposes of subpart F. Consequently, such individual is not treated
as a United States shareholder under section 951(b), and possession corporations
described in section 957(c) that are controlled by such individuals are not treated
as controlled foreign corporations under
section 957(a).
In the case of a bona fide resident of
Puerto Rico, section 957(c)(1) applies with
respect to a corporation organized under
the laws of the Commonwealth of Puerto
Rico if a dividend received by such individual during the taxable year from such
corporation would, for purposes of section
933(1), be treated as income derived from
sources within Puerto Rico. (As discussed
in more detail below in section II.B. of this

May 16, 2005

explanation, such would be the case if, during a three-year testing period ending with
the taxable year, the corporation’s gross
income was derived entirely from sources
within Puerto Rico or the corporation met
certain gross income and trade or business
requirements.)
In the case of a bona fide resident of a
section 931 possession, section 957(c)(2)
applies with respect to a corporation organized under the laws of such a possession
if the following conditions are satisfied—
(1) 80 percent or more of the gross income of the corporation for the 3-year period ending at the close of the taxable year
(or for such part of such period as such corporation or any predecessor has been in existence) was derived from sources within
such a possession or was effectively connected with the conduct of a trade or business in such a possession; and
(2) 50 percent or more of the gross income of the corporation for such period (or
part) was derived from the active conduct
of a trade or business within such a possession.
These regulations amend the existing
regulations under section 957 to reflect
this post-1986 Act statutory framework.
These regulations also make corresponding changes to the regulations under sections 6038 and 6046 (relating to information reporting requirements with respect
to certain foreign corporations owned by
United States persons).
F. Taxation of aliens residing in a
possession
Under section 876, individuals who
are nonresident aliens with respect to the
United States and are bona fide residents
of certain possessions are subject to U.S.
Federal income tax on their worldwide
income under section 1 (rather than solely
on their income from sources within the
United States or effectively connected
with the conduct of a trade or business in
the United States under section 871). Prior
to the 1986 Act, section 876 applied only
to alien individuals who were bona fide
residents of Puerto Rico. As amended by
the 1986 Act, section 876 applies also to
alien individuals who are bona fide residents of section 931 possessions.
These regulations amend the existing
regulations under section 876 to reflect this
post-1986 Act statutory framework.

May 16, 2005

G. Entity status
The IRS and Treasury are aware that
some taxpayers have deliberately treated
business entities in an inconsistent manner for U.S. Federal income tax purposes
and for purposes of determining income
tax liabilities incurred to mirror code possessions, in order to reduce their overall
tax liability below what otherwise would
be due in the absence of the mirror system. The IRS and Treasury believe that
such inconsistent treatment is inappropriate and contrary to the purpose of the mirror system. Accordingly, these regulations
contain special rules requiring consistent
treatment of business entities for U.S. and
mirror code tax purposes.
Under these rules, if an entity status
election (such as a subchapter S election
or an election under §301.7701–3(c)) is
filed with the IRS but not with the relevant mirror code possession, then the appropriate tax authority of the mirror code
possession may, at his or her discretion,
deem the election also to have been made
for mirror code tax purposes. Similarly, if
any such election is filed in a mirror code
possession but not with the IRS, the Commissioner may, at his discretion, deem the
election to have been made for U.S. Federal income tax purposes. In the event
that inconsistent elections are filed with
the IRS and the mirror code possession,
both the Commissioner and the appropriate tax authority of the mirror code possession may, at their individual discretion,
deem the elections they received to be invalid and may deem the election filed with
the other jurisdiction to have been made
also for tax purposes in their own jurisdiction. Further, in the absence of an election, the default characterization of an eligible entity organized in a mirror code
possession shall be determined under the
rules applicable to domestic eligible entities under §301.7701–3(b). These consistency rules apply to elections under section
1362(a) and §301.7701–3(c), and to other
similar elections. The IRS and Treasury
request comments relating to elections that
should be specifically mentioned or excluded from the regulations.
These special rules generally apply to
elections made after, and entities created
after, April 11, 2005. Transition rules are
provided for existing entities, under which

1020

these special rules generally apply as of the
beginning of the next taxable year.
H. Effective date
To the extent they provide rules under
the operative provisions of the Code relating to the possessions, as amended by
1986 Act and the 2004 Act, these regulations generally apply to taxable years ending after October 22, 2004. The underlying
statutory rules, however, generally apply
to taxable years beginning after December 31, 1986. Accordingly, taxpayers may
rely upon the guidance provided in these
regulations with respect to prior years for
which the underlying statutory rules are
in effect, provided that they do so consistently.
II. Definitional Provisions
As indicated above in section I of this
explanation, when applying the operative
provisions of the Code relating to the possessions, determinations must be made
regarding whether an individual is a bona
fide resident of a particular possession, or
whether income is derived from sources
within a particular possession or is effectively connected with the conduct of a
trade or business in a particular possession. Section 937 and these regulations
provide guidance on these issues, as discussed below.
A. Bona fide residency in a possession
The term bona fide resident has been
an integral part of the special provisions of
the Code relating to U.S. possessions since
1950. See sections 220 and 221 of Public Law 81–814. From the beginning, this
term has been used to identify the class of
persons entitled to Federal tax exemptions
or other special treatment under these provisions, and its meaning has remained essentially unchanged through all of the expansions and revisions of these provisions.
Historically, the determination of
whether an individual is a bona fide
resident of a possession has turned on
the facts and circumstances and, specifically, on an individual’s intentions with
respect to the length and nature of his
or her stay in the possession.
See,
e.g., §§1.933–1(a), 1.934–1(c)(2), and
1.935–1(a)(3) (generally applying the
principles of §§1.871–2 through 1.871–5).

2005–20 I.R.B.

But see §301.7701(b)–1(d) (applying the
rules of section 7701(b) for determining
whether alien individuals qualified as residents of mirror code possessions for taxable years beginning after December 31,
1984). The qualifier “bona fide” indicates
that a claim of residence in a possession is
respected for Federal tax purposes when it
is made in good faith.
As enacted by the 2004 Act, section
937(a) provides that an individual generally will be considered a bona fide resident
of a possession only if he or she satisfies all
three of the following conditions—
(1) He or she is physically present in the
possession for 183 days during the taxable
year (physical presence test);
(2) He or she does not have a tax home
(determined under the principles of section
911(d)(3) without regard to the second sentence thereof) outside the possession during the taxable year (tax home test); and
(3) He or she does not have a closer connection (determined under the principles
of section 7701(b)(3)(B)(ii)) to the United
States or a foreign country than to the possession (closer connection test).
Section 937(a) further provides that, for
purposes of the physical presence test, the
determination as to whether a person is
present for any day shall be made under the
principles of section 7701(b). The legislative history explains that, under this rule,
an individual is to be considered present
in a possession for a particular day if he is
physically present in such possession during any time during such day, and in certain
circumstances (e.g., certain medical emergencies), an individual’s presence outside
a possession is ignored. See H.R. Rep. No.
108–755, at 780 (2004).
The tax home and closer connection
tests are similar to the conditions that individuals historically have needed to meet
to be considered residents of a possession.
Congress also provided regulatory
authority for the IRS and Treasury to create exceptions to this general definition,
for cases in which an individual’s absence from the possession is motivated
by reasons other than tax avoidance. In
particular, the legislative history indicates
that Congress anticipated that exceptions
would be provided for military personnel, workers in the fisheries trade, and
retirees who may travel outside of a possession for personal reasons. At the same
time, the legislative history makes clear

2005–20 I.R.B.

that Congress wished to ensure that individuals who live and work stateside
cannot avail themselves of the tax benefits
that Congress intended to provide only
to individuals who actually reside in the
possessions. See H.R. Rep. No. 108–755,
at 780 (2004).
Consistent with this legislative history,
these regulations include several exceptions to the general statutory rules of section 937(a).
First, these regulations provide several
alternatives to the 183-day rule for purposes of satisfying the physical presence
test. One alternative is that the individual
spend no more than 90 days in the United
States during the taxable year. Thus, for
example, workers in the fisheries trade
who spend considerable periods at sea,
and individuals who travel extensively to
neighboring islands to provide goods and
services, may satisfy the physical presence
requirement under this alternative.
Another alternative is that the individual spend more days in the possession
than in the United States and have no
earned income (as defined in §1.911–3(b))
in the United States during the taxable
year. Thus, for example, retirees who
spend several months each year stateside
for vacation, for medical treatment, or to
visit relatives, and some time traveling in
foreign countries, may satisfy the physical
presence requirement under this alternative.
A final alternative is that the individual have no permanent connection to
the United States. For this purpose, the
term permanent connection to the United
States includes a permanent residence and
a spouse or dependent with a principal
place of abode in the United States. In
other words, the absence of a permanent
connection will enable an individual to
satisfy the physical presence test. Thus,
for example, an individual who lives in a
possession but travels extensively in the
United States for business reasons or to
receive medical treatment may satisfy the
physical presence requirement under this
alternative.
For purposes of determining whether
the above-mentioned alternatives are satisfied, certain days spent in the United States
are disregarded. In particular, days spent
as a full-time student, as a full-time government official or employee of a possession, or as a professional athlete participat-

1021

ing in a charitable event generally are disregarded. In addition, days spent in transit and days that an individual is prevented
from leaving the United States because of a
medical condition that arose while the individual was present in the United States
generally will also be disregarded.
The above-mentioned alternatives apply with respect to individuals who are
U.S. citizens or resident aliens (as defined
in section 7701(b)). A different approach
is appropriate in the case of individuals
who are nonresident aliens with respect to
the United States. For such individuals, in
lieu of the above-mentioned alternatives,
a mirrored version of the section 7701(b)
substantial presence test applies.
For purposes of the tax home test, these
regulations provide a special rule for seafarers. Under this special rule, an individual will not be considered to have a
tax home outside the relevant possession
solely by reason of employment on a ship
or other seafaring vessel that is predominantly used in local and international waters.
For purposes of the closer connection
test, these regulations provide a special
rule under which another possession is not
considered a foreign country. Thus, for example, an individual who has a tax home in
the USVI and a closer connection to Puerto
Rico, and who satisfies the presence test
with respect to both possessions, generally
will be considered a bona fide resident of
the USVI, and not of Puerto Rico.
Special rules apply under Federal law
for determining the residence of military
personnel for tax purposes. See 50 App.
U.S.C. 571(a). Consistent with these special rules, these regulations provide that an
individual’s absence from or presence in a
possession in compliance with military orders generally does not affect whether the
individual qualifies as a bona fide resident
of such possession.
Finally, consistent with existing law
(see Notice 2000–61, 2000–2 C.B. 569),
these regulations provide that only natural persons may be considered bona fide
residents of a possession for U.S. Federal
income tax purposes. Thus, juridical persons such as corporations, partnerships,
trusts, and estates cannot be considered
bona fide residents of a possession for
U.S. Federal income tax purposes.
It should be noted that the 2004 Act
modified sections 932 and 935, to conform

May 16, 2005

the treatment of individuals who acquire or
relinquish residency in mirror code possessions with the historical treatment of individuals who acquire or relinquish residency in Puerto Rico and section 931 possessions. Thus, for example, in order to
be subject to the special rules of section
932(c), an individual must qualify as a
bona fide resident of the USVI during the
entire year. Accordingly, an individual
generally is not subject to such special
rules for any year during which he or she
moves to or from the USVI.
The 2004 Act provisions and these regulations as they relate to the determination of bona fide residency in a possession generally apply to taxable years ending after October 22, 2004, except that
the physical presence requirement applies
only to taxable years beginning after October 22, 2004. In addition, taxpayers may
choose to apply the rules set forth in these
regulations in their entirety (including the
physical presence test) to any open taxable years by notifying the IRS upon examination of their intent to do so. Alternatively, for such years, U.S. citizens and
resident alien individuals (as well as nonresident aliens in possessions other than
mirror code possessions) may continue to
apply the principles of §§1.871–2 through
1.871–5, and nonresident alien individuals
in mirror code possessions may continue to
apply the rules of §301.7701(b)–1(d) (as in
effect for such years).
B. Income from sources in a possession
In general, the rules for determining
whether income is derived from sources
within the United States have applied for
purposes of determining whether income
is derived from sources within a possession. See §1.863–6. The 2004 Act codified this rule in section 937(b), with two
exceptions.
First, section 937(b)(2) (U.S. income
rule) provides that an item of income
shall not be considered to be derived from
sources within a possession (or effectively
connected with the conduct of a trade
or business within a possession) if such
item of income constitutes income from
sources within the United States or income
effectively connected with the conduct of
a trade or business in the United States
under the general rules of sections 861
through 865.

May 16, 2005

Second, section 937(b) provides an express grant of authority, consistent with the
authority contained in sections 931, 934,
and 957 as amended by the 1986 Act, for
Treasury and the IRS to provide appropriate exceptions to the general source rules.
The legislative history to the 2004 Act
indicates that Congress intended for Treasury and the IRS to use this authority to
continue the existing treatment of income
from the sale of goods manufactured in
a possession. The 2004 Act legislative
history further indicates that Congress intended for this authority to be used to prevent abuse, for example, to prevent U.S.
persons from avoiding U.S. tax on appreciated property by acquiring residency in
a possession prior to its disposition. See
H.R. Rep. No. 108–755, at 781 (2004).
The legislative history to the 1986 Act
reflects similar concerns. For example,
Congress did not believe that a mainland resident who moves to a possession
while owning appreciated personal property such as corporate stock or precious
metals and who sells that property in the
possession should escape all tax, both in
the United States and the possession, on
that appreciation. Similarly, Congress
did not believe that a resident of a possession who owns financial assets such
as stocks or debt of companies organized
in, but the underlying value of which is
primarily attributable to activities performed outside, the possession should
escape tax on the income from those assets. Accordingly, Congress anticipated
that regulations would treat such income
as sourced outside the possession where
the taxpayer resides. See H.R. Rep. No.
99–426, at 487 and 489 (1985); S. Rep.
No. 99–313, at 481 and 484 (1986).
These regulations include several exceptions to the general statutory rules of
section 937(b).
First, the regulations provide that the
U.S. income rule only applies for income
earned after December 31, 2004.
Second, the regulations contain a special conduit rule to prevent the avoidance
of the U.S. income rule. Under this special conduit rule, income is considered to
be from sources within the United States
for purposes of the U.S. income rule if,
pursuant to a plan or arrangement, (i) the
income is received in exchange for consideration provided to another person, and
(ii) such person (or another person) pro-

1022

vides the same consideration (or consideration of a like kind) to a third person in
exchange for one or more payments constituting income from sources within the
United States. This rule supplements, and
does not supersede, other potentially applicable conduit rules. See, for example,
Aiken Indus., Inc. v. Commissioner, 56
T.C. 925 (1971). Unlike more generally
applicable conduit rules, however, the special conduit rule in these regulations applies only for purposes of section 937 (and
provisions for which the rules of section
937 apply); it does not cause the income to
be treated as income from sources within
the United States for other purposes of the
Code.
Third, the regulations preserve the existing treatment of income from the sale of
goods manufactured in a possession under
§1.863–3(f). These existing rules reflect a
careful consideration of the relevant policy considerations arising with respect to
the transactions to which they apply, and
Congress did not intend for this result to
be changed through a mechanical application of the general source rules of section
937(b). For the same reason, these regulations contain rules to preserve the results
with respect to the allocation of income between the United States and its possessions
under sections 863(c), 863(e), 865(g)(3),
and 865(h)(2)(B).
Fourth, the regulations provide special
rules for gains from dispositions of certain
property held by a U.S. person prior to becoming a resident of a possession. Under
these rules, such gains generally are treated
as income from sources outside of the possession. These rules supplement, and do
not supersede, the special source rule of
section 1277(e) of the 1986 Act, which applies to individuals who become residents
of Pacific possessions. Under this 1986
Act special source rule, gains from dispositions of certain property held by a U.S.
person prior to becoming a resident in a Pacific possession is treated as income from
sources within the United States for all purposes of the Code (including section 7654
of the 1954 Code as applicable to Guam
and the NMI). The regulations also contain rules that are designed to prevent the
avoidance of these special gain rules.
Fifth, the regulations provide special
rules for dividends from corporations created or organized in a possession (possessions corporations). In general, such

2005–20 I.R.B.

dividends constitute income from sources
within a possession under the principles
of section 861(a)(2)(A). A special lookthrough rule applies, however, when the
shareholder owns, directly or indirectly, at
least 10 percent of the voting stock of the
corporation. Under this special rule, only
a ratable portion of any dividend paid or
accrued by a possessions corporation to
such a shareholder is treated as income
from sources within the possession. The
ratable portion is determined by applying
to the dividend the ratio of the corporation’s income from sources within the possession over its total income over a threeyear testing period ending with the year in
which the dividend is paid. (See also sections 881(b) and 957(c) for which a similar three-year testing period applies.) This
look-through rule does not apply, however,
if the corporation meets the following conditions (the 80/50 conditions)—
(1) 80 percent or more of the gross income of the corporation for the three-year
testing period was derived from sources
within the possession or was effectively
connected with the conduct of a trade or
business in the possession; and
(2) 50 percent or more of the gross income of the corporation for such period
was derived from the active conduct of a
trade or business within the possession.
Sixth, the regulations provide rules for
determining the extent to which income
inclusions (for example, under section
951(a)) may be considered to be derived
from sources within a possession. Specifically, for shareholders owning at least
10 percent of the voting stock of the corporation, the regulations generally apply
the principles of section 904(h)(2), under
which the source of income inclusions
ordinarily is determined for foreign tax
credit purposes. For all other shareholders, income inclusions are considered to
be derived from sources within the jurisdiction in which the corporation is created
or organized.
Seventh, the regulations provide rules
for determining the extent to which interest payments may be considered to be
derived from sources within a possession.
In general, interest paid by possessions
corporations and noncorporate residents
of a possession constitutes income from
sources within the possession under the
principles of section 861(a)(1). A special look-through rule applies, however,

2005–20 I.R.B.

when the interest is paid by a possessions
corporation to a shareholder who owns,
directly or indirectly, at least 10 percent of
the voting stock of the corporation. Under
this special rule, which is applied in accordance with the principles of §§1.861–9
through 1.861–12, the interest is treated as
income from sources within the possession
only to the extent that such interest is allocable to assets giving rise to income from
sources within the possession or income
effectively connected with the conduct
of a trade or business within the possession. This look-through rule does not
apply, however, if the corporation meets
the 80/50 conditions described above. The
regulations further provide that interest
paid by a partnership is treated as income
from sources within a possession only
to the extent that such interest is allocable (under the principles of §1.882–5) to
income effectively connected with the
conduct of a trade or business in the possession.
Special rules apply under Federal law
for determining, for tax purposes, the
source of income from the performance
of services by military personnel. See 50
App. U.S.C. 571(b). Consistent with these
special rules, these regulations provide that
income from military services performed
stateside (or in another possession) by a
bona fide resident of a possession is considered to be income from sources within
such possession, and income from military
services performed in a possession by an
individual who is not a bona fide resident
of such possession is not considered to be
income from sources within such possession.
Lastly, the regulations continue the existing treatment of income from services
performed within a possession and from
dividends paid by corporations created or
organized outside of a possession. Thus,
compensation received for services performed in a possession constitutes income
from sources within the possession without regard to the de minimis exception in
section 861(a)(3), and dividends paid by
corporations created or organized outside
of a possession constitute income from
sources outside of the possession in all
cases.
The rules of section 937(b) and these
regulations generally apply for purposes
of all provisions of the Code for which
a determination must be made regarding

1023

whether income is derived from sources
within a possession. They generally do
not apply, however, for purposes of applying mirrored provisions of the Code in
mirror code possessions. Thus, for example, gain that is treated as income from
sources outside the USVI for purposes of
section 934(b) under the special gain rules
described above (in the paragraph regarding dispositions of certain property held by
a U.S. person prior to becoming a resident
of a possession), nonetheless may constitute income from sources within the USVI
for purposes of mirrored section 904. In
addition, in order to avoid unintended reduction of the tax base of mirror code possessions, certain of the special rules described above do not apply for determining
whether individuals who are not bona fide
residents of such possessions have income
from sources within such possessions for
purposes of sections 932 and 935.
The 2004 Act provisions concerning
the determination of whether income is
derived from sources within a possession
generally apply to taxable years ending after October 22, 2004, except that the U.S.
income rule applies only to income earned
after October 22, 2004. The regulations
generally adopt these effective dates, except that the regulations provide that the
U.S. income rule only applies for income
earned after December 31, 2004. Also,
the special rules provided for gains from
dispositions of certain personal property
apply to dispositions after April 11, 2005,
and the conduit rule and the look-through
rules for dividends and interest from possessions corporations apply to amounts
paid or accrued after April 11, 2005. For
taxable years beginning after December
31, 1986, and ending before October 23,
2004, the rules of §1.863–6 (as in effect
for such years) remain applicable.
C. Income effectively connected with
the conduct of trade or business in a
possession
In 1960, in response to concerns about
the reach of a local, tax-related subsidy
program, section 934 was enacted to
provide explicit limits on the ability of
the USVI to reduce income tax liabilities. The legislative history explains
that, “while recognizing the desirability
of economic development” in the USVI,
Congress believed that “in no case should

May 16, 2005

this be attained by granting windfall gains
to taxpayers with respect to income derived from investments in corporations
in the continental United States, or with
respect to income in any other manner
derived from sources outside of the Virgin
Islands.” S. Rep. No. 1767, 86th Cong.,
2nd Sess. 4 (1960).
In 1986, in response to certain identified abuses and other problems related to
tax administration in the possessions, section 934 was modified and current section
931 was enacted (among other changes to
the rules relating to the possessions). In so
doing, Congress expressed concerns similar to those expressed in 1960:
“While the committee believes it is appropriate to provide more local autonomy
to these possessions, the committee does
not intend to allow them to be used as tax
havens. The committee believes that it
may be appropriate for these possessions
to reduce tax on local income in some
cases, but the committee has included antiabuse rules to prevent use of these possessions to avoid U.S. tax. The complexity and ambiguity of the present law rules
have provoked taxpayers to take return positions that, while plausible under a literal
reading, would result in tax avoidance beyond what taxpayers would ask from this
committee or from Congress. The committee is seeking to prevent this in the future.” H.R. Rep. No. 99–426, at 485–486
(1985). See also S. Rep. No. 99–313, at
479 (1986).
This concern was also expressed in the
legislative history regarding how the IRS
and Treasury might exercise their authority
under sections 931 and 934 as enacted and
modified, respectively, by the 1986 Act,
to define the scope of income that would
be considered derived from sources within
a possession or effectively connected with
the conduct of a trade or business in a possession (possession ECI). The discussion
in the legislative history was devoted exclusively to ways in which the IRS and
Treasury might narrow the scope of these
concepts (as compared to the scope they
otherwise would have under a mirrored application of the existing principles for determining whether income is considered to
be derived from sources within the United
States or effectively connected with the
conduct of a trade or business in the United
States). H.R. Rep. No. 99–426, at 487 and

May 16, 2005

489 (1985); S. Rep. No. 99–313, at 481
and 484 (1986).
In 2004, in response to certain abusive
cases that had been identified, the rules relating to the possessions were again modified. In so doing, Congress once again expressed its concern about how such rules
might be used as an inappropriate means
to reduce U.S. taxes: “The conferees are
further concerned that the general rules for
determining whether income is effectively
connected with the conduct of a trade or
business in a possession present numerous
opportunities for erosion of the U.S. tax
base.” H.R. Rep. No. 108–755, at 780
(2004). The U.S. income rule discussed
above (see section II.B. of this explanation) was enacted in order to prevent such
U.S. tax avoidance.
Reflecting the concern that tax benefits
intended to foster economic development
in the possessions should not be permitted
to be used as a means to reduce U.S. taxes
on income derived from U.S. economic
activity, these regulations incorporate the
U.S. income rule of section 937(b)(2), as
well as a conduit rule (as described above
in section II.B. of this explanation) that is
intended to prevent the avoidance of the
U.S. income rule. Accordingly, income
from U.S. sources generally will not be
considered possession ECI.
Section 937(b) also includes regulatory
authority for the IRS and Treasury to provide exceptions to this rule. As noted
above in section II.B. of this explanation,
the legislative history to the 2004 Act indicates that Congress intended for Treasury and the IRS to use this authority to
continue the existing treatment of income
from the sale of goods manufactured in a
possession. Accordingly, these regulations
provide an exception from the U.S. income
rule for such income. In addition, the regulations provide that the U.S. income rule
only applies for income earned after December 31, 2004.
Apart from the U.S. income rule, these
regulations apply the same principles for
determining whether income is possession
ECI as have applied since the 1986 Act.
See Francisco v. Commissioner, 119 T.C.
317 (2002) aff’d, 370 F.3d 1228 (D.C. Cir.
2004) (principles of section 864(c)(4) apply for determining whether U.S. source
income is possession ECI for U.S. Federal
income tax purposes).

1024

The rules of section 937(b) and these
regulations generally apply for purposes
of all provisions of the Code for which
a determination must be made regarding
whether income is possession ECI. They
generally do not apply, however, for purposes of applying mirrored provisions
of the Code in mirror code possessions.
Thus, for example, U.S. source income
that is treated as income not effectively
connected with the conduct of a trade or
business within the USVI for purposes of
section 934(b) under the U.S. income rule
described above nonetheless may constitute income effectively connected with
the conduct of a trade or business within
the USVI for purposes of mirrored section
871 or 882.
The 2004 Act provisions concerning
the determination of whether income is
possession ECI generally apply to taxable
years ending after October 22, 2004, except that the U.S. income rule applies only
to income earned after October 22, 2004.
The regulations generally adopt these effective dates, except that the regulations
provide that the U.S. income rule only
applies for income earned after December
31, 2004. In addition, the conduit rule
applies only to amounts paid or accrued
after April 11, 2005. For taxable years
beginning after December 31, 1986, and
ending before October 23, 2004, the principles of section 864(c) (including section
864(c)(4)) remain applicable.
III. Information Reporting by Residents
of a Possession
Section 7654(e), as enacted by the 1972
Act and still applicable with respect to section 935 possessions, provides an express
grant of authority for the IRS and Treasury to issue regulations prescribing information reporting requirements for individuals to whom section 935 applies, as necessary to carry out the provisions of sections 935 and 7654. Section 7654(e), as
amended by the 1986 Act, provides a similar express grant of authority for the IRS
and Treasury to issue regulations prescribing information reporting requirements for
individuals to whom sections 931 and 932
apply, as necessary to carry out the provisions of those sections and section 7654.
The penalty provided under section 6688,
as amended by the 2004 Act, for failure

2005–20 I.R.B.

to satisfy such reporting requirements is
$1,000.
The 2004 Act supplemented this general grant of authority with a specific requirement under section 937(c) for information reporting by individuals who take
the position for U.S. income tax reporting
purposes that they became, or ceased to
be, bona fide residents of Guam, American Samoa, the NMI, Puerto Rico, or the
USVI. For taxable years ending after October 22, 2004, as well as for any of an
individual’s preceding three taxable years,
section 937(c) requires that such individuals provide notice of their change in residency. Thus, for calendar year taxpayers,
such information reporting generally is required if they changed their residency to
or from a possession during 2001, 2002,
2003, or 2004 (or if they do so in any future year).
Section 937(c) authorizes the IRS and
Treasury to prescribe the time and manner by which taxpayers are to provide such
notice. In early 2005, the IRS will provide a form on which the notice required
by section 937(c) is to be made, as well as
instructions specifying the time and manner for filing the form. The IRS and Treasury anticipate issuing guidance that will
provide appropriate exceptions to the general statutory rules in order to minimize the
reporting burden on taxpayers. Reporting
will not be required until the form and instructions are made available. The same
$1,000 penalty under section 6688 will apply in cases of failure to file this form when
required.

Commissioner, 357 F.3d 1108 (10th Cir.
2004).
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter
5) does not apply to these regulations. For
the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the
Special Analyses section of the preamble
to the cross-referencing notice of proposed
rulemaking published in this issue of the
Bulletin. Pursuant to section 7805(f) of the
Code, these temporary regulations will be
submitted to the Chief Counsel for Advocacy of the Small Business Administration
for comment on their impact on small business.
Drafting Information
The principal authors of these regulations are W. Edward Williams and
J. David Varley, Office of the Associate
Chief Counsel (International), IRS. However, other personnel from the IRS and
Treasury Department participated in their
development.
*****
Amendments to the Regulations
Accordingly, 26 CFR parts 1, 301, and
602 are amended as follows:

Section 1.957–3T also issued under 26
U.S.C. 957(c). * * *
Par. 2. In §1.170A–1, paragraph (j)(9)
is revised to read as follows:
§1.170A–1 Charitable, etc., contributions
and gifts; allowance of deduction.
*****
(j)(9) [Reserved]. For further guidance,
see §1.170A–1T(j)(9).
*****
Par. 3. Section 1.170A–1T is added to
read as follows:
§1.170A–1T Charitable, etc.,
contributions and gifts; allowance
of deduction (temporary).
(a) through (j)(8) [Reserved]. For further guidance, see §1.170A–1(a) through
(j)(8).
(j)(9) Charitable contributions paid by
bona fide residents of a section 931 possession as defined in §1.931–1T(c)(1) or
Puerto Rico are deductible only to the extent allocable to income that is not excluded under section 931 or 933. For the
rules for allocating deductions for charitable contributions, see the regulations under
section 861.
(j)(10) and (11) [Reserved]. For further
guidance, see §1.170–1(j)(10) and (11).
(k) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par.
4.
In §1.243–3, paragraph
(a)(2)(iii) is revised to read as follows:

IV. Removal of Obsolete Regulations
PART 1 — INCOME TAXES
This document also removes certain
regulations, and cross-references to such
regulations, which became obsolete with
the enactment of the 1986 Act. The 1986
Act amendments that rendered them obsolete were effective for tax years beginning
after December 31, 1986. For example,
the regulations promulgated by T.D. 6500,
25 FR 11910; T.D. 7283, 1973–2 C.B. 79
[38 FR 20825}; and T.D. 7385, 1975–2
C.B. 298 [40 FR 50260], relating to former
section 931, were rendered obsolete with
the enactment of the 1986 Act. Thus, such
regulations have no legal effect for taxable
years beginning after December 31, 1986.
See, e.g., Specking v. Commissioner, 117
T.C. 95 (2001), aff’d sub nom. Umbach v.

2005–20 I.R.B.

Paragraph 1. The authority citation for
part 1 is amended by adding entries in numerical order to read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.931–1T also issued under 26
U.S.C. 7654(e).
Section 1.932–1T also issued under 26
U.S.C. 7654(e).
Section 1.935–1T also issued under 26
U.S.C. 7654(e). * * *
Section 1.937–1T also issued under 26
U.S.C. 937(a).
Section 1.937–2T also issued under 26
U.S.C. 937(b).
Section 1.937–3T also issued under 26
U.S.C. 937(b). * * *

1025

§1.243–3 Certain dividends from foreign
corporations.
*****
(a)(2) * * *
(iii) by a domestic corporation during
any period to which section 931 (relating to income from sources within possessions of the United States), as in effect for
taxable years beginning before January 1,
1976, applied.
Par.
5.
In §1.702–1, paragraph
(c)(1)(iii) is revised to read as follows:
§1.702–1 Income and credits of partner.
*****
(c)(1) * * *

May 16, 2005

(iii) In computing the amount of gross
income received from sources within possessions of the United States (section 937).
*****
Par. 6. In §1.861–3, paragraph (a)(2) is
revised to read as follows:
§1.861–3 Dividends.
*****
(a)(2) [Reserved]. For further guidance, see §1.861–3T(a)(2).
Par. 7. Section 1.861–3T is added to
read as follows:
§1.861–3T Dividends (temporary).
(a)(1) [Reserved]. For further guidance, see §1.861–3(a)(1).
(2) Dividend from a domestic corporation. A dividend described in this paragraph (a)(2) is a dividend from a domestic
corporation other than a corporation which
has an election in effect under section 936.
See paragraph (a)(5) of this section for
the treatment of certain dividends from a
DISC or former DISC.
(a)(3) through (c) [Reserved]. For further guidance, see §1.861–3(a)(3) through
(c).
(d) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 8. In §1.861–8, paragraphs
(f)(1)(vi)(E), (F), and (H) are revised
to read as follows:
§1.861–8 Computation of taxable income
from sources within the United States and
from other sources and activities.
*****
(f) * * *
(1) * * *
(vi) * * *
(E) [Reserved].
(F) [Reserved].
*****
(H) [Reserved].
*****
Par. 9. Section 1.863–6 is revised to
read as follows:
§1.863–6 Income from sources within a
foreign country.
The principles applied in sections 861
through 863 and section 865 and the regulations thereunder for determining the

May 16, 2005

gross and the taxable income from sources
within and without the United States shall
generally be applied in determining the
gross and the taxable income from sources
within and without a particular foreign
country when such a determination must
be made under any provision of Subtitle
A of the Internal Revenue Code, including section 952(a)(5). This section shall
not apply, however, to the extent it is
determined by applying §1.863–3 that
a portion of the taxable income is from
sources within the United States and the
balance of the taxable income is from
sources within a foreign country. In the
application of this section, the name of the
particular foreign country shall be used
instead of the term United States, and
the term domestic shall be construed to
mean created or organized in such foreign
country. In applying section 861 and the
regulations thereunder for purposes of this
section, references to sections 243 and
245 shall be excluded, and the exception
in section 861(a)(3) shall not apply. In the
case of any item of income, the income
from sources within a foreign country shall
not exceed the amount which, by applying
any provision of sections 861 through 863
and section 865 and the regulations thereunder without reference to this section, is
treated as income from sources without the
United States. See §1.937–2T for rules for
determining income from sources within a
possession of the United States.
Par. 10. Section 1.871–1 is amended
by:
1. Removing paragraph (b)(6).
2. Redesignating paragraph (b)(7) as
(b)(6).
Par. 11. Section 1.876–1 is revised to
read as follows:
§1.876–1 Alien residents of Puerto Rico,
Guam, American Samoa, or the Northern
Mariana Islands.
[Reserved]. For further guidance, see
§1.876–1T.
Par. 12. Section 1.876–1T is added to
read as follows:
§1.876–1T Alien residents of Puerto Rico,
Guam, American Samoa, or the Northern
Mariana Islands (temporary).
(a) Scope. Section 876 and this section
apply to any nonresident alien individual

1026

who is a bona fide resident of Puerto Rico
or of a section 931 possession during the
entire taxable year.
(b) In general. An individual to whom
this section applies is, in accordance with
the provisions of section 876, subject to
tax under sections 1 and 55 in generally
the same manner as an alien resident of
the United States. See §§1.1–1(b) and
1.871–1. The tax generally is imposed
upon the taxable income of such individual, determined in accordance with section
63(a) and the regulations thereunder, from
sources both within and without the United
States, except for amounts excluded from
gross income under the provisions of section 931 or 933. For determining the form
of return to be used by such an individual,
see section 6012 and the regulations thereunder.
(c) Exceptions. Though subject to the
tax imposed by section 1, an individual to
whom this section applies shall nevertheless be treated as a nonresident alien individual for the purpose of many provisions
of the Internal Revenue Code relating to
nonresident alien individuals. Thus, for
example, such an individual is not allowed
the standard deduction (section 63(c)(6));
is subject to withholding of tax at source
under chapter 3 of the Internal Revenue
Code (e.g., section 1441(e)); is generally
excepted from the collection of income tax
at source on wages for services performed
in the possession (section 3401(a)(6)); is
not allowed to make a joint return (section
6013(a)(1)); and, if described in section
6072(c), must pay his first installment of
estimated income tax on or before the 15th
day of the 6th month of the taxable year
(section 6654(j) and (k)) and must pay his
income tax on or before the 15th day of the
6th month following the close of the taxable year (sections 6072(c) and 6151(a)).
In addition, under section 152(b)(3), an individual is not allowed a deduction for a
dependent who is a resident of the relevant
possession unless the dependent is a citizen or national of the United States.
(d) Credits against tax— (1) Certain
credits under the Internal Revenue Code
are available to any taxpayer subject to the
tax imposed by section 1, including individuals to whom this section applies. For
example, except as otherwise provided under section 931 or 933, the credits provided by the following sections are allowable to the extent provided under such sec-

2005–20 I.R.B.

tions against the tax determined in accordance with this section—
(i) Section 23 (relating to the credit for
adoption expenses);
(ii) Section 31 (relating to the credit for
tax withheld on wages);
(iii) Section 33 (relating to the credit
for tax withheld at source on nonresident
aliens); and
(iv) Section 34 (relating to the credit for
certain uses of gasoline and special fuels).
(2) Certain credits under the Internal
Revenue Code are not available to nonresident aliens or are subject to limitations
based on such factors as principal place of
abode in the United States. For example,
the credits provided by the following sections are not allowable against the tax determined in accordance with this section
except to the extent otherwise provided under such sections—
(i) Section 22 (relating to the credit for
the elderly and disabled);
(ii) Section 25A (relating to the Hope
Scholarship and Lifetime Learning Credits); and
(iii) Section 32 (relating to the earned
income credit).
(e) Definitions. For purposes of this
section:
(1) Bona fide resident is defined in
§1.937–1T.
(2) Section 931 possession is defined in
§1.931–1T(c)(1).
(f) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 13. In §1.881–1(c), revise the third
and fourth sentences to read as follows:
§1.881–1 Manner of taxing foreign
corporations.
*****
(c) * * * The term foreign corporation has the meaning assigned to it by section 7701(a)(3) and (5) and the regulations
thereunder. However, for special rules relating to possessions of the United States,
see §1.881–5T.
*****
Par. 14. Section 1.881–5T is added to
read as follows:

2005–20 I.R.B.

§1.881–5T Exception for certain
possessions corporations (temporary).
(a) Scope. Section 881(b) and this section provide special rules for the application of sections 881 and 884 to certain corporations created or organized in possessions of the United States. Paragraph (g)
of this section provides special rules for
the application of sections 881 and 884 to
corporations created or organized in the
United States for purposes of determining
tax liability incurred to certain possessions
that administer income tax laws that are
identical (except for the substitution of the
name of the possession for the term United
States where appropriate) to those in force
in the United States. See §1.884–0T(b) for
special rules relating to the application of
section 884 with respect to possessions of
the United States.
(b) Operative rules. (1) Corporations
described in paragraphs (c) and (d) of this
section are not treated as foreign corporations for purposes of section 881. Accordingly, they are exempt from the tax imposed by section 881(a).
(2) For corporations described in paragraph (e) of this section, the rate of tax
imposed by section 881(a) on U.S. source
dividends received is 10 percent (rather
than the generally applicable 30 percent).
(c) U.S.V.I. and section 931 possessions. A corporation created or organized
in, or under the law of, the United States
Virgin Islands or a section 931 possession
is described in this paragraph (c) for a taxable year when the following conditions
are satisfied—
(1) At all times during such taxable
year, less than 25 percent in value of the
stock of such corporation is beneficially
owned (directly or indirectly) by foreign
persons;
(2) At least 65 percent of the gross income of such corporation is shown to the
satisfaction of the Commissioner upon examination to be effectively connected with
the conduct of a trade or business in such
a possession or the United States for the
3-year period ending with the close of the
taxable year of such corporation (or for
such part of such period as the corporation
or any predecessor has been in existence);
and
(3) No substantial part of the income
of such corporation for the taxable year
is used (directly or indirectly) to satisfy

1027

obligations to persons who are not bona
fide residents of such a possession or the
United States.
(d) Section 935 possessions. A corporation created or organized in, or under
the law of, a section 935 possession is described in this paragraph (d) for a taxable
year when the following conditions are satisfied—
(1) At all times during such taxable
year, less than 25 percent in value of the
stock of such corporation is owned (directly or indirectly) by foreign persons;
and
(2) At least 20 percent of the gross
income of such corporation is shown to
the satisfaction of the Commissioner upon
examination to have been derived from
sources within such possession for the
3-year period ending with the close of the
preceding taxable year of such corporation (or for such part of such period as the
corporation has been in existence).
(e) Puerto Rico. A corporation created
or organized in, or under the law of, Puerto
Rico is described in this paragraph (e) for
a taxable year when the conditions of paragraphs (c)(1) through (3) are satisfied (using the language “Puerto Rico” instead of
“such a possession”).
(f) Definitions and other rules. For purposes of this section:
(1) Section 931 possession is defined in
§1.931–1T(c)(1).
(2) Section 935 possession is defined in
§1.935–1T(a)(3)(i).
(3) Foreign person means any person
other than—
(i) A United States person (as defined
in section 7701(a)(30) and the regulations
thereunder); or
(ii) A person who would be a United
States person if references to the United
States in section 7701 included references
to a possession of the United States.
(4) Bona fide resident —
(i) With respect to a possession, is defined in §1.937–1T; and
(ii) With respect to the United States,
means an individual who is a citizen or
resident of the United States and who does
not have a tax home (as defined in section
911(d)(3)) in a foreign country.
(5) Source. The rules of §1.937–2T
shall apply for determining whether income is from sources within a possession.
(6) Effectively connected income. The
rules of §1.937–3T (other than paragraph

May 16, 2005

(c) of that section) shall apply for determining whether income is effectively connected with the conduct of a trade or business in a possession.
(7) Indirect ownership.
The rules
of section 318(a)(2) shall apply except
that the language “5 percent” shall be
used instead of “50 percent” in section
318(a)(2)(C).
(g) Mirror code jurisdictions. For purposes of applying mirrored section 881 to
determine tax liability incurred to a section
935 possession or the United States Virgin
Islands—
(1) The rules of paragraphs (b) through
(d) of this section shall not apply; and
(2) A corporation created or organized
in, or under the law of, such possession or
the United States shall not be considered a
foreign corporation.
(h) Example. The principles of this section are illustrated by the following example:
Example 1. X is a corporation organized under
the law of the United States Virgin Islands (USVI)
with a branch located in State F. At least 65 percent
of the gross income of X is effectively connected with
the conduct of a trade or business in the USVI and no
substantial part of the income of X for the taxable year
is used to satisfy obligations to persons who are not
bona fide residents of the United States or the USVI.
Seventy-four percent of the stock of X is owned by
unrelated individuals who are residents of the United
States or the USVI. Y, a corporation organized under the law of State D, and Z, a partnership organized
under the law of State F, each own 13 percent of the
stock of X. A, an unrelated foreign individual, owns
100 percent of the stock of corporation Y. B and C,
unrelated foreign individuals, each own a 50 percent
interest in partnership Z. Thus, the condition of paragraph (c)(1) of this section is not satisfied, because 26
percent of X is owned indirectly by foreign persons
(A, B, and C). Accordingly, X is treated as a foreign
corporation for purposes of section 881.

(i) Effective dates. Except as provided
in this paragraph (i), this section applies to
payments made after April 11, 2005. The
rules of paragraphs (b)(2) and (e) apply
to dividends paid after October 22, 2004.
However, if, on or after October 22, 2004,
an increase in the rate of the Commonwealth of Puerto Rico’s withholding tax
which is generally applicable to dividends
paid to United States corporations not engaged in a trade or business in the Commonwealth to a rate greater than 10 percent takes effect, the rules of paragraphs
(b)(2) and (e) shall not apply to dividends
received on or after the effective date of the
increase.

May 16, 2005

Par. 15. In §1.884–0, paragraph (b) is
redesignated as paragraph (c), and a new
paragraph (b) is added.
The addition reads as follows:
§1.884–0 Overview of regulation
provisions for section 884.
*****
(b) Special rules for U.S. possessions.
[Reserved]. For further guidance, see
§1.884–0T(b).
*****
Par. 16. Section 1.884–0T is added as
follows.
§1.884–0T Overview of regulation
provisions for section 884 (temporary).
(a) [Reserved]. For further guidance,
see §1.884–0(a).
(b) Special rules for U.S. possessions.
(1) Section 884 does not apply to a corporation created or organized in, or under
the law of, American Samoa, Guam, the
Northern Mariana Islands, or the United
States Virgin Islands, provided that the
conditions of §1.881–5T(c)(1) through (3)
are satisfied with respect to such corporation. The preceding sentence applies for
taxable years ending after April 11, 2005.
(2) Section 884 does not apply for purposes of determining tax liability incurred
to a section 935 possession or the United
States Virgin Islands by a corporation
created or organized in, or under the law
of, such possession or the United States.
The preceding sentence applies for taxable
years ending after April 11, 2005.
(c) [Reserved]. For further guidance,
see §1.884–0(c).
Par. 17. In §1.901–1, paragraph (g) is
revised to read as follows:
§1.901–1 Allowance of credit for taxes.
*****
(g) [Reserved]. For further guidance,
see §1.901–1T(g).
*****
Par. 18. Section 1.901–1T is added to
read as follows:
§1.901–1T Allowance of credit for taxes
(temporary).
(a) through (f) [Reserved]. For further
guidance, see §1.901–1(a) through (f).

1028

(g) Taxpayers to whom credit not allowed. Among those to whom the credit
for taxes is not allowed are the following—
(1) Except as provided in section 906, a
foreign corporation;
(2) Except as provided in section 906, a
nonresident alien individual who is not described in section 876 (see sections 874(c)
and 901(b)(4));
(3) A nonresident alien individual described in section 876 other than a bona
fide resident (as defined in section 937(a)
and the regulations thereunder) of Puerto
Rico during the entire taxable year (see
sections 901(b)(3) and (4)); and
(4) A U.S. citizen or resident alien individual who is a bona fide resident of
a section 931 possession (as defined in
§1.931–1T(c)(1)), the U.S. Virgin Islands,
or Puerto Rico, and who excludes certain
income from U.S. gross income to the extent of taxes allocable to the income so excluded (see sections 931(b)(2), 933(1), and
932(c)(4)).
(h) [Reserved]. For further guidance,
see §1.901–1(h).
(i) [Reserved]. For further guidance,
see §1.901–1(i).
(j) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 19. Section 1.931–1 is revised to
read as follows:
§1.931–1 Exclusion of certain income
from sources within Guam, American
Samoa, or the Northern Mariana Islands.
[Reserved]. For further guidance, see
§1.931–1T.
Par. 20. Section 1.931–1T is added to
read as follows:
§1.931–1T Exclusion of certain income
from sources within Guam, American
Samoa, or the Northern Mariana Islands
(temporary).
(a) General rule. (1) An individual
(whether a United States citizen or an
alien), who is a bona fide resident of a
section 931 possession during the entire
taxable year, shall exclude from gross
income the income derived from sources
within any section 931 possession and
the income effectively connected with the
conduct of a trade or business by such
individual within any section 931 possession, except amounts received for services

2005–20 I.R.B.

performed as an employee of the United
States or any agency thereof.
(2) The following example illustrates
the application of the general rule in paragraph (a)(1) of this section:
Example. D, a United States citizen, files returns
on a calendar year basis. In April 2005, D moves to
American Samoa, purchases a house, and accepts a
permanent position with a local employer. For the remainder of the year and throughout 2006, D continues
to live and work in American Samoa, and establishes
a closer connection to American Samoa than to the
United States or any foreign country. In September
2007, as a result of the termination of his employment
in American Samoa, D sells his house and moves to
State H. D is entitled to the exclusion provided in section 931 for 2006, but not for 2005 or 2007 (assuming
that during the first quarter of 2005 and the last quarter of 2007, D has a tax home outside of American
Samoa or a closer connection to the United States or
a foreign country).

(b) Deductions and credits. In any case
in which any amount otherwise constituting gross income is excluded from gross
income under the provisions of section
931, there shall not be allowed as a deduction from gross income any items of
expenses or losses or other deductions
(except the deduction under section 151,
relating to personal exemptions), or any
credit, properly allocable to, or chargeable
against, the amounts so excluded from
gross income. For purposes of the preceding sentence, the rules of §1.861–8
shall apply (with creditable expenditures
treated in the same manner as deductible
expenditures).
(c) Definitions. For purposes of this
section:
(1) The term section 931 possession
means a possession that is a specified possession and that has entered into an implementing agreement, as described in section
1271(b) of the Tax Reform Act of 1986
(Public Law 99–514 (100 Stat. 2085)),
with the United States that is in effect for
the entire taxable year.
(2) The term specified possession
means Guam, American Samoa, or the
Northern Mariana Islands.
(3) The rules of §1.937–1T shall apply
for determining whether an individual is a
bona fide resident of a section 931 possession.
(4) The rules of §1.937–2T shall apply
for determining whether income is from
sources within a section 931 possession.
(5) The rules of §1.937–3T shall apply for determining whether income is effectively connected with the conduct of a

2005–20 I.R.B.

trade or business within a section 931 possession.
(d) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 21. Section 1.932–1 is revised to
read as follows:
§1.932–1 Coordination of United States
and Virgin Islands income taxes.
[Reserved]. For further guidance, see
§1.932–1T.
Par. 22. Section 1.932–1T is added to
read as follows:
§1.932–1T Coordination of United
States and Virgin Islands income taxes
(temporary).
(a) Scope— (1) In general. Section 932
and this section set forth the special rules
relating to the filing of income tax returns
and income tax liabilities of individuals
described in paragraph (a)(2) of this section. Paragraph (h) of this section also
provides special rules requiring consistent
treatment of business entities in the United
States and in the United States Virgin Islands (Virgin Islands).
(2) Individuals covered. This section
shall apply to any individual who:
(i) Is a bona fide resident of the Virgin
Islands during the entire taxable year;
(ii)(A) Is a citizen or resident of the
United States (other than a bona fide resident of the Virgin Islands) during the entire taxable year; and
(B) Has income derived from sources
within the Virgin Islands, or effectively
connected with the conduct of a trade or
business within the Virgin Islands, for the
taxable year; or
(iii) Files a joint return for the taxable
year with any individual described in paragraph (a)(2)(i) or (ii) of this section.
(3) Definitions. For purposes of this
section:
(i) The rules of §1.937–1T shall apply
for determining whether an individual is a
bona fide resident of the Virgin Islands.
(ii) The rules of §1.937–2T shall apply
for determining whether income is from
sources within the Virgin Islands.
(iii) The rules of §1.937–3T shall apply for determining whether income is effectively connected with the conduct of a
trade or business within the Virgin Islands.

1029

(b) U.S. individuals with V.I. income—
(1) Dual filing requirement. Subject to
paragraph (d) of this section, an individual described in paragraph (a)(2)(ii) of this
section shall make an income tax return for
the taxable year to the United States and
file a copy of such return with the Virgin
Islands. Such individuals must also attach
Form 8689, “Allocation of Individual Income Tax to the Virgin Islands,” to the U.S.
income tax return and to the income tax return filed with the Virgin Islands.
(2) Tax payments. (i) Each individual
to whom this paragraph (b) applies for the
taxable year shall pay the applicable percentage of the taxes imposed by this chapter for such taxable year (determined without regard to paragraph (b)(2)(ii) of this
section) to the Virgin Islands.
(ii) There shall be allowed as a credit
against the tax imposed by this chapter for
the taxable year an amount equal to the
taxes required to be paid to the Virgin Islands under paragraph (b)(2)(i) of this section which are so paid. Such taxes shall
be considered creditable in the same manner as taxes paid to the United States (e.g.,
under section 31) and not as taxes paid to
a foreign government (e.g., under sections
27 and 901).
(iii) For purposes of this paragraph
(b)(2):
(A) The term applicable percentage
means the percentage which Virgin Islands
adjusted gross income bears to adjusted
gross income.
(B) The term Virgin Islands adjusted
gross income means adjusted gross income
determined by taking into account only income derived from sources within the Virgin Islands and deductions properly apportioned or allocable thereto. For purposes of the preceding sentence, the rules
of §1.861–8 shall apply.
(C) Pursuant to §1.937–2T(a), the rules
of §1.937–2T(c)(1)(ii) and (c)(2) do not
apply.
(c) Bona fide residents of the Virgin Islands. Subject to paragraph (d) of this section, an individual described in paragraph
(a)(2)(i) of this section shall be subject to
the following income tax return filing requirements:
(1) V.I. filing requirements. An individual to whom this paragraph (c) applies
shall file an income tax return for the taxable year with the Virgin Islands. On this
return, the individual shall report income

May 16, 2005

from all sources and identify the source of
each item of income shown on the return.
(2) U.S. filing requirements. For purposes of calculating the income tax liability to the United States of an individual
to whom this paragraph (c) applies, gross
income shall not include any amount included in gross income on the return filed
with the Virgin Islands pursuant to paragraph (c)(1) of this section, and deductions
and credits allocable to such income shall
not be taken into account, provided that—
(i) The individual fully satisfied the reporting requirements of paragraph (c)(1)
of this section; and
(ii) The individual fully paid the tax liability referred to in section 934(a) to the
Virgin Islands with respect to such income.
(d) Joint returns. In the case of married
persons, if one or both spouses is an individual described in paragraph (a)(2) of this
section and they file a joint return of income tax, the spouses shall file their joint
return with, and pay the tax due on such
return to, the jurisdiction (or jurisdictions)
where the spouse who has the greater adjusted gross income for the taxable year
would be required under paragraph (b) or
(c) of this section to file a return if separate returns were filed and all of their
income were the income of such spouse.
For this purpose, adjusted gross income of
each spouse is determined under section 62
and the regulations thereunder but without
regard to community property laws; and,
if one of the spouses dies, the taxable year
of the surviving spouse shall be treated as
ending on the date of such death.
(e) Place for filing returns— (1) U.S.
returns. A return required under the rules
of paragraphs (b) and (c) of this section
to be filed with the United States shall be
filed as directed in the applicable forms
and instructions.
(2) V.I. returns. A return required under
the rules of paragraphs (b) and (c) of this
section to be filed with the Virgin Islands
shall be filed as directed in the applicable
forms and instructions.
(f) Tax accounting standards— (1) In
general. A dual filing taxpayer must use
the same tax accounting standards on the
returns filed with the United States and
the Virgin Islands. A taxpayer who has
filed a return only with the United States
or only with the Virgin Islands as a single filing taxpayer for a prior taxable year
and is required to file a return only with

May 16, 2005

the other jurisdiction as a single filing taxpayer for a later taxable year may not, for
such later taxable year, use different tax
accounting standards unless the second jurisdiction consents to such change. However, such change will not be effective for
returns filed thereafter with the first jurisdiction unless before such later date of
filing the taxpayer also obtains the consent of the first jurisdiction to make such
change. Any request for consent to make a
change pursuant to this paragraph (f) must
be made to the office where the return is
required to be filed under paragraph (e) of
this section and in sufficient time to permit
a copy of the consent to be attached to the
return for the taxable year.
(2) Definitions. For purposes of this
paragraph (f):
(i) The term dual filing taxpayer means
a taxpayer who is required to file returns
with the United States and the Virgin Islands for the same taxable year under the
rules of paragraph (b) or (c) of this section.
(ii) The term single filing taxpayer
means a taxpayer who is required to file
a return only with the United States (because the individual is not described in
paragraph (a)(2) of this section) or only
with the Virgin Islands (because the individual is described in paragraph (a)(2)(i)
of this section and satisfies the conditions
of paragraphs (c)(2)(i) and (ii) of this section) for the taxable year.
(iii) The term tax accounting standards
includes the taxpayer’s accounting period,
methods of accounting, and any election to
which the taxpayer is bound with respect to
the reporting of taxable income.
(g) Extension of territory— (1) Section
932(a) taxpayers— (i) General rule. With
respect to an individual to whom section
932(a) applies for a taxable year, for purposes of taxes imposed by Chapter 1 of the
Internal Revenue Code, the United States
generally shall be treated, in a geographical and governmental sense, as including
the Virgin Islands. The purpose of this rule
is to facilitate the coordination of the tax
systems of the United States and the Virgin
Islands. Accordingly, the rule will have no
effect where it is manifestly inapplicable or
its application would be incompatible with
the intent of any provision of the Internal
Revenue Code.
(ii) Application of general rule. Contexts in which the general rule of paragraph
(g)(1)(i) of this section apply include:

1030

(A) The characterization of taxes paid
to the Virgin Islands. An individual to
whom section 932(a) applies may take income tax required to be paid to the Virgin
Islands under section 932(b) into account
under sections 31, 6315, and 6402(b) as
payments to the United States. Taxes paid
to the Virgin Islands and otherwise satisfying the requirements of section 164(a) will
be allowed as a deduction under that section, but income taxes required to be paid
to the Virgin Islands under section 932(b)
will be disallowed as a deduction under
section 275(a).
(B) The determination of the source
of income for purposes of the foreign tax
credit (e.g., sections 901 through 904).
Thus, for example, after an individual to
whom section 932(a) applies determines
which items of income constitute income
from sources within the Virgin Islands
under the rules of section 937(b), such
income shall be treated as income from
sources within the United States for purposes of section 904.
(C) The eligibility of a corporation to
make a subchapter S election (sections
1361 through 1379). Thus, for example,
for purposes of determining whether a
corporation created or organized in the
Virgin Islands may make an election under section 1362(a) to be a subchapter S
corporation, it shall be treated as a domestic corporation and a shareholder to whom
section 932(a) applies shall not be treated
as a nonresident alien individual with respect to such corporation. While such
an election is in effect, the corporation
shall be treated as a domestic corporation
for all purposes of the Internal Revenue
Code. For the consistency requirement
with respect to entity status elections, see
paragraph (h) of this section.
(D) The treatment of items carried over
from other tax years. Thus, for example, if
an individual to whom section 932(a) applies has for a taxable year a net operating
loss carryback or carryover under section
172, a foreign tax credit carryback or carryover under section 904, a business credit
carryback or carryover under section 39, a
capital loss carryover under section 1212,
or a charitable contributions carryover under section 170, the carryback or carryover will be reported on the return filed
in accordance with paragraph (b)(1) of this
section, even though the return of the taxpayer for the taxable year giving rise to the

2005–20 I.R.B.

carryback or carryover was required to be
filed with the Virgin Islands under section
932(c).
(E) The treatment of property exchanged for property of a like kind (section
1031). Thus, for example, if an individual
to whom section 932(a) applies exchanges
real property located in the United States
for real property located in the Virgin
Islands, notwithstanding the provisions of
section 1031(h), such exchange may qualify as a like-kind exchange under section
1031 (provided that all the other requirements of section 1031 are satisfied).
(iii) Nonapplication of the general rule.
Contexts in which the general rule of paragraph (g)(1)(i) of this section does not apply include:
(A) The application of any rules or
regulations that explicitly treat the United
States and any (or all) of its possessions
as separate jurisdictions (e.g., sections 931
through 937, 7651, and 7654).
(B) The determination of any aspect
of an individual’s residency (e.g., sections
937(a) and 7701(b)). Thus, for example, an individual whose principal place of
abode is in the Virgin Islands is not considered to have a principal place of abode
in the United States for purposes of section
32(c).
(C) The characterization of a corporation for purposes other than subchapter S
(e.g., sections 367, 951 through 964, 1291
through 1298, 6038, and 6038B). Thus,
for example, if an individual to whom section 932(a) applies transfers appreciated
tangible property to a corporation created
or organized in the Virgin Islands in a
transaction described in section 351, he or
she must recognize gain unless an exception under section 367(a) applies. Also, if
a corporation created or organized in the
Virgin Islands qualifies as a passive foreign investment company under sections
1297 and 1298 with respect to an individual to whom section 932(a) applies, a dividend paid to such shareholder does not
constitute qualified dividend income under
section 1(h)(11)(B).
(2) Section 932(c) taxpayers— (i) General rule. With respect to an individual to
whom section 932(c) applies for a taxable
year, for purposes of the territorial income
tax of the Virgin Islands (i.e., mirrored sections of the Internal Revenue Code), the
Virgin Islands generally shall be treated, in
a geographical and governmental sense, as

2005–20 I.R.B.

including the United States. The purpose
of this rule is to facilitate the coordination
of the tax systems of the United States and
the Virgin Islands. Accordingly, the rule
will have no effect where it is manifestly
inapplicable or its application would be incompatible with the intent of any provision
of the Internal Revenue Code.
(ii) Application of general rule. Contexts in which the general rule of paragraph
(g)(2)(i) of this section apply include:
(A) The characterization of taxes paid
to the United States. A taxpayer described
in section 932(c)(1) may take income tax
paid to the United States into account
under mirrored sections 31, 6315, and
6402(b) as payments to the Virgin Islands.
(B) The determination of the source of
income for purposes of the foreign tax
credit (e.g., mirrored sections 901 through
904). Thus, for example, any item of income that constitutes income from sources
within the United States under the rules of
sections 861 through 865 shall be treated
as income from sources within the Virgin
Islands for purposes of mirrored section
904.
(C) The eligibility of a corporation to
make a subchapter S election (mirrored
sections 1361 through 1379). Thus, for
example, for purposes of determining
whether a corporation created or organized in the United States may make an
election under mirrored section 1362(a)
to be a subchapter S corporation, it shall
be treated as a domestic corporation and
a shareholder to whom section 932(c)
applies shall not be treated as a nonresident alien individual with respect to such
corporation. While such an election is in
effect, the corporation shall be treated as
a domestic corporation for all purposes of
the territorial income tax. For the consistency requirement with respect to entity
status elections, see paragraph (h) of this
section.
(D) The treatment of items carried over
from other tax years. Thus, for example, if
an individual to whom section 932(c) applies has for a taxable year a net operating
loss carryback or carryover under mirrored
section 172, a foreign tax credit carryback
or carryover under mirrored section 904,
a business credit carryback or carryover
under mirrored section 39, a capital loss
carryover under mirrored section 1212, or
a charitable contributions carryover under
mirrored section 170, the carryback or car-

1031

ryover will be reported on the return filed
in accordance with paragraph (c)(1) of this
section, even though the return of the taxpayer for the taxable year giving rise to the
carryback or carryover was required to be
filed with the United States.
(E) The treatment of property exchanged for property of a like kind (mirrored section 1031). Thus, for example,
if an individual to whom section 932(c)
applies exchanges real property located in
the United States for real property located
in the Virgin Islands, notwithstanding the
provisions of mirrored section 1031(h),
such exchange may qualify as a like-kind
exchange under mirrored section 1031
(provided that all the other requirements
of mirrored section 1031 are satisfied).
(iii) Nonapplication of general rule.
Contexts in which the general rule of paragraph (g)(2)(i) of this section does not
apply include:
(A) The determination of any aspect of
an individual’s residency (e.g., mirrored
section 7701(b)). Thus, for example, an
individual whose principal place of abode
is in the United States is not considered
to have a principal place of abode in the
Virgin Islands for purposes of mirrored
section 32(c).
(B) The determination of the source of
income for purposes other than the foreign
tax credit (e.g., sections 932(a) and (b),
934(b), and 937). Thus, for example, compensation for services performed in the
United States and rentals or royalties from
property located in the United States do
not constitute income from sources within
the Virgin Islands for purposes of section
934(b).
(C) The definition of wages (mirrored
section 3401). Thus, for example, services performed by an employee for an
employer in the United States do not constitute services performed in the Virgin Islands under mirrored section 3401(a)(8).
(h) Entity status consistency requirement— (1) In general. Taxpayers should
make consistent entity status elections (as
defined in paragraph (h)(3) of this section),
where applicable, in both the United States
and the Virgin Islands. In the case of a
business entity to which this paragraph (h)
applies:
(i) If an entity status election is filed
with the Internal Revenue Service but not
with the Virgin Islands Bureau of Internal
Revenue (BIR), the Director of the BIR or

May 16, 2005

his delegate, at his discretion, may deem
the election also to have been made for
Virgin Islands tax purposes.
(ii) If an entity status election is filed
with the BIR but not with the Internal Revenue Service, the Commissioner, at his discretion, may deem the election also to have
been made for U.S. Federal tax purposes.
(iii) If inconsistent entity status elections are filed with the BIR and the Internal
Revenue Service, both the Commissioner
and the Director of the BIR or his delegate
may, at their individual discretion, treat the
elections they each received as invalid and
may deem the election filed in the other jurisdiction to have been made also for tax
purposes in their own jurisdiction. (See
Rev. Proc. 89–8, 1989–1 C.B. 778, for
procedures for requesting the assistance of
the Internal Revenue Service when a taxpayer is or may be subject to inconsistent
tax treatment by the Internal Revenue Service and a U.S. possession tax agency.)
(2) Scope. This paragraph (h) applies to
the following business entities:
(i) A business entity (as defined in
§301.7701–2(a) of this chapter) that is domestic (as defined in §301.7701–5 of this
chapter), or otherwise treated as domestic for purposes of the Internal Revenue
Code, and that is owned in whole or in part
by any person who is either a bona fide
resident of the Virgin Islands or a business
entity created or organized in the Virgin
Islands.
(ii) A business entity that is created or
organized in the Virgin Islands and that
is owned in whole or in part by any U.S.
person (other than a bona fide resident of
the Virgin Islands).
(3) Definition. For purposes of this
section, the term entity status election includes an election under §301.7701–3(c)
of this chapter, an election under section
1362(a), and any other similar elections.
(4) Default status. Solely for the purpose of determining classification of an
eligible entity under §301.7701–3(b), and
§301.7701–3(b) as mirrored in the Virgin
Islands, an eligible entity subject to this
paragraph (h) shall be classified for both
U.S. Federal and Virgin Islands tax purposes using the rule that applies to domestic eligible entities.
(5) Transition rules— (i) In the case of
an election filed prior to April 11, 2005,
except as provided in paragraph (h)(5)(ii)
of this section, the rules of paragraph (h)(1)

May 16, 2005

of this section shall apply as of the first
day of the first taxable year of the entity
beginning after April 11, 2005.
(ii) In the unlikely circumstance that
inconsistent elections described in paragraph (h)(1)(iii) are filed prior to April 11,
2005, and the entity cannot change its classification to achieve consistency because
of the sixty-month limitation described in
§301.7701–3(c)(1)(iv) of this chapter, then
the entity may nevertheless request permission from the Commissioner or the Director of the BIR or his delegate to change
such election to avoid inconsistent treatment by the Commissioner and the Director of the BIR or his delegate.
(iii) Except as provided in paragraphs
(h)(5)(i) and (h)(5)(ii) of this section, in the
case of an election filed with respect to an
entity before it became an entity described
in paragraph (h)(2) of this section, the rules
of paragraph (h)(1) of this section shall apply as of the first day that such entity is described in paragraph (h)(2) of this section.
(iv) In the case of an entity created or
organized prior to April 11, 2005, paragraph (h)(4) of this section shall take effect
for U.S. Federal income tax purposes (or
Virgin Islands income tax purposes, as the
case may be) as of the first day of the first
taxable year of the entity beginning after
April 11, 2005.
(i) Examples. The rules of this section
are illustrated by the following examples:
Example 1. (i) A is a U.S. citizen who resides in
State R. The Federal Individual Income Tax Return,
Form 1040, that A prepares for 2004 reports adjusted
gross income of $90x, including $30x from sources
in the U.S. Virgin Islands (USVI). The income tax liability reported on A’s Form 1040 is $18x. A files a
copy of his Federal Form 1040 with the USVI Bureau
of Internal Revenue as required by section 932(a)(2)
and paragraph (b)(1) of this section, and pays the applicable percentage of his Federal income tax liability
to the USVI as required by section 932(b) and paragraph (b)(2) of this section, computed as follows:
30/90 x 18x

=

$6x income tax liability
to the USVI
(ii) A claims a credit against his Federal income
tax liability reported on his Form 1040 in the amount
of $6x. A attaches a Form 8689, “Allocation of Individual Income Tax to the Virgin Islands,” to the Form
1040 filed with the Internal Revenue Service and to
the copy of the Form 1040 filed with the USVI.
Example 2. B, a U.S. citizen, files returns on a
calendar year basis. In April 2005, B moves to the
U.S. Virgin Islands (USVI), purchases a house, and
accepts a permanent position with a local employer.
For the remainder of the year and throughout 2006,
B continues to live and work in the USVI, and establishes a closer connection to the USVI than to the

1032

United States or any foreign country. In September
2007, as a result of the termination of his employment
in the USVI, B sells his house and moves to State G.
As a consequence of his employment in the USVI,
B earns income from the performance of services in
the USVI from April 2005 through September 2007.
Section 932(c) and paragraph (c) of this section apply to B for 2006, but not for 2005 or 2007 (assuming
that during the first quarter of 2005 and the last quarter of 2007, B has a tax home outside of the USVI or
a closer connection to the United States or a foreign
country). For 2005 and 2007, B is subject to the rules
of sections 932(a) and (b) and paragraph (b) of this
section because he has income derived from sources
within the USVI as determined under the rules of section 937(b) and §1.937–2T.
Example 3. H and W are U.S. citizens. H resides
in State T and W is a bona fide resident of the U.S.
Virgin Islands (USVI). For 2004, H and W prepare
a joint Individual Income Tax Return, Form 1040,
which reports total adjusted gross income of $75x
of which $40x is attributable to compensation that
W received for services performed in the USVI and
$35x to compensation that H received for services
performed in State T. Pursuant to section 932(d) and
paragraph (d) of this section, the joint income tax return of H and W is filed with the USVI as required
by section 932(c) and paragraph (c) of this section.
H and W may claim a tax credit on such return for
income tax withheld during 2004 and paid to the Internal Revenue Service.
Example 4. (i) The facts are the same as in example 3, except that H also earns $25x for services
performed in the USVI, so that H and W’s total adjusted gross income is $100x, and their total income
tax liability is $20x.
(ii) Pursuant to section 932(d) and paragraph (d)
of this section, H and W must file a copy of their joint
Federal Form 1040 with the Bureau of Internal Revenue of the USVI as required by section 932(a)(2) and
paragraph (b)(1) of this section, and pay the applicable percentage of their Federal income tax liability to
the USVI as required by section 932(b) and paragraph
(b)(2) of this section, computed as follows:
65/100 x 20x

=

$13x income tax liability
to the USVI

(iii) H and W claim a credit against their Federal
income tax liability reported on the Form 1040 in the
amount of $13x, the portion of their Federal income
tax liability required to be paid to the USVI. H and W
attach a Form 8689, “Allocation of Individual Income
Tax to the Virgin Islands,” to the Form 1040 filed with
the Internal Revenue Service and to the copy of the
Form 1040 filed with the USVI.
Example 5. J is a U.S. citizen and a bona fide
resident of the U.S. Virgin Islands (USVI). In 2005, J
receives compensation for services performed in the
USVI in the amount of $40x. J prepares and files an
Individual Income Tax Return, Form 1040, with the
USVI and reports gross income of only $30x. J has
not satisfied the conditions of section 932(c)(4) and
paragraph (c) of this section for an exclusion from
gross income for U.S. Federal income tax purposes
and, therefore, must file a Federal income tax return
in accordance with the Internal Revenue Code and the
regulations.
Example 6. (i) N is a U.S. citizen and a bona fide
resident of the U.S. Virgin Islands. In 2004, N re-

2005–20 I.R.B.

ceives compensation for services performed in Country M. N prepares and files an Individual Income Tax
Return, Form 1040, with the USVI and reports the
compensation as income effectively connected with
the conduct of a trade or business in the USVI. N
claims a special credit against the tax on this compensation purportedly pursuant to a USVI law enacted
within the limits of its authority under section 934.
(ii) Under the principles of section 864(c)(4)
as applied pursuant to section 937(b)(1) and
§1.937–3T(b), compensation for services performed
outside the USVI may not be treated as income
effectively connected with the conduct of a trade or
business in the USVI for purposes of section 934(b).
Consequently, N is not entitled to claim the special
credit under USVI law with respect to N’s income
from services performed in Country M. Given that
N has not fully paid his tax liability referred to in
section 934(a), he has not satisfied the conditions of
section 932(c)(4) and paragraph (c) of this section
for an exclusion from gross income for U.S. Federal
income tax purposes. Accordingly, N must file a
Federal income tax return in accordance with the
Internal Revenue Code and the regulations.

(j) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 23. Section 1.933–1 is amended by
revising paragraphs (a) and (c) and adding
paragraphs (d) and (e) to read as follows:
§1.933–1 Exclusion of certain income
from sources within Puerto Rico.
(a) [Reserved]. For further guidance,
see §1.933–1T(a).
*****
(c) [Reserved]. For further guidance,
see §1.933–1T(c).
(d) [Reserved]. For further guidance,
see §1.933–1T(d).
(e) [Reserved]. For further guidance,
see §1.933–1T(e).
Par. 24. Section 1.933–1T is added to
read as follows:
§1.933–1T Exclusion of certain income
from sources within Puerto Rico
(temporary).
(a) General rule— (1) An individual (whether a United States citizen or
an alien), who is a bona fide resident of
Puerto Rico during the entire taxable year,
shall exclude from gross income the income derived from sources within Puerto
Rico, except amounts received for services
performed as an employee of the United
States or any agency thereof.
(2) The following example illustrates
the application of the general rule in paragraph (a)(1) of this section:

2005–20 I.R.B.

Example. E, a United States citizen, files returns
on a calendar year basis. In April 2005, E moves to
Puerto Rico, purchases a house, and accepts a permanent position with a local employer. For the remainder of the year and throughout 2006, E continues to
live and work in Puerto Rico, and establishes a closer
connection to Puerto Rico than to the United States or
any foreign country. In September 2007, as a result
of the termination of his employment in Puerto Rico,
E sells his house and moves to State J. E is entitled
to the exclusion provided in section 933 for 2006, but
not for 2005 or 2007 (assuming that during the first
quarter of 2005 and the last quarter of 2007, E has a
tax home outside of Puerto Rico or a closer connection to the United States or a foreign country).

(b) [Reserved]. For further guidance,
see §1.933–1(b).
(c) Deductions and credits. In any case
in which any amount otherwise constituting gross income is excluded from gross
income under the provisions of section
933, there shall not be allowed as a deduction from gross income any items of
expenses or losses or other deductions
(except the deduction under section 151,
relating to personal exemptions), or any
credit, properly allocable to, or chargeable
against, the amounts so excluded from
gross income. For purposes of the preceding sentence, the rules of §1.861–8
shall apply (with creditable expenditures
treated in the same manner as deductible
expenditures).
(d) Definitions. For purposes of this
section:
(1) The rules of §1.937–1T shall apply
for determining whether an individual is a
bona fide resident of Puerto Rico.
(2) The rules of §1.937–2T shall apply
for determining whether income is from
sources within Puerto Rico.
(e) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 25. Section 1.934–1 is revised to
read as follows:
§1.934–1 Limitation on reduction in
income tax liability incurred to the Virgin
Islands.
[Reserved]. For further guidance, see
§1.934–1T.
Par. 26. Section 1.934–1T is added to
read as follows:

1033

§1.934–1T Limitation on reduction in
income tax liability incurred to the Virgin
Islands (temporary).
(a) General rule. Section 934(a) provides that tax liability incurred to the
United States Virgin Islands (Virgin Islands) shall not be reduced or remitted in
any way, directly or indirectly, whether by
grant, subsidy, or other similar payment,
by any law enacted in the Virgin Islands,
except to the extent provided in section
934(b). For purposes of the preceding sentence, the term “tax liability” means the
liability incurred to the Virgin Islands pursuant to subtitle A of the Internal Revenue
Code, as made applicable in the Virgin
Islands by the Act of July 12, 1921 (48
U.S.C. 1397), or pursuant to section 28(a)
of the Revised Organic Act of the Virgin
Islands (48 U.S.C. 1642), as modified by
section 7651(5)(B).
(b) Exception for V.I. income— (1) In
general. Section 934(b)(1) provides an
exception to the application of section
934(a). Under this exception, section
934(a) does not apply with respect to tax
liability incurred to the Virgin Islands to
the extent that such tax liability is attributable to income derived from sources
within the Virgin Islands or income effectively connected with the conduct of a
trade or business within the Virgin Islands.
(2) Limitation. Section 934(b)(2) limits the scope of the exception provided by
section 934(b)(1). Pursuant to this limitation, the exception does not apply with respect to an individual who is a citizen or
resident of the United States (other than a
bona fide resident of the Virgin Islands).
For the rules for determining tax liability
incurred to the Virgin Islands by such an
individual, see section 932(a) and the regulations thereunder.
(3) Computation rule— (i) Operative
rule. For purposes of section 934(b)(1)
and this paragraph (b), tax liability incurred to the Virgin Islands for the taxable year attributable to income derived
from sources within the Virgin Islands
or income effectively connected with the
conduct of a trade or business within the
Virgin Islands shall be computed as follows:
(A) Add to the income tax liability
incurred to the Virgin Islands any credit
against the tax allowed under mirrored
section 901(a);

May 16, 2005

(B) Multiply by taxable income from
sources within the Virgin Islands and income effectively connected with the conduct of a trade or business within the Virgin Islands (applying the rules of §1.861–8
to determine deductions allocable to such
income);
(C) Divide by total taxable income; and
(D) Subtract the portion of any credit
allowed under mirrored section 901 (other
than credits for taxes paid to the United
States) determined by multiplying the
amount of taxable income from sources
outside the Virgin Islands or the United
States that is effectively connected to the
conduct of a trade or business in the Virgin Islands divided by the total amount of
taxable income from such sources.
(ii) Limitation. Tax liability incurred to
the Virgin Islands attributable to income
derived from sources within the Virgin Islands or income effectively connected with
the conduct of a trade or business within
the Virgin Islands, as computed in this
paragraph (b)(3), however, shall not exceed the total amount of income tax liability actually incurred.
(4) Definitions. For purposes of this
section:
(i) Bona fide resident. The rules of
§1.937–1T shall apply for determining
whether an individual is a bona fide resident of the Virgin Islands.
(ii) Source. The rules of §1.937–2T
shall apply for determining whether income is from sources within the Virgin Islands.
(iii) Effectively connected income. The
rules of §1.937–3T shall apply for determining whether income is effectively connected with the conduct of a trade or business in the Virgin Islands.
(c) Exception for qualified foreign
corporations— (1) In general. Section
934(b)(3) provides an exception to the

application of section 934(a). Under this
exception, section 934(a) does not apply
with respect to tax liability incurred to the
Virgin Islands by a qualified foreign corporation to the extent that such tax liability
is attributable to income which is derived
from sources outside the United States and
which is not effectively connected with
the conduct of a trade or business within
the United States.
(2) Qualified foreign corporation. For
purposes of paragraph (c)(1) of this section, the term qualified foreign corporation
means any foreign corporation if 1 or more
United States persons own or are treated
as owning (within the meaning of section
958) less than 10 percent of—
(i) The total voting power of the stock
of such corporation; and
(ii) The total value of the stock of such
corporation,
(3) Computation rule— (i) Operative
rule. For purposes of section 934(b)(3)
and this paragraph (c), tax liability incurred to the Virgin Islands for the taxable
year attributable to income which is derived from sources outside the United
States and which is not effectively connected with the conduct of a trade or
business within the United States shall be
computed as follows—
(A) Add to the income tax liability
incurred to the Virgin Islands any credit
against the tax allowed under mirrored
section 901(a);
(B) Multiply by taxable income which
is derived from sources outside the United
States and which is not effectively connected with the conduct of a trade or business within the United States (applying the
rules of §1.861–8 to determine deductions
allocable to such income);
(C) Divide by total taxable income; and
(D) Subtract any credit allowed under
mirrored section 901 (other than credits for

taxes paid to the United States or taxes for
which a credit is allowable for U.S. Federal
income tax purposes under section 906 of
the Internal Revenue Code).
(ii) Limitation. Tax liability incurred to
the Virgin Islands attributable to income
which is derived from sources outside the
United States and which is not effectively
connected with the conduct of a trade or
business within the United States, as computed in this paragraph (c)(3), however,
shall not exceed the total amount of income tax liability actually incurred.
(4) U.S. income— (i) In general. For
purposes of this section, except as provided in paragraph (c)(4)(ii) of this section, the rules of sections 861 through 865
and the regulations thereunder shall apply
for determining whether income is from
sources outside the United States or effectively connected with the conduct of a
trade or business within the United States.
(ii) Conduit arrangements. Income
shall be considered to be from sources
within the United States for purposes of
paragraph (c)(1) of this section if, pursuant
to a plan or arrangement—
(A) The income is received in exchange
for consideration provided to another person; and
(B) Such person (or another person)
provides the same consideration (or consideration of a like kind) to a third person
in exchange for one or more payments constituting income from sources within the
United States.
(d) Examples. The rules of this section
are illustrated by the following examples:
Example 1. (i) S is a U.S. citizen and a bona
fide resident of the U.S. Virgin Islands (USVI). For
2005, S files a Form 1040INFO, “Non-Virgin Islands
Source Income of Virgin Islands Residents,” with the
USVI on which S reports total gross income as follows:

Compensation for services performed in the USVI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Compensation for services performed in the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$50,000
40,000

Compensation for services performed in Mexico . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

30,000

Income from inventory sales in Latin America attributable to USVI Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

20,000

Interest on a U.S. bank account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6,000

Interest on a V.I. bank account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,000

Dividends from a U.S. corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4,000

(ii) Accordingly, S has total gross income of
$155,000, comprising income from sources within
the USVI or effectively connected to the conduct

May 16, 2005

of a trade or business in the USVI (USVI ECI) of
$75,000, income from sources within the United
States of $50,000, and income from other sources

1034

(not USVI ECI) of $30,000. After taking into account allowable deductions, S’s total taxable income
is $120,000, of which $45,000 is taxable income from

2005–20 I.R.B.

sources within the USVI, $15,000 is taxable income
from other sources that is USVI ECI under the rules
of section 937(b) and §§1.937–2T and 1.937–3T,
and $22,500 is taxable income from sources outside
the USVI (and outside the United States) that is not
USVI ECI. S’s tax liability incurred to the USVI
pursuant to the Internal Revenue Code as applicable
in the USVI (mirror code) is $30,000. S is entitled to

claim a credit under section 901 of the mirror code in
the amount of $10,000 for income tax paid to Mexico
and other Latin American countries, for a net income
tax liability of $20,000.
(iii) Pursuant to a USVI law that was duly enacted
within the limits of its authority under section 934, S
may claim a special deduction relating to his business activities in the USVI. However, under section

934(b), S’s ability to claim this special deduction is
limited. Specifically, the maximum amount of the reduction in S’s mirror code tax liability that may result from claiming this deduction, computed in accordance with paragraph (b)(3) of this section, is as
follows:

(20,000 + 10,000) x ((45,000 + 15,000) / (120,000)) - 10,000 x ((15,000) / (15,000 + 22,500))
= 30,000 x (.5) - 10,000 x (.4) = 15,000 - 4,000 = $11,000
(iv) Accordingly, S’s net tax liability incurred to
the USVI must be at least $19,000 (30,000 - 11,000),
prior to taking into account any foreign tax credit.
Example 2. The facts are the same as Example
1, except that S is a U.S. citizen who resides in the
United States. As required by section 932(a) and (b),
S files with the U.S. Virgin Islands (USVI) a copy of
his Federal income tax return and pays to the USVI
the portion of his Federal income tax liability that
his Virgin Islands adjusted gross income bears to his
adjusted gross income. Under section 934(b)(2), S
may not claim the special deduction offered under
USVI law relating to business activities like his in the
USVI to reduce any of his tax liability payable to the
USVI under section 932(b).
Example 3. (i) Z is a nonresident alien who resides in Country FC. In 2005, Z receives dividends
from a corporation organized under the law of the
U.S. Virgin Islands (USVI) in the amount of $90x.
Z’s tax liability incurred to the USVI pursuant to section 871(a) of the Internal Revenue Code as applicable in the USVI (mirror code) is $27x.
(ii) Pursuant to a USVI law that was duly enacted
within the limits of its authority under section 934, Z
may claim a special exemption for income relating to
his investment in the USVI. The maximum amount
of the reduction in Z’s mirror code tax liability that

may result from claiming this exemption, computed
in accordance with paragraph (b)(3) of this section, is
as follows:
27x (90x/90x) = $27x
(iii) Accordingly, depending on the terms of the
exemption as provided under USVI law, Z’s net tax
liability incurred to the USVI may be reduced or eliminated entirely.
Example 4. (i) A Corp is organized under the laws
of the U.S. Virgin Islands (USVI) and is engaged in a
trade or business in the United States through an office in State N. All of A Corp’s outstanding stock is
owned by U.S. citizens who are bona fide residents
of the USVI. During 2005, A Corp had $50x in gross
income from sources within the USVI (as determined
under section 937(b) and §1.937–2T) that is not effectively connected with the conduct of a trade or business in the United States; $20x in gross income from
sources in Country H that is effectively connected
with the conduct of A Corp’s trade or business in the
United States; and $10x in gross income from sources
in Country R that is not effectively connected with the
conduct of A Corp’s trade or business in the United
States.

(ii) Section 934(b)(3) permits the USVI to reduce
or remit the income tax liability of a qualified foreign corporation arising under the Internal Revenue
Code as applicable in the USVI (mirror code) with respect to income that is derived from sources outside
the United States and that is not effectively connected
with the conduct of a trade or business in the United
States. A foreign corporation constitutes a “qualified foreign corporation” under section 934(b)(3)(B)
if less than 10 percent of the total voting power and
value of the stock of the corporation is owned or
treated as owned (within the meaning of section 958)
by one or more United States persons. A U.S. citizen is a United States person as defined in section
7701(a)(30)(A). Given that 10 percent or more of
the voting power and value of its stock is owned by
U.S. citizens, A Corp does not constitute a “qualified foreign corporation” under section 934(b)(3)(B).
Accordingly, the USVI may only reduce or remit A
Corp’s mirror code income tax liability with respect
to its $50x in gross income from sources within the
USVI.
Example 5. (i) The facts are the same as in Example 4, except that the outstanding stock of A Corp is
owned by the following individuals:

U. S. citizens who are bona fide residents of the USVI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5%

U. S. citizens who are not bona fide residents of the USVI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3%

Nonresident aliens who are bona fide residents of the USVI. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

42%

Nonresident aliens who are not bona fide residents of the USVI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

50%

(ii) Given that less than 10 percent of the voting
power and value of its stock is owned by United
States persons, A Corp constitutes a qualified foreign
corporation under section 934(b)(3)(B). Accordingly, the USVI may reduce or remit A Corp’s mirror
code income tax liability with respect to its $50x
in gross income from sources within the USVI and
its $10x in gross income from sources in Country R
that is not effectively connected with the conduct of
A Corp’s trade or business in the United States. In
no event, however, may the USVI reduce or remit A
Corp’s mirror code income tax liability with respect
to its $20x in gross income from sources in Country
H that is effectively connected with the conduct of A
Corp’s trade or business in the United States.

section applies to amounts paid or accrued
after April 11, 2005.
Par. 27. Section 1.935–1 is amended as
follows:
1. Revise the heading and paragraphs
(a)(1) through (a)(3).
2. Revise paragraphs (b)(1) and (b)(3),
and add paragraphs (b)(5) through (b)(7).
3. Revise paragraphs (c) through (f).
4. Add paragraph (g).
The revisions and additions are as follows:

(a)(1) through (a)(3) [Reserved]. For
further guidance, see §1.935–1T(a)(1)
through (a)(3).
(b)(1) [Reserved]. For further guidance, see §1.935–1T(b)(1).
*****
(b)(3) [Reserved]. For further guidance, see §1.935–1T(b)(3).
*****
(b)(5) through (b)(7) [Reserved]. For
further guidance, see §1.935–1T(b)(5)
through (b)(7).

(e) Effective date. Except as otherwise
provided in this paragraph (e), this section
applies for taxable years ending after October 22, 2004. Paragraph (c)(4)(ii) of this

2005–20 I.R.B.

§1.935–1 Coordination of individual
income taxes with Guam and the Northern
Mariana Islands.

1035

May 16, 2005

(c) through (f) [Reserved]. For further
guidance, see §1.935–1T(c) through (f).
(g) [Reserved]. For further guidance,
see §1.935–1T(g).
Par. 28. Section 1.935–1T is added to
read as follows:
§1.935–1T Coordination of individual
income taxes with Guam and the Northern
Mariana Islands (temporary).
(a) Application of section— (1) Scope.
Section 935 and this section set forth the
special rules relating to the filing of income tax returns, income tax liabilities,
and estimated income tax of individuals
described in paragraph (a)(2) of this section. Paragraph (e) of this section also
provides special rules requiring consistent
treatment of business entities in the United
States and in section 935 possessions.
(2) Individuals covered. This section
shall apply to any individual who—
(i) Is a bona fide resident of a section 935 possession during the entire
taxable year, whether or not such individual is a citizen of the United States
or a resident alien (as defined in section
7701(b)(1)(A));
(ii) Is a citizen of a section 935 possession but not otherwise a citizen of the
United States;
(iii) Has income from sources within
a section 935 possession for the taxable
year, is a citizen of the United States or
a resident alien (as defined in section
7701(b)(1)(A)) and is not a bona fide resident of a section 935 possession during
the entire taxable year; or
(iv) Files a joint return for the taxable
year with any individual described in paragraph (a)(2)(i), (ii), or (iii) of this section.
(3) Definitions. For purposes of this
section:
(i) The term section 935 possession
means Guam or the Northern Mariana
Islands, unless such possession has entered into an implementing agreement, as
described in section 1271(b) of the Tax
Reform Act of 1986 (Public Law 99–514
(100 Stat. 2085)), with the United States
that is in effect for the entire taxable year.
(ii) The term relevant possession
means:
(A) With respect to an individual described in paragraph (a)(2)(i) of this section, the section 935 possession of which
such individual is a bona fide resident.

May 16, 2005

(B) With respect to an individual described in paragraph (a)(2)(ii) of this section, the section 935 possession of which
such individual is a citizen.
(C) With respect to an individual described in paragraph (a)(2)(iii) of this
section, the section 935 possession from
which such individual derives income.
(iii) The rules of §1.937–1T shall apply
for determining whether an individual is a
bona fide resident of a section 935 possession.
(iv) The rules of §1.937–2T generally
shall apply for determining whether income is from sources within a section 935
possession. Pursuant to §1.937–2T(a),
however, the rules of §1.937–2T(c)(1)(ii)
and (c)(2) do not apply for purposes of
section 935(a)(3) (as in effect before the
effective date of its repeal) and paragraph
(a)(2)(iii) of this section.
(v) The term citizen of the United
States means any individual who is a citizen within the meaning of §1.1–1(c),
except that the term does not include an
individual who is a citizen of a section 935
possession but not otherwise a citizen of
the United States. The term citizen of a
section 935 possession but not otherwise
a citizen of the United States means any
individual who has become a citizen of the
United States by birth or naturalization in
the section 935 possession.
(vi) With respect to the United States,
the term resident means an individual who
is a citizen (as defined in §1.1–1(c)) or resident alien (as defined in section 7701(b))
and who does not have a tax home (as
defined in section 911(d)(3)) in a foreign
country during the entire taxable year. The
term does not include an individual who is
a bona fide resident of a section 935 possession.
(vii) The term U.S. taxpayer means an
individual described in paragraph (b)(1)(i)
or (iii)(B) of this section.
(b) Filing requirement— (1) Tax jurisdiction. An individual described in paragraph (a)(2) of this section shall file an income tax return for the taxable year—
(i) With the United States if such individual is a resident of the United States;
(ii) With the relevant possession if
such individual is described in paragraph
(a)(2)(i) of this section; or
(iii) If neither paragraph (b)(1)(i) nor
paragraph (b)(1)(ii) of this section applies—

1036

(A) With the relevant possession if
such individual is described in paragraph
(a)(2)(ii) of this section; or
(B) With the United States if such individual is a citizen of the United States, as
defined in paragraph (a)(3) of this section.
(2) [Reserved]. For further guidance,
see §1.935–1(b)(2).
(3) Place for filing returns— (i) U.S. returns. A return required under this paragraph (b) to be filed with the United States
shall be filed as directed in the applicable
forms and instructions.
(ii) Guam returns. A return required
under this paragraph (b) to be filed with
Guam shall be filed as directed in the applicable forms and instructions.
(iii) NMI returns. A return required under this paragraph (b) to be filed with the
Northern Mariana Islands shall be filed as
directed in the applicable forms and instructions
(4) [Reserved]. For further guidance,
see §1.935–1(b)(4).
(5) Tax payments. The tax shown on
the return shall be paid to the jurisdiction
with which such return is required to be
filed and shall be determined by taking
into account any credit under section 31
for tax withheld by the relevant possession
or the United States on wages, any credit
under section 6402(b) for an overpayment
of income tax to the relevant possession or
the United States, and any payments under
section 6315 of estimated income tax paid
to the relevant possession or the United
States.
(6) Liability to other jurisdiction— (i)
Filing with the relevant possession. In the
case of an individual who is required under paragraph (b)(1) of this section to file
a return with the relevant possession for
a taxable year, if such individual properly
files such return and fully pays his or her
income tax liability to the relevant possession, such individual is relieved of liability
to file an income tax return with, and to pay
an income tax to, the United States for the
taxable year.
(ii) Filing with the United States. In the
case of an individual who is required under
paragraph (b)(1) of this section to file a
return with the United States for a taxable
year, such individual is relieved of liability
to file an income tax return with, and to pay
an income tax to, the relevant possession
for the taxable year.
(7) Information reporting. [Reserved].

2005–20 I.R.B.

(c) Extension of territory— (1) U.S. taxpayers— (i) General rule. With respect to
a U.S. taxpayer, for purposes of taxes imposed by Chapter 1 of the Internal Revenue
Code, the United States generally shall be
treated, in a geographical and governmental sense, as including the relevant possession. The purpose of this rule is to facilitate the coordination of the tax systems of
the United States and the relevant possession. Accordingly, the rule will have no effect where it is manifestly inapplicable or
its application would be incompatible with
the intent of any provision of the Internal
Revenue Code.
(ii) Application of general rule. Contexts in which the general rule of paragraph
(c)(1)(i) of this section apply include:
(A) The characterization of taxes paid
to the relevant possession. Income tax
paid to the relevant possession may be
taken into account under sections 31, 6315,
and 6402(b) as payments to the United
States. Taxes paid to the relevant possession and otherwise satisfying the requirements of section 164(a) will be allowed as
a deduction under that section, but income
taxes paid to the relevant possession will
be disallowed as a deduction under section
275(a).
(B) The determination of the source
of income for purposes of the foreign tax
credit (e.g., sections 901 through 904).
Thus, for example, after a U.S. taxpayer
determines which items of income constitute income from sources within the
relevant possession under the rules of section 937(b), such income shall be treated
as income from sources within the United
States for purposes of section 904.
(C) The eligibility of a corporation to
make a subchapter S election (sections
1361 through 1379). Thus, for example,
for purposes of determining whether a
corporation created or organized in the
relevant possession may make an election
under section 1362(a) to be a subchapter
S corporation, it shall be treated as a domestic corporation and a U.S. taxpayer
shareholder shall not be treated as a nonresident alien individual with respect to
such corporation. While such an election
is in effect, the corporation shall be treated
as a domestic corporation for all purposes
of the Internal Revenue Code. For the
consistency requirement with respect to
entity status elections, see paragraph (e)
of this section.

2005–20 I.R.B.

(D) The treatment of items carried over
from other tax years. Thus, for example,
if a U.S. taxpayer has for a taxable year a
net operating loss carryback or carryover
under section 172, a foreign tax credit carryback or carryover under section 904, a
business credit carryback or carryover under section 39, a capital loss carryover under section 1212, or a charitable contributions carryover under section 170, the
carryback or carryover will be reported
on the return filed with the United States
in accordance with paragraph (b)(1)(i) or
(b)(1)(iii)(B) of this section, even though
the return of the taxpayer for the taxable
year giving rise to the carryback or carryover was required to be filed with a section
935 possession.
(E) The treatment of property exchanged for property of a like kind (section
1031). Thus for example, if a U.S. taxpayer exchanges real property located in
the United States for real property located
in the relevant possession, notwithstanding the provisions of section 1031(h), such
exchange may qualify as a like-kind exchange under section 1031 (provided that
all the other requirements of section 1031
are satisfied).
(iii) Nonapplication of general rule.
Contexts in which the general rule of paragraph (c)(1)(i) of this section does not
apply include:
(A) The application of any rules or
regulations that explicitly treat the United
States and any (or all) of its possessions
as separate jurisdictions (e.g., sections 931
through 937, 7651, and 7654).
(B) The determination of any aspect
of an individual’s residency (e.g., sections
937(a) and 7701(b)). Thus, for example, an individual whose principal place
of abode is in the relevant possession is
not considered to have a principal place of
abode in the United States for purposes of
section 32(c).
(C) The determination of the source of
income for purposes other than the foreign tax credit (e.g., sections 935, 937,
and 7654). Thus, for example, income
determined to be derived from sources
within the relevant possession under section 937(b) shall not be considered income
from sources within the United States for
purposes of Form 5074, “Allocation of
Individual Income Tax to Guam or the
Commonwealth of the Northern Mariana
Islands”.

1037

(D) The definition of wages (section
3401). Thus, for example, services performed by an employee for an employer
in the relevant possession do not constitute
services performed in the United States under section 3401(a)(8).
(E) The characterization of a corporation for purposes other than subchapter S
(e.g., sections 367, 951 through 964, 1291
through 1298, 6038, and 6038B). Thus,
for example, if a U.S. taxpayer transfers
appreciated tangible property to a corporation created or organized in the relevant
possession in a transaction described in
section 351, he or she must recognize gain
unless an exception under section 367(a)
applies. Also, if a corporation created
or organized in the relevant possession
qualifies as a passive foreign investment
company under sections 1297 and 1298
with respect to a U.S. taxpayer, a dividend
paid to such shareholder does not constitute qualified dividend income under
section 1(h)(11)(B).
(2) Application in relevant possession.
In applying the territorial income tax of the
relevant possession, such possession generally shall be treated, in a geographical
and governmental sense, as including the
United States. Thus, for example, income
tax paid to the United States may be taken
into account under sections 31, 6315, and
6402(b) as payments to the relevant possession. Moreover, a citizen of the United
States (as defined in paragraph (a)(3) of
this section) not a resident of the relevant
possession will not be treated as a nonresident alien individual for purposes of the
territorial income tax of the relevant possession. Thus, for example, a citizen of the
United States (as so defined), or a resident
of the United States, will not be treated as
a nonresident alien individual for purposes
of section 1361(b)(1)(C) of the Guamanian
Territorial income tax.
(d) Special rules for estimated income
tax— (1) In general. An individual must
make each payment of estimated income
tax (and any amendment to the estimated
tax payment) to the jurisdiction with which
the individual reasonably believes, as of
the date of that payment (or amendment),
that he or she will be required to file a return for the taxable year under paragraph
(b)(1) of this section. In determining the
amount of such estimated income tax, income tax paid to the relevant possession
may be taken into account under sections

May 16, 2005

31 and 6402(b) as payments to the United
States, and vice versa. For other rules relating to estimated income tax, see section
6654.
(2) Joint estimated income tax. In the
case of married persons making a joint
payment of estimated income tax, the taxpayers must make each payment of estimated income tax (and any amendment
to the estimated tax payment) to the jurisdiction where the spouse who has the
greater estimated adjusted gross income
for the taxable year would be required under paragraph (d)(1) of this section to pay
estimated income tax if separate payments
were made. For this purpose, estimated adjusted gross income of each spouse for the
taxable year is determined without regard
to community property laws.
(3) Erroneous payment. If the individual or spouses erroneously pay estimated
income tax to the United States instead of
the relevant possession or vice versa, only
subsequent payments or amendments of
the payments are required to be made pursuant to paragraph (d)(1) or (d)(2) of this
section with the other jurisdiction.
(4) Place for payment. Estimated income tax required under this paragraph (d)
to be paid to Guam or the Northern Mariana Islands shall be paid as directed in the
applicable forms and instructions issued
by the relevant possession. Estimated income tax required under paragraph (d)(1)
of this section to be paid to the United
States shall be paid as directed in the applicable forms and instructions.
(5) Liability to other jurisdiction— (i)
Filing with Guam or the Northern Mariana Islands. Subject to paragraph (d)(6) of
this section, an individual required under
this paragraph (d) to pay estimated income
tax (and amendments thereof) to Guam or
the Northern Mariana Islands is relieved of
liability to pay estimated income tax (and
amendments thereof) to the United States.
(ii) Filing with the United States. Subject to paragraph (d)(6) of this section, an
individual required under this paragraph
(d) to pay estimated income tax (and
amendments thereof) to the United States
is relieved of liability to pay estimated
income tax (and amendments thereof) to
the relevant possession.
(6) Underpayments. The liability of
an individual described in paragraph (a)(2)
of this section for underpayments of estimated income tax for a taxable year, as de-

May 16, 2005

termined under section 6654, shall be to
the jurisdiction with which the individual
is required under paragraph (b) of this section to file his or her return for the taxable
year.
(e) Entity status consistency requirement— (1) In general. Taxpayers should
make consistent entity status elections (as
defined in paragraph (e)(3)(ii) of this section), when applicable, in both the United
States and section 935 possessions. In the
case of a business entity to which this paragraph (e) applies:
(i) If an entity status election is filed
with the Internal Revenue Service but not
with the relevant possession, the appropriate tax authority of the relevant possession,
at his discretion, may deem the election
also to have been made for the relevant
possession tax purposes.
(ii) If an entity status election is filed
with the relevant possession but not with
the Internal Revenue Service, the Commissioner, at his discretion, may deem the
election also to have been made for U.S.
Federal tax purposes.
(iii) If inconsistent entity status elections are filed with the relevant possession
and the Internal Revenue Service, both the
Commissioner and the appropriate tax authority of the relevant possession may, at
their individual discretion, treat the elections they each received as invalid and may
deem the election filed in the other jurisdiction to have been made also for tax purposes in their own jurisdiction. (See Rev.
Proc. 89–8, 1989–1 C.B. 778, for procedures for requesting the assistance of the
Internal Revenue Service when a taxpayer
is or may be subject to inconsistent tax
treatment by the Internal Revenue Service
and a U.S. possession tax agency.)
(2) Scope. This paragraph (e) applies to
the following business entities:
(i) A business entity (as defined in
§301.7701–2(a) of this chapter) that is domestic (as defined in §301.7701–5 of this
chapter), or otherwise treated as domestic for purposes of the Internal Revenue
Code, and that is owned in whole or in
part by any person who is either a bona
fide resident of a section 935 possession
or a business entity created or organized
in a section 935 possession.
(ii) A business entity that is created or
organized in a section 935 possession and
that is owned in whole or in part by any

1038

U.S. person (other than a bona fide resident
of such possession).
(3) Definitions. For purposes of this
section—
(i) The term appropriate tax authority
of the relevant possession means the individual responsible for tax administration in
such possession or his delegate.
(ii) The term entity status election includes an election under §301.7701–3(c)
of this chapter, an election under section
1362(a), and any other similar elections.
(4) Default status. Solely for the purpose of determining classification of an
eligible entity under §301.7701–3(b), and
§301.7701–3(b) as mirrored in the relevant
possession, an eligible entity subject to this
paragraph (e) shall be classified for both
U.S. Federal and the relevant possession
tax purposes using the rule that applies to
domestic eligible entities.
(5) Transition rules— (i) In the case of
an election filed prior to April 11, 2005,
except as provided in paragraph (e)(5)(ii)
of this section, the rules of paragraph (e)(1)
of this section shall apply as of the first
day of the first taxable year of the entity
beginning after April 11, 2005.
(ii) In the unlikely circumstance that
inconsistent elections described in paragraph (e)(1)(iii) are filed prior to April 11,
2005, and the entity cannot change its classification to achieve consistency because
of the sixty-month limitation described in
§301.7701–3(c)(1)(iv) of this chapter, then
the entity may nevertheless request permission from the Commissioner or appropriate tax authority of the relevant possession to change such election to avoid inconsistent treatment by the Commissioner
and the appropriate tax authority of the relevant possession.
(iii) Except as provided in paragraphs
(e)(5)(i) and (e)(5)(ii) of this section, in the
case of an election filed with respect to an
entity before it became an entity described
in paragraph (e)(2) of this section, the rules
of paragraph (e)(1) of this section shall apply as of the first day that such entity is described in paragraph (e)(2) of this section.
(iv) In the case of an entity created or organized prior to April 11, 2005, paragraph
(e)(4) of this section shall take effect for
U.S. Federal income tax purposes (or the
relevant possession income tax purposes,
as the case may be) as of the first day of
the first taxable year of the entity beginning after April 11, 2005.

2005–20 I.R.B.

(f) Examples. The application of this
section is illustrated by the following examples:
Example 1. B, a United States citizen, files returns on a calendar year basis. In April 2005, B
moves to Possession G, which is a section 935 possession, purchases a house, and accepts a permanent
position with a local employer. For the remainder of
the year and throughout 2006, B continues to live and
work in Possession G, and establishes a closer connection to Possession G than to the United States or
any foreign country. In September 2007, as a result
of the termination of his employment in Possession
G, B sells his house and moves to State H. As a consequence of his employment in Possession G, B earns
income from the performance of services in Possession G from April 2005 through September 2007.
Section 935(b)(1)(B) and paragraph (b)(1)(ii) of this
section apply to B for 2006, but not for 2005 or 2007
(assuming that during the first quarter of 2005 and
the last quarter of 2007, B has a tax home outside
of Possession G or a closer connection to the United
States or a foreign country). For 2005 and 2007, B
is subject to the rules applicable to individuals described in paragraph (a)(2)(iii) of this section because
he has income derived from sources within Possession G as determined under the rules of section 937(b)
and §1.937–2T.
Example 2. The facts are the same as in Example
1 except that B’s employment terminated in September 2008 rather than 2007. B properly pays his April
2005 estimated tax to the United States, continues to
pay estimated tax for the 2005 tax year to the United
States under paragraph (d) of this section, and properly files his 2005 return with the United States.
(i)(A) On the date of each payment of estimated
tax in 2006, B reasonably believes that he would be
required to file his return for 2006 with Possession G
under paragraph (b)(1) of this section.
(B) In August 2006, B determines that he has
overpaid tax for the previous year in the amount of
$1000. B properly pays all estimated taxes to Possession G for 2006, subtracting the $1000 overpayment
from his estimated tax payments pursuant to section
6402(b), and properly files his tax return with Possession G.
(ii) In April 2007, B reasonably believes that he
would be returning to the United States in the Fall of
2007, and properly pays estimated tax to the United
States. By June 2007, B reasonably believes that he
would not be moving from Possession G and would
be a bona fide resident of Possession G for the entire
taxable year. B makes his remaining estimated tax
payments to Possession G. On his 2007 tax return
filed with Possession G, pursuant to section 6315, B
properly takes into account payments made to both
the United States and Possession G as estimated
taxes.
(iii) In April and June 2008, B reasonably believes that he would be a bona fide resident of Possession G for the entire taxable year 2008 and properly pays estimated taxes to Possession G. By the time
B pays his estimated taxes for September 2008, B’s
employment terminates and he moves to State H. B
properly makes his remaining estimated tax payments
to the United States. On his return for 2008, properly filed with the United States, B determines that
he has underpaid estimated taxes throughout 2008 in
an amount subject to penalty under section 6654. B

2005–20 I.R.B.

owes the United States an estimated tax penalty under section 6654.

(g) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 29. Section 1.937–1T is added to
read as follows:
§1.937–1T Bona fide residency in a
possession (temporary).
(a) Scope— (1) In general. Section
937(a) and this section set forth the rules
for determining whether an individual
qualifies as a bona fide resident of a particular possession (the relevant possession)
for purposes of the Internal Revenue Code,
including Subpart D, Part III, Subchapter
N, Chapter 1 of the Internal Revenue Code
as well as section 865(g)(3), section 876,
section 881(b), paragraphs (2) and (3) of
section 901(b), section 957(c), section
3401(a)(8)(C), and section 7654(a).
(2) Definitions. For purposes of this
section and §§1.937–2 and 1.937–3—
(i) Possession means one of the following United States possessions: American
Samoa, Guam, the Northern Mariana
Islands, Puerto Rico, or the Virgin Islands.
When used in a geographical sense, the
term comprises only the territory of each
such possession (without application of
sections 932(c)(3) and 935(c)(2) (as in
effect before the effective date of its repeal)).
(ii) United States, when used in a geographical sense, is defined in section
7701(a)(9), and without application of
sections 932(a)(3) and 935(c)(1) (as in effect before the effective date of its repeal).
(b) Bona fide resident— (1) General
rule. An individual qualifies as a bona
fide resident of the relevant possession if
such individual satisfies the requirements
of paragraphs (c) through (e) of this section with respect to such possession.
(2) Special rule for members of the
Armed Forces. A member of the Armed
Forces of the United States who qualified
as a bona fide resident of the relevant
possession in a prior taxable year shall be
deemed to have satisfied the requirements
of paragraphs (c) through (e) of this section for a subsequent taxable year if such
individual otherwise is unable to satisfy
such requirements by reason of being absent from such possession or present in
the United States during such year solely

1039

in compliance with military orders. Conversely, a member of the Armed Forces of
the United States who did not qualify as
a bona fide resident of the relevant possession in a prior taxable year shall not be
considered to have satisfied the requirements of paragraphs (c) through (e) of this
section for a subsequent taxable year by
reason of being present in such possession
solely in compliance with military orders.
Armed Forces of the United States is defined (and members of the Armed Forces
are described) in section 7701(a)(15).
(3) Juridical persons. Only natural persons may qualify as bona fide residents of
a possession. The rules governing the tax
treatment of bona fide residents of a possession do not apply to juridical persons
(e.g., corporations, partnerships, trusts,
and estates).
(4) Transition rule. For taxable years
beginning before October 23, 2004, and
ending after October 22, 2004, an individual will be considered to qualify as a bona
fide resident of the relevant possession if
such individual satisfies the requirements
of paragraphs (d) and (e) of this section
with respect to such possession for such
year.
(c) Presence test— (1) In general. A
United States citizen or resident alien (as
defined in section 7701(b)(1)(A)) individual satisfies the requirements of this paragraph (c) for a taxable year if during that
taxable year such individual—
(i) Was present in the relevant possession for at least 183 days;
(ii) Was present in the United States for
no more than 90 days;
(iii) Had no earned income (as defined
in §1.911–3(b)) in the United States and
was present for more days in the relevant
possession than in the United States; or
(iv) Had no permanent connection (see
paragraph (c)(4) of this section) to the
United States.
(2) Special rule for alien individuals.
A nonresident alien individual (as defined in section 7701(b)(1)(B)) satisfies
the requirements of this paragraph (c) for
a taxable year if during that taxable year
such individual satisfies the substantial
presence test of §301.7701(b)–1(c) of this
chapter (except for the substitution of the
name of the relevant possession for the
term United States where appropriate).
(3) Days of presence. For purposes of
paragraph (c)(1) of this section—

May 16, 2005

(i) An individual is considered to be
present in the relevant possession on any
day that he or she is physically present in
such possession at any time during the day.
(ii) An individual is considered to be
present in the United States on any day that
he or she is physically present in the United
States at any time during the day. However, the following days shall be excluded
and will not count as days of presence in
the United States:
(A) Any day that an individual is prevented from leaving the United States
because of a medical condition that
arose while the individual was present
in the United States (as described in
§301.7701(b)–3(c) of this chapter);
(B) Any day that an individual is in transit between two points outside the United
States (as described in §301.7701(b)–3(d)
of this chapter), and is physically present in
the United States for fewer than 24 hours;
(C) Any day that an individual is temporarily present in the United States as
a professional athlete to compete in a
charitable sports event (as described in
§301.7701(b)–3(b)(5) of this chapter);
(D) Any day during which the individual is temporarily in the United States as
a student (as defined in section 152(f)(2));
and
(E) In the case of an individual who
is an elected representative of the relevant
possession, or who serves full time as an
elected or appointed official or employee
of the government of the relevant possession (or any political subdivision thereof),
any day spent serving the relevant possession in such role.
(iii) If, during a single day, an individual is physically present—
(A) In the United States and in the relevant possession, such day shall be considered a day of presence in the relevant possession;
(B) In two possessions, such day shall
be considered a day of presence in the possession where the individual’s tax home
is located (applying the rules of paragraph
(d) of this section).
(4) Permanent connection. For purposes of paragraph (c)(1) of this section—
(i) A permanent connection to the
United States includes—
(A) A permanent home (as described
in §301.7701(b)–2(d)(2) of this chapter) in
the United States;

May 16, 2005

(B) A spouse or dependent (as defined
in section 152 and the regulations thereunder) whose principal place of abode is in
the United States; or
(C) Current registration to vote in any
political subdivision of the United States.
(ii) However, a permanent connection
to the United States does not include—
(A) A valid professional license conferred by any political subdivision of the
United States; or
(B) Relatives (other than those specified in paragraph (c)(4)(i)(B) of this section) whose principal place of abode is in
the United States.
(d) Tax home test— (1) General rule.
An individual satisfies the requirements of
this paragraph (d) for a taxable year if such
individual did not have a tax home outside
the relevant possession during any part of
the taxable year. For purposes of section
937 and this section, an individual’s tax
home is determined under the principles of
section 911(d)(3) without regard to the second sentence thereof. Thus, under section
937, an individual’s tax home is considered to be located at the individual’s regular or principal (if more than one regular)
place of business. If the individual has no
regular or principal place of business because of the nature of the business, or because the individual is not engaged in carrying on any trade or business within the
meaning of section 162(a), then the individual’s tax home is the individual’s regular place of abode in a real and substantial
sense.
(2) Special rule for seafarers. For purposes of section 937 and this section, an
individual will not be considered to have
a tax home outside the relevant possession
solely by reason of employment on a ship
or other seafaring vessel that is predominantly used in local and international waters. For this purpose, a vessel will be considered to be predominantly used in local
and international waters if, during the taxable year, the aggregate amount of time it
is used in international water and in the water within three miles of the relevant possession exceeds the aggregate amount of
time it is used in the territorial water of the
United States or any foreign country.
(3) Special rule for students and government officials. Any days described in
paragraphs (c)(3)(ii)(D) and (E) of this
section shall be disregarded for purposes
of determining whether an individual has

1040

a tax home outside the relevant possession
under paragraph (d)(1) of this section during any part of the taxable year.
(e) Closer connection test. An individual satisfies the requirements of this paragraph (e) for a taxable year if such individual did not have a closer connection to the
United States or a foreign country than to
the relevant possession. For purposes of
the preceding sentence—
(1) The principles of section
7701(b)(3)(B)(ii) and §301.7701(b)–2(d)
of this chapter shall apply; and
(2) Another possession shall not be considered a foreign country.
(f) Examples. The principles of this section are illustrated by the following examples:
Example 1. Presence test. H and W are U.S. citizens who live for part of the taxable year in a condominium, which they own, located in Possession P. H
and W also own a house in State N where they live
for 120 days a year to be near their grown children
and grandchildren. H and W are retired and their income consists solely of pension payments, dividends,
interest, and Social Security benefits. In 2005, H and
W are only present in Possession P for a total of 175
days because of a 70 day vacation to Europe and Asia.
Thus, in 2005, H and W are not present in Possession
P for at least 183 days, are present in the United States
for more than 90 days, and have a permanent connection to the United States by reason of their permanent home. However, under paragraph (c)(1)(iii) of
this section, H and W each still satisfy the presence
test in paragraph (c) of this section with respect to
Possession P because they have no earned income in
the United States and are physically present for more
days in Possession P than in the United States.
Example 2. Presence test. T, a U.S. citizen, is a
sales representative for a company based in Possession V. T lives with his wife and minor children in
their house in Possession V, where he is also registered to vote. T’s business travel requires T to spend
120 days in the United States and another 120 days
in foreign countries. When traveling on business,
T generally stays at hotels but sometimes stays with
his brother, who lives in State A. Under paragraphs
(c)(1)(iv) and (c)(4) of this section, T satisfies the
presence test in paragraph (c) of this section because
he has no permanent connection to the United States.
Example 3. Alien resident of possession— presence test. F is a citizen of Country G. F’s tax home
is in Possession C and F has no closer connection to
the United States or a foreign country than to Possession C. F is physically present in Possession C for 123
days and in the United States for 110 days every year.
Accordingly, F is a nonresident alien with respect to
the United States under section 7701(b), and a bona
fide resident of Possession C under paragraphs (b),
(c)(2), (d), and (e) of this section.
Example 4. Seafarers— tax home. S, a U.S. citizen, is employed by a fishery and spends 250 days
at sea on a fishing vessel. When not at sea, S resides
with his wife at a house they own in Possession G.
The fishing vessel upon which S works departs and
arrives at various ports in Possession G, other posses-

2005–20 I.R.B.

sions, and foreign countries, but is in international or
local waters (within the meaning of paragraph (d)(2)
of this section) for 225 days. Under paragraph (d)(2)
of this section, S will not be considered to have a tax
home outside Possession G for purposes of section
937 and this section solely by reason of S’s employment on board the fishing vessel.
Example 5. Seasonal workers— tax home and
closer connection. P, a U.S. citizen, is a permanent
employee of a hotel in Possession I, but works only
during the tourist season. For the remainder of each
year, P lives with her husband and children in Possession Q, where she has no outside employment. Most
of P’s personal belongings, including her automobile,
are located in Possession Q. P is registered to vote in,
and has a driver’s license issued by, Possession Q. P
does her personal banking in Possession Q and P routinely lists her address in Possession Q on forms and
documents. P satisfies the presence test of paragraph
(c) of this section with respect to both Possession Q
and Possession I, because, among other reasons, under paragraph (c)(1)(ii) of this section she does not
spend more than 90 days in the United States during the taxable year. P satisfies the tax home test of
paragraph (d) of this section only with respect to Possession I, because her regular place of business is in
Possession I. P satisfies the closer connection test of
paragraph (e) of this section with respect to both Possession Q and Possession I, because she does not have
a closer connection to the United States or to any foreign country (and for this purpose, under paragraph
(e)(2) of this section, Possession Q is not treated as a
foreign country with respect to Possession I). Therefore, P is a bona fide resident of Possession I for purposes of the Internal Revenue Code.
Example 6. Closer connection to United States
than to possession. Z, a U.S. citizen, relocates to
Possession V in 2003 to start an investment consulting and venture capital business. Z’s wife and two
teen-aged children remain in State C to allow the children to complete high school. Z travels back to the
United States regularly to see his wife and children,
to engage in business activities, and to take vacations.
He has an apartment available for his full-time use in
Possession V, but he remains a joint-owner of the residence in State C where his wife and children reside.
Z and his family have automobiles and personal belongings such as furniture, clothing, and jewelry located at both residences. Although Z is a member of
the Possession V Chamber of Commerce, Z also belongs to and has current relationships with social, political, cultural, and religious organizations in State C.
Z receives mail in State C, including brokerage statements, credit card bills, and bank advices. Z is not a
bona fide resident of Possession V because he has a
closer connection to the United States than to Possession V and therefore fails to satisfy the requirements
of paragraphs (b)(1) and (e) of this section.

(g) Information reporting requirement.
The following individuals are required to
file notice of their new tax status in such
time and manner as the Commissioner may
prescribe by notice, form, instructions, or
other publication (see §601.601(d)(2) of
this chapter):
(1) Individuals who take the position for
U.S. tax reporting purposes that they qual-

2005–20 I.R.B.

ify as bona fide residents of a possession
for a tax year subsequent to a tax year for
which they were required to file Federal income tax returns as citizens or residents of
the United States who did not so qualify.
(2) Citizens and residents of the United
States who take the position for U.S. tax
reporting purposes that they do not qualify
as bona fide residents of a possession for a
tax year subsequent to a tax year for which
they were required to file income tax returns (with the Internal Revenue Service,
the tax authorities of a possession, or both)
as individuals who did so qualify.
(3) Bona fide residents of Puerto Rico
or a section 931 possession (as defined
in §1.931–1T(c)(1)) who take a position
for U.S. tax reporting purposes that they
qualify as bona fide residents of such
possession for a tax year subsequent to a
tax year for which they were required to
file income tax returns as bona fide residents of the United States Virgin Islands
or a section 935 possession (as defined in
§1.935–1T(a)(3)(i)).
(h) Effective date. Except as provided
in this paragraph (h), this section shall apply to taxable years ending after October
22, 2004. Paragraph (g) of this section also
applies to the 3 taxable years preceding the
first taxable year ending after October 22,
2004.
Par. 30. Section 1.937–2T is added to
read as follows:
§1.937–2T Income from sources within a
possession (temporary).
(a) Scope. Section 937(b) and this section set forth the rules for determining
whether income is considered to be from
sources within a particular possession (the
relevant possession) for purposes of the
Internal Revenue Code, including section
957(c) and Subpart D, Part III, Subchapter N, Chapter 1 of the Internal Revenue
Code, as well as section 7654(a) of the
1954 Internal Revenue Code (until the
effective date of its repeal). Paragraphs
(c)(1)(ii) and (c)(2) of this section do not
apply, however, for purposes of sections
932(a) and (b) and 935(a)(3) (as in effect
before the effective date of its repeal).
In the case of a possession or territory
that administers income tax laws that are
identical (except for the substitution of the
name of the possession or territory for the
term United States where appropriate) to

1041

those in force in the United States, these
rules do not apply for purposes of the application of such laws. These rules also
do not affect the determination of whether
income is considered to be from sources
without the United States for purposes of
the Internal Revenue Code.
(b) In general. Except as provided in
paragraphs (c) through (i) of this section,
the principles of sections 861 through 865
and the regulations thereunder (relating to
the determination of the gross and the taxable income from sources within and without the United States) generally shall be
applied in determining the gross and the
taxable income from sources within and
without the relevant possession. In the application of such principles, the name of
the relevant possession shall be used instead of the term United States, the term
bona fide resident of followed by the name
of the relevant possession shall be used instead of the term United States resident,
and the term domestic shall be construed
to mean created or organized in such possession.
(c) U.S. income— (1) In general. Except as provided in paragraph (d) of this
section, income from sources within the
relevant possession shall not include any
item of income determined under the rules
of sections 861 through 865 and the regulations thereunder to be—
(i) From sources within the United
States; or
(ii) Effectively connected with the conduct of a trade or business within the
United States.
(2) Conduit arrangements. Income
shall be considered to be from sources
within the United States for purposes of
paragraph (c)(1) of this section if, pursuant
to a plan or arrangement—
(i) The income is received in exchange
for consideration provided to another person; and
(ii) Such person (or another person)
provides the same consideration (or consideration of a like kind) to a third person
in exchange for one or more payments
constituting income from sources within
the United States.
(d) Income from certain sales of inventory property. For special rules that
apply to determine the source of income
from certain sales of inventory property,
see §1.863–3(f).

May 16, 2005

(e) Income from services— (1) No de
minimis rule. In applying the principles of
section 861 and the regulations thereunder
pursuant to paragraph (b) of this section,
the exception in section 861(a)(3) shall not
apply.
(2) Service in the Armed Forces. In the
case of a member of the Armed Forces of
the United States, the following rules shall
apply for determining the source of compensation for services performed in compliance with military orders:
(i) If the individual is a bona fide resident of a possession and such services are
performed in the United States or in another possession, the compensation constitutes income from sources within the possession of which the individual is a bona
fide resident (and not from sources within
the United States or such other possession).
(ii) If the individual is not a bona fide
resident of a possession and such services
are performed in a possession, the compensation constitutes income from sources
within the United States (and not from
sources within such possession).
(f) Gains from certain dispositions of
property— (1) Property of former U.S.
residents. (i) Income from sources within
the relevant possession shall not include
gains from the disposition of property
described in paragraph (f)(1)(ii) of this
section by an individual described in paragraph (f)(1)(iii) of this section. See also
section 1277(e) of Public Law 99–514
(100 Stat. 2985) (providing that gains
from the disposition of certain property
by individuals who acquired residency in
certain possessions shall be considered to
be from sources within the United States).
(ii) Property is described in this paragraph (f)(1)(ii) when the following conditions are satisfied—
(A) The property is of a kind described
in section 731(c)(3)(C)(i) or 954(c)(1)(B);
and
(B) The property was owned by the individual before such individual became a
bona fide resident of the relevant possession.
(iii) An individual is described in this
paragraph (f)(1)(iii) when the following
conditions are satisfied—
(A) For the taxable year for which the
source of the gain must be determined, the
individual is a bona fide resident of the
relevant possession; and

May 16, 2005

(B) For any of the 10 years preceding
such year, the individual was a citizen or
resident of the United States (other than a
bona fide resident of the relevant possession).
(iv) If an individual described in paragraph (f)(1)(iii) of this section exchanges
property described in paragraph (f)(1)(ii)
of this section for other property in a transaction in which gain or loss is not required
to be recognized (in whole or in part) under U.S. income tax principles, such other
property shall also be considered property described in paragraph (f)(1)(ii) of this
section.
(v) If an individual described in paragraph (f)(1)(iii) of this section owns, directly or indirectly, at least 10 percent (by
value) of any entity to which property described in paragraph (f)(1)(ii) of this section is transferred in a transaction in which
gain or loss is not required to be recognized
(in whole or in part) under U.S. income
tax principles, any gain recognized upon
a disposition of the property by such entity shall be treated as income from sources
outside the relevant possession if any gain
recognized upon a direct or indirect disposition of the individual’s interest in such
entity would have been so treated under
paragraph (f)(1)(iv) of this section.
(2) Special rules under section 865 for
possessions— (i) Except as provided in
paragraph (f)(1) of this section—
(A) Gain that is considered to be derived from sources outside of the United
States under section 865(g)(3) shall be
considered income from sources within
Puerto Rico; and
(B) Gain that is considered to be derived from sources outside of the United
States under section 865(h)(2)(B) shall be
considered income from sources within the
possession in which the liquidating corporation is created or organized.
(ii) In applying the principles of section 865 and the regulations thereunder
pursuant to paragraph (b) of this section,
the rules of section 865(g) shall not apply,
but the special rule of section 865(h)(2)(B)
shall apply with respect to gain recognized
upon the liquidation of corporations created or organized in the United States.
(g) Dividends— (1) Dividends from
certain possessions corporations— (i) In
general. Except as provided in paragraph
(g)(1)(ii) of this section, with respect to
any possessions shareholder, only the

1042

possessions source ratio of any dividend
paid or accrued by a corporation created
or organized in a possession (possessions
corporation) shall be treated as income
from sources within such possession. For
purposes of this paragraph (g)—
(A) The possessions source ratio shall
be a fraction, the numerator of which
equals the gross income of the possessions
corporation from sources within the possession in which it is created or organized
(applying the rules of this section) for the
testing period, and the denominator of
which equals the total gross income of the
corporation for the testing period; and
(B) The term possessions shareholder
means any individual who is a bona fide
resident of the possession in which the corporation is created or organized and who
owns, directly or indirectly, at least 10 percent of the total voting stock of the corporation.
(ii) Dividends from corporations engaged in the active conduct of a trade or
business in the relevant possession. The
entire amount of any dividend paid or accrued by a possessions corporation shall
be treated as income from sources within
the possession in which it is created or
organized when the following conditions
are met—
(A) 80 percent or more of the gross income of the corporation for the testing period was derived from sources within such
possession (applying the rules of this section) or was effectively connected with the
conduct of a trade or business in such possession (applying the rules of §1.937–3T);
and
(B) 50 percent or more of the gross income of the corporation for the testing period was derived from the active conduct
of a trade or business within such possession.
(iii) Testing period. For purposes of this
paragraph (g)(1), the term testing period
means the 3-year period ending with the
close of the taxable year of the payment
of the dividend (or for such part of such
period as the corporation has been in existence).
(iv) Subsidiary look-through rule. For
purposes of this paragraph (g)(1), if a possessions corporation owns (directly or indirectly) at least 25 percent (by value) of
the stock of another corporation, such possessions corporation shall be treated as if
it—

2005–20 I.R.B.

(A) Directly received its proportionate
share of the income of such other corporation; and
(B) Actively conducted any trade or
business actively conducted by such other
corporation.
(2) Dividends from other corporations.
In applying the principles of section 861
and the regulations thereunder pursuant to
paragraph (b) of this section, the special
rules relating to dividends for which deductions are allowable under section 243
or 245 shall not apply.
(h) Income inclusions. For purposes of
determining whether an amount described
in section 904(h)(1)(A) constitutes income
from sources within the relevant possession—
(1) If the individual owns (directly or
indirectly) at least 10 percent of the total voting stock of the corporation from
which such amount is derived, the principles of section 904(h)(2) shall apply. In the
case of an individual who is not a possessions shareholder (as defined in paragraph
(g)(1)(i)(B) of this section), the preceding
sentence shall apply only if the corporation qualifies as a United States-owned foreign corporation for purposes of section
904(h); and
(2) In all other cases, the amount shall
be considered income from sources in the
jurisdiction in which the corporation is created or organized.
(i) Interest— (1) Interest from certain
possessions corporations— (i) In general.
Except as provided in paragraph (i)(1)(ii)
of this section, with respect to any possessions shareholder (as defined in paragraph (g)(1)(i)(B) of this section), interest paid or accrued by a possessions corporation shall be treated as income from
sources within the possession in which it

is created or organized to the extent that
such interest is allocable to assets that generate, have generated, or could reasonably
have been expected to generate income
from sources within such possession (under the rules of this section) or income effectively connected with the conduct of a
trade or business within such possession
(under the rules of §1.937–3T). For purposes of the preceding sentence, the principles of §§1.861–9 through 1.861–12 shall
apply.
(ii) Interest from corporations engaged
in the active conduct of a trade or business in the relevant possession. The entire
amount of any interest paid or accrued by a
possessions corporation shall be treated as
income from sources within the possession
in which it is created or organized when
the conditions of paragraphs (g)(1)(ii)(A)
and (B) of this section are met (applying
the rules of paragraphs (g)(1)(iii) and (iv)
of this section).
(2) Interest from partnerships. Interest paid or accrued by a partnership shall
be treated as income from sources within
a possession only to the extent that such
interest is allocable to income effectively
connected with the conduct of a trade or
business in such possession. For purposes
of the preceding sentence, the principles of
§1.882–5 shall apply (as if the partnership
were a foreign corporation and as if the
trade or business in the possession were a
trade or business in the United States).
(j) Indirect ownership. For purposes of
this section, the rules of section 318(a)(2)
shall apply except that the language “5 percent” shall be used instead of “50 percent”
in section 318(a)(2)(C).
(k) Examples. The provisions of this
section may be illustrated by the following
examples:

Possession I Sources
2004

Example 1. X, a U.S. citizen, resides in State N
and acquires the stock of Corporation C, a domestic corporation, in 2000. X moves to the Northern
Mariana Islands (NMI) in 2003. In 2004, while a
bona fide resident of the NMI, X recognizes gain on
the sale of the Corporation C stock. Pursuant to section 1277(e) of the Tax Reform Act of 1986, Public
Law 99–514 (100 Stat. 2085) (October 22, 1986),
this gain is treated as income from sources within the
United States for all purposes of the Internal Revenue
Code (including section 7654, as in effect with respect to the NMI), and not as income from sources
in the NMI.
Example 2. X, a U.S. citizen, resides in State F
and acquires a 5 percent interest in Partnership P in
2003. X moves to the U.S. Virgin Islands (USVI)
in 2004. In 2006, while a bona fide resident of the
USVI, X recognizes gain on the sale of the interest
in Partnership P. Pursuant to paragraph (f)(1) of this
section, the gain shall not be treated as income from
sources within the USVI for purposes of the Internal
Revenue Code (for example, for purposes of section
934(b)).
Example 3. X, a bona fide resident of Possession I, a section 931 possession (as defined in
§1.931–1T(c)(1)), is engaged in a trade or business
in the United States through an office in State H.
In 2005, this office materially participates in the
sale of inventory property in Possession I, such that
the income from these inventory sales is considered
effectively connected to this trade or business in the
United States under section 864(c)(4)(B)(iii). This
income shall not be treated as income from sources
within Possession I for purposes of section 931(a)(1)
pursuant to paragraph (c)(1)(ii) of this section, but
nonetheless shall continue to be treated as income
from sources without the United States under section
862 (for example, for purposes of section 904).
Example 4. (i) X, a bona fide resident of Possession I, owns 25 percent of the outstanding shares of
A Corp, a corporation organized under the laws of
Possession I. In 2006, X receives a dividend of $70x
from A Corp. During 2004 through 2006, A Corp has
gross income from the following sources:

Sources Outside Possession I

2005

$10x
20x

$20x
10x

2006

25x

15x

(ii) A Corp owns 50 percent of the outstanding
shares of B Corp, a corporation organized under the

laws of Country FC. During 2004 through 2006, B
Corp has gross income from the following sources:

Possession I Sources
2004

Sources Outside Possession I

2005

$10x
14x

$6x
8x

2006

10x

4x

2005–20 I.R.B.

1043

May 16, 2005

(iii) A Corp is treated as having received 50 percent of the gross income of B Corp. Therefore, for

2004 through 2006, the gross income of A Corp is
from the following sources:

Possession I Sources
2004
2005

Sources Outside Possession I

$15x
27x

$23x
14x

2006

30x

17x

Totals

$72x

$54x

(iv) Pursuant to paragraph (g) of this section, the
portion of the dividend of $70x that X receives from
Corp A in 2006 that is treated as income from sources
within Possession I is 72/126 of $70x, or $40x.
Example 5. X is a U.S. citizen and a bona fide
resident of the Northern Mariana Islands (NMI).
In 2005, X receives compensation for services performed as a member of the crew of a fishing boat.
Ten percent of the services for which X receives compensation are performed in the NMI, and 90 percent
of X’s services are performed in international waters.
X is a “United States person” as defined in section
7701(a)(30)(A). Accordingly, pursuant to section
863(d)(1)(A), the compensation that X receives for
services performed in international waters is treated
as income from sources within the United States for
purposes of the Internal Revenue Code (including
section 7654, as in effect with respect to the NMI).
Under the principles of section 861(a)(3) as applied
pursuant to paragraph (b) of this section, the compensation that X receives for services performed in
the NMI is treated as income from sources within the
NMI.

(l) Effective date. Except as otherwise
provided in this paragraph (l), this section applies to income earned in tax years
ending after October 22, 2004. Paragraph
(c)(1) of this section applies to income
earned after December 31, 2004. Paragraph (f) of this section applies to dispositions after April 11, 2005. Paragraphs
(c)(2), (g)(1), (h), and (i) of this section apply to amounts paid or accrued after April
11, 2005.
Par. 31. Section 1.937–3T is added to
read as follows:
§1.937–3T Income effectively connected
with the conduct of a trade or business in
a possession (temporary).
(a) Scope. Section 937(b) and this section set forth the rules for determining
whether income is effectively connected
with the conduct of a trade or business
within a particular possession (the relevant possession) for purposes of the
Internal Revenue Code, including sections
881(b) and 957(c) and Subpart D, Part III,
Subchapter N, Chapter 1 of the Internal
Revenue Code. Paragraph (c) of this section does not apply, however, for purposes

May 16, 2005

of section 881(b). In the case of a possession or territory that administers income
tax laws that are identical (except for the
substitution of the name of the possession or territory for the term United States
where appropriate) to those in force in the
United States, these rules do not apply for
purposes of the application of such laws.
(b) In general. Except as provided in
paragraphs (c) and (d) of this section, the
principles of section 864(c) and the regulations thereunder (relating to the determination of income, gain or loss which
is effectively connected with the conduct
of a trade or business within the United
States) shall generally be applied in determining whether income is effectively connected with the conduct of a trade or business within the relevant possession (except for the substitution of the name of
the relevant possession for the term United
States where appropriate), without regard
to whether the taxpayer qualifies as a nonresident alien individual or a foreign corporation with respect to such possession.
For purposes of the preceding sentence,
all income other than income from sources
within the relevant possession (as determined under the rules of §1.937–2T) shall
be considered income from sources without the relevant possession, and subject to
the rules of this section, the principles of
section 864(c)(4) shall apply for purposes
of determining whether such income constitutes income effectively connected with
the conduct of a trade or business in the relevant possession.
(c) U.S. income— (1) In general. Except as provided in paragraph (d) of this
section, income considered to be effectively connected with the conduct of a
trade or business within the relevant possession shall not include any item of
income determined under the rules of sections 861 through 865 and the regulations
thereunder to be—
(i) From sources within the United
States; or

1044

(ii) Effectively connected with the conduct of a trade or business within the
United States.
(2) Conduit arrangements. Income
shall be considered to be from sources
within the United States for purposes of
paragraph (c)(1) of this section if, pursuant
to a plan or arrangement—
(i) The income is received in exchange
for consideration provided to another person; and
(ii) Such person (or another person)
provides the same consideration (or consideration of a like kind) to a third person
in exchange for one or more payments
constituting income from sources within
the United States.
(d) Income from certain sales of inventory property. Paragraph (c) of this section
shall not apply to income from sales of inventory property described in §1.863–3(f).
(e) Examples. The provisions of this
section may be illustrated by the following
examples:
Example 1. X is a bona fide resident of Possession I, a section 931 possession (as defined in
§1.931–1T(c)(1)). X has an office in Possession
I from which X conducts a business consisting of
the development and sale of specialized computer
software. A purchaser of software will frequently
pay X an additional amount to install the software
on the purchaser’s operating system and to ensure
that the software is functioning properly. X performs
the installation services at the purchaser’s place of
business which may be in Possession I, in the United
States, or in another country. The provision of such
services is not de minimis and constitutes a separate
transaction under the rules of §1.861–18. Under the
principles of section 864(c)(4) as applied pursuant to
paragraph (b) of this section, the compensation that
X receives for personal services performed outside
of Possession I is not considered to be effectively
connected with the conduct of a trade or business in
Possession I for purposes of section 931(a)(2).
Example 2. (i) F Bank is organized under the
laws of Country FC and operates an active banking business from offices in the U.S. Virgin Islands
(USVI). In connection with this banking business, F
Bank makes loans to and receives interest payments
from borrowers who reside in the USVI, in the United
States, and in Country FC.
(ii) Under the principles of section 861(a)(1) as
applied pursuant to §1.937–2T(b), interest payments

2005–20 I.R.B.

received by F Bank from borrowers who reside in
the United States or in Country FC constitute income
from sources outside of the USVI. Under the principles of section 864(c)(4) as applied pursuant to paragraph (b) of this section, interest income from sources
outside of the USVI generally may constitute income
that is effectively connected with the conduct of a
trade or business within the USVI for purposes of the
Internal Revenue Code. However, interest payments
received by F Bank from borrowers who reside in the
United States constitute income from sources within
the United States under section 861(a)(1). Accordingly, under paragraph (c)(1) of this section, such interest income shall not be treated as effectively connected with the conduct of a trade or business in the
USVI for purposes of the Internal Revenue Code (for
example, for purposes of section 934(b)). Interest
payments received by F Bank from borrowers who reside in Country FC, however, may be treated as effectively connected with the conduct of a trade or business in the USVI for purposes of the Internal Revenue
Code (including section 934(b)).
(iii) To the extent that, as described in section
934(a), the USVI administers income tax laws that
are identical (except for the substitution of the name
of the USVI for the term United States where appropriate) to those in force in the United States, interest
payments received by F Bank from borrowers who
reside in the United States or in Country FC may be
treated as income that is effectively connected with
the conduct of a trade or business in the USVI for
purposes of F Bank’s income tax liability to the USVI
under mirrored section 882.
Example 3. (i) G is a partnership that is organized
under the laws of, and that operates an active financing business from offices in, Possession I. Interests in
G are owned by D, a bona fide resident of Possession
I, and N, an alien individual who resides in Country
FC. Pursuant to a pre-arrangement, G loans $x to T, a
business entity organized under the laws of Country
FC, and T in turn loans $y to E, a U.S. resident. In
accordance with the arrangement, E pays interest to
T, which in turn pays interest to G.
(ii) The arrangement constitutes a conduit arrangement under paragraph (c)(2) of this section,
and the interest payments received by G are treated
as income from sources within the United States
for purposes of paragraph (c)(1) of this section.
Accordingly, the interest received by G shall not be
treated as effectively connected with the conduct
of a trade or business in Possession I for purposes
of the Internal Revenue Code (including sections
931(a)(2) and 934(b), if applicable with respect to
D). Whether such interest constitutes income from
sources within the United States for other purposes
of the Internal Revenue Code under generally applicable conduit principles will depend on the facts and
circumstances. See, for example, Aiken Indus., Inc.
v. Commissioner, 56 T.C. 925 (1971).
(iii) If Possession I administers income tax laws
that are identical (except for the substitution of the
name of the possession for the term United States
where appropriate) to those in force in the United
States, the interest received by G may be treated as
income effectively connected with the conduct of a
trade or business in Possession I under mirrored section 864(c)(4) for purposes of determining the Possession I territorial income tax liability of N under
mirrored section 871.

2005–20 I.R.B.

(f) Effective date. Except as otherwise
provided in this paragraph (f), this section applies to income earned in taxable
years ending after October 22, 2004. Paragraph (c)(1) of this section applies to income earned after December 31, 2004.
Paragraph (c)(2) of this section applies to
amounts paid or accrued after April 11,
2005.
Par. 32. Section 1.957–3 is revised to
read as follows:
§1.957–3 United States person defined.
[Reserved]. For further guidance, see
§1.957–3T.
Par. 33. Section 1.957–3T is added to
read as follows:
§1.957–3T United States person defined
(temporary).
(a) Basic rule— (1) In general. The
term United States person has the same
meaning for purposes of sections 951
through 965 which it has under section
7701(a)(30) and the regulations thereunder, except as provided in paragraphs
(b) and (c) of this section which provide,
with respect to corporations organized
in possessions of the United States, that
certain residents of such possessions are
not United States persons. The effect of
determining that an individual is not a
United States person for such purposes is
to exclude such individual in determining
whether a foreign corporation created or
organized in, or under the laws of, a possession of the United States is a controlled
foreign corporation. See §1.957–1 for the
definition of the term controlled foreign
corporation.
(2) Special provisions applicable to
possessions of the United States. For purposes of this section—
(i) The term possession of the United
States means the Commonwealth of Puerto
Rico (Puerto Rico) or any section 931 possession.
(ii) The term section 931 possession
has the same meaning which it has under
§1.931–1T(c)(1).
(iii) The rules of §1.937–1T shall apply
for determining whether an individual is a
bona fide resident of a possession of the
United States.
(iv) The rules of §1.937–2T shall apply
for determining whether income is from

1045

sources within a possession of the United
States.
(v) The rules of §1.937–3T shall apply for determining whether income is effectively connected with the conduct of a
trade or business in a possession of the
United States.
(b) Puerto Rico corporation and resident. An individual (who, without regard
to this paragraph (b), is a United States
person) shall not be considered a United
States person with respect to a foreign corporation created or organized in, or under
the laws of, Puerto Rico for the taxable
year of such corporation which ends with
or within the taxable year of such individual if—
(1) Such individual is a bona fide resident of Puerto Rico during his entire taxable year in which or with which the taxable year of such foreign corporation ends;
and
(2) A dividend received by such individual from such corporation during the
taxable year of such corporation would,
for purposes of section 933(1), be treated
as income derived from sources within
Puerto Rico.
(c) Section 931 possession corporation
and resident. An individual (who, without regard to this paragraph (c), is a United
States person) shall not be considered a
United States person with respect to a foreign corporation created or organized in,
or under the laws of, a section 931 possession for the taxable year of such corporation which ends with or within the taxable
year of such individual if—
(1) Such individual is a bona fide resident of such section 931 possession during his entire taxable year in which or with
which the taxable year of such foreign corporation ends; and
(2) Such corporation satisfies the following conditions—
(i) 80 percent or more of its gross income for the 3-year period ending at the
close of the taxable year (or for such part
of such period as such corporation or any
predecessor has been in existence) was derived from sources within section 931 possessions or was effectively connected with
the conduct of a trade or business in section 931 possessions; and
(ii) 50 percent or more of its gross income for such period (or part) was derived
from the active conduct of a trade or business within section 931 possessions.

May 16, 2005

(d) Effective date. This section shall apply for taxable years ending after October
22, 2004.

§1.1402(a)–12T Continental shelf and
certain possessions of the United States
(temporary).

§1.957–4 [Removed]

(a) Certain possessions. For purposes
of the tax on self-employment income, the
exclusion from gross income provided by
section 931 (relating to bona fide residents
of certain possessions of the United States)
shall not apply. Net earnings from self-employment are subject to the tax on self-employment income even if such amounts are
excluded from gross income under section
931.
(b) Continental shelf. For the definition of the term United States and for
other geographical definitions relating to
the continental shelf, see section 638 and
§1.638–1.
(c) Effective date. This section shall apply for taxable years ending after October
22, 2004.
Par. 38. In §1.6038–2, paragraph (d) is
revised to read as follows:

Par. 34. Section 1.957–4 is removed.
Par. 35. In §1.1402(a)–11, paragraph
(b) is revised to read as follows:
§1.1402(a)–11 Ministers and members of
religious orders.
*****
(b) In employ of American employer. If
a minister or member of a religious order
engaged in a trade or business described in
section 1402(c) and §1.1402(c)–5 is a citizen of the United States and performs service, in his capacity as a minister or member of a religious order, as an employee
of an American employer, as defined in
section 3121(h) and the regulations thereunder in Part 31 of this chapter (Employment Tax Regulations), his net earnings
from self-employment derived from such
service shall be computed as provided in
paragraph (a) of this section but without regard to the exclusions from gross income
provided in section 911, relating to earned
income from sources without the United
States, and section 931, relating to income
from sources within certain possessions
of the United States. Thus, even though
all the income of the minister or member
for service of the character to which this
paragraph is applicable was derived from
sources without the United States, or from
sources within certain possessions of the
United States, and therefore may be excluded from gross income, such income is
included in computing net earnings from
self-employment.
*****
Par. 36. Section 1.1402(a)–12 is revised to read as follows:
§1.1402(a)–12 Continental shelf and
certain possessions of the United States.
[Reserved]. For further guidance, see
§1.1402(a)–12T.
Par. 37. Section 1.1402(a)–12T is
added to read as follows:

May 16, 2005

§1.6038–2 Information returns required
of United States persons with respect to
annual accounting periods of certain
foreign corporations.
*****
(d) [Reserved]. For further guidance,
see §1.6038–2T(d).
Par. 39. Section 1.6038–2T is added to
read as follows:
§1.6038–2T Information returns required
of United States persons with respect to
annual accounting periods of certain
foreign corporations (temporary).
(a) through (c) [Reserved]. For further
guidance, see §1.6038–2(a) through (c).
(d) U.S. person— (1) In general. For
purposes of section 6038 and this section, the term United States person has
the meaning assigned to it by section
7701(a)(30), except as provided in paragraphs (d)(2) and (3) of this section.
(2) Special rule for individuals residing in certain possessions. With respect
to individuals who are bona fide residents
of Puerto Rico or any section 931 possession, as defined in §1.931–1T(c)(1), the
term United States person has the meaning
assigned to it by §1.957–3T.
(3) Special rule for certain nonresident
aliens. An individual for whom an election under section 6013(g) or (h) is in effect

1046

shall, subject to the exceptions contained
in paragraph (d)(2) of this section, be considered a United States person for purposes
of section 6038 and this section.
(e) through (l)(2) [Reserved]. For further guidance, see §1.6038–2(e) through
(l)(2).
(m) Effective date. This section shall
apply for taxable years ending after October 22, 2004.
Par. 40. Section 1.6046–1 is amended
as follows:
1. Revise the heading.
2. Revise paragraph (f)(3).
3. Remove the undesignated paragraph
that follows paragraph (f)(3)(iii).
The revisions are as follows:
§1.6046–1 Returns as to organization or
reorganization of foreign corporations
and as to acquisitions of their stock.
*****
(f)(3) [Reserved]. For further guidance,
see §1.6046–1T(f)(3).
*****
Par. 41. Section 1.6046–1T is added to
read as follows:
§1.6046–1T Returns as to organization
or reorganization of foreign corporations
and as to acquisitions of their stock
(temporary).
(a) through (f)(2) [Reserved]. For further guidance, see §1.6046–1(a) through
(f)(2).
(f)(3) U.S. person— (i) In general.
For purposes of section 6046 and this
section, the term United States person
has the meaning assigned to it by section
7701(a)(30), except as provided in paragraphs (f)(3)(ii) and (iii) of this section.
(ii) Special rule for individuals residing in certain possessions. With respect
to individuals who are bona fide residents
of Puerto Rico or any section 931 possession, as defined in §1.931–1T(c)(1), the
term United States person has the meaning
assigned to it by §1.957–3T.
(iii) Special rule for certain nonresident
aliens. An individual for whom an election under section 6013(g) or (h) is in effect
shall, subject to the exceptions contained
in paragraph (f)(3)(ii) of this section, be
considered a United States person for purposes of section 6046 and this section.

2005–20 I.R.B.

(f)(4) through (k) [Reserved]. For
further guidance, see §1.6046–1(f)(4)
through (k).
(l) Effective date. This section shall apply for taxable years ending after October
22, 2004.
PART 301 — PROCEDURE AND
ADMINISTRATION
Par. 42. The authority citation for part
301 continues to read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 43. Section 301.6688–1 is revised
to read as follows:
§301.6688–1 Assessable penalties with
respect to information required to be
furnished with respect to possessions.
[Reserved]. For further guidance, see
§301.6688–1T.
Par. 44. Section 301.6688–1T is added
to read as follows:
§301.6688–1T Assessable penalties with
respect to information required to be
furnished with respect to possessions
(temporary).
(a) In general. Each individual who
is subject to an information reporting requirement promulgated under the authority of section 937(c) or 7654 and who fails
to fully satisfy such requirement within
the time prescribed for reporting such information shall, in addition to any criminal penalty provided by law, pay a penalty
of $1000 for each such failure. Information reporting requirements promulgated
under the authority of sections 937(c) and
7654(e) include the following:
(1) The requirement to file Form 8689,
“Allocation of Individual Income Tax to the
Virgin Islands,” under §1.932–1T(b)(1) of
this chapter, for certain individuals with
income from sources within the United
States Virgin Islands.
(2) [Reserved].
(3) [Reserved].
(4) The requirement for individuals to
report that they became or ceased to be a
bona fide resident of a possession under
§1.937–1T(g) of this chapter.
(b) Manner of payment. The penalty set
forth in paragraph (a) of this section shall
be paid in the same manner as tax upon the
issuance of a notice and demand therefor.

2005–20 I.R.B.

(c) Reasonable cause— (1) In general.
The penalty set forth in paragraph (a) of
this section shall not apply if it is established to the satisfaction of the appropriate tax authority (as defined in paragraph
(c)(2) of this section) that the failure to file
the information return or furnish the information within the prescribed time was
due to reasonable cause and not to willful neglect. An individual who wishes to
avoid the penalty must make an affirmative showing of all facts alleged as a reasonable cause for failure to file the information return on time, or furnish the information on time, in the form of a written
statement containing a declaration that it
is made under penalties of perjury. Such
statement must be filed with the appropriate tax authority. In determining whether
there was reasonable cause for failure to
furnish the required information, account
will be taken of the fact that the individual
was unable to furnish the required information in spite of the exercise of ordinary
business care and prudence in his effort to
furnish the information. An individual will
be considered to have exercised ordinary
business care and prudence in his effort to
furnish the required information if he made
reasonable efforts to furnish the information but was unable to do so because of a
lack of sufficient facts on which to make a
proper determination.
(2) Appropriate tax authority. For purposes of this section, the appropriate tax
authority is the person responsible for tax
administration in the jurisdiction to which
the information is required to be provided.
Thus, in the case of information required
under section 937(c) or under section 7654
to be provided to the Internal Revenue Service, the appropriate tax authority is the
Commissioner. In the case of information
required under section 7654 (as in effect
with respect to section 935 possessions (as
defined in §1.935–1T(a)(3)(i) of this chapter)) to be provided to the tax authorities
of a section 935 possession, the appropriate tax authority is the person responsible
for tax administration in such possession
or his delegate. See §1.935–1(b) of this
chapter for the rules that specify where returns of income tax must be filed for the
taxable year by individuals to whom section 935 applies.
(d) Effective date. This section shall apply for taxable years ending after October
22, 2004.

1047

Par. 45. In §301.7701(b)–1, paragraph
(d) is revised to read as follows:
§301.7701(b)–1 Resident alien.
*****
(d) [Reserved]. For further guidance,
see §301.7701(b)–1T(d).
*****
Par. 46. Section 301.7701(b)–1T is
added to read as follows:
§301.7701(b)–1T Resident alien
(temporary).
(a) through (c) [Reserved]. For further
guidance, see §301.7701(b)–1(a) through
(c).
(d) Application of section 7701(b) to the
possessions and territories— (1) Application to aliens for purposes of mirror systems. Section 7701(b) provides the basis for determining whether an alien individual is a resident of a United States
possession or territory that administers income tax laws that are identical (except for
the substitution of the name of the possession or territory for the term United States
where appropriate) to those in force in the
United States, for purposes of applying
such laws with respect to income tax liability incurred to such possession or territory.
(2) Non-application for bona fide resident determination.
Section 7701(b)
does not provide the basis for determining
whether an individual (including an alien
individual) is a bona fide resident of a
United States possession or territory for
U.S. Federal income tax purposes. For
the applicable rules for making this determination, see section 937(a) and the
regulations thereunder.
(e) [Reserved]. For further guidance,
see §301.7701(b)–1(e).
(f) Effective date. This section shall apply for taxable years ending after October
22, 2004.
PART 602 — OMB CONTROL
NUMBERS UNDER THE PAPERWORK
REDUCTION ACT
Par. 47. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 48. In §602.101, paragraph (b) is
amended by adding an entry in numerical
order to the table to read as follows:

May 16, 2005

§602.101 OMB Control numbers.
*****
(b) * * *
CFR part or section where
identified and described

Current OMB
control No.

*****
1.937–1T

...........................................................

1545–1930

*****
Linda M. Kroening,
Acting Deputy Commissioner for
Services and Enforcement.

(Filed by the Office of the Federal Register on April 6, 2005,
11:05 a.m., and published in the issue of the Federal Register
for April 11, 2005, 70 F.R. 18919)

Approved March 25, 2005.

26 CFR 1.1014–1: Basis of property acquired from a
decedent.

Eric Solomon,
Acting Deputy Assistant Secretary
of the Treasury.

May 16, 2005

Section 1014.—Basis of
Property Acquired From
a Decedent

How a death benefit received by the beneficiary
of a deferred annuity contract after the death of the
owner-annuitant will be treated under section 1014.
See Rev. Rul. 2005-30, page 1015.

1048

2005–20 I.R.B.