Td 9391

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 937.—Residence
and Source Rules Involving
Possessions
26 CFR 1.937–1: Bona fide residency in a possession.

T.D. 9391
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 301
Source Rules Involving U.S.
Possessions and Other
Conforming Changes
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.
SUMMARY: This document contains final regulations that provide rules under
section 937(b) of the Internal Revenue
Code (Code) for determining whether income is derived from sources within a
U.S. possession or territory specified in
section 937(a)(1) (generally referred to in
this preamble as a “territory”) and whether
income is effectively connected with the
conduct of a trade or business within a
territory. The final regulations also provide 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,
Public Law 99–514 (100 Stat. 2085) (the
1986 Act) and the American Jobs Creation
Act of 2004, Public Law 108–357 (118
Stat. 1418) (the 2004 Act). Conforming
changes are also made to regulations under sections 1, 170A, 861, 871, 901, 1402,
6038, 6046, and 7701 of the Code.
DATES: Effective Date: These regulations
are effective on April 9, 2008.
Applicability Date:
For dates
of
applicability,
see
§§1.1–1(d),
1.170A–1(k), 1.861–3(d), 1.861–8(h),
1.871–1(c),
1.876–1(f),
1.881–1(f),
1.881–5(i),
1.884–0(b),
1.901–1(j),
1.931–1(d),
1.932–1(j),
1.933–1(e),

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1.934–1(e),
1.935–1(g),
1.937–2(l),
1.937–3(f), 1.957–3(d), 1.1402(a)–12(c),
1.6038–2(m), 1.6046–1(l), 301.6688–
1(d), 301.7701(b)–9(b)(5).
FOR
FURTHER
INFORMATION
CONTACT: J. David Varley, (202)
435–5262 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On April 11, 2005, the Treasury Department and the IRS published in the Federal Register temporary regulations (T.D.
9194, 2005–1 C.B. 1016 [70 FR 18920], as
corrected at 70 FR 32589–01), which provided rules to implement section 937 and
to conform existing regulations to other
legislative changes with respect to the territories. A notice of proposed rulemaking
(REG–159243–03, 2005–1 C.B. 1075 [70
FR 18949]) cross-referencing the temporary regulations was published in the Federal Register on the same day. Written
comments were received in response to
the notice of proposed rulemaking and a
public hearing on the proposed regulations
was held on July 21, 2005.
After consideration of the comments,
the Treasury Department and the IRS
on January 31, 2006, published in the
Federal Register final regulations (T.D.
9248, 2006–1 C.B. 524 [71 FR 4996],
as corrected at 71 FR 14099) under section 937(a) concerning the determination
of bona fide residency in the territories.
Following further comments and consideration, the Treasury Department and the
IRS on November 14, 2006, published
in the Federal Register final regulations
(T.D. 9297, 2006–2 C.B. 1089 [71 FR
66232], as corrected at 71 FR 75882) under section 937(a) providing additional
rules for determining bona fide residency
in the territories.
The proposed regulations relating to
source and effectively connected income
with respect to the territories (specifically,
§§1.937–2 and 1.937–3) as well as the
other rules concerning the territories are
adopted as amended by this Treasury decision, and the corresponding temporary
regulations are removed.

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Explanation of Provisions and
Summary of Comments
The final regulations under Code section 937(b) provide rules for determining
whether income is from sources within a
territory and whether income is effectively
connected with the conduct of a trade or
business within a territory (territory ECI).
Section 937(b)(1) provides that, except as
provided in regulations, rules similar to the
rules for determining whether income is
from sources within the United States or
is effectively connected with the conduct
of a trade or business within the United
States will apply for purposes of determining whether income is from sources
within a specified territory or effectively
connected with the conduct of a trade or
business in any such territory. Section
937(b)(2) provides that, except as provided
in regulations, any U.S. source income or
U.S. effectively connected income will not
be treated as territory source income or as
territory ECI.
The U.S. tax consequences of classifying income as being from sources within
a territory or as being territory ECI vary
from territory to territory. The final regulations under Code sections 931 through
935 contain rules implementing the operative substantive and procedural provisions
of U.S. income tax law specifically applicable to each territory, including the rules
regarding the filing requirements and the
determination of the income tax liability of
bona fide residents and other persons with
territory source income. In addition to the
rules under Code sections 937(b) and 931
through 935, the final regulations provide
conforming changes to rules under related
provisions of the Code.
The Treasury Department and the IRS
recognize that the interaction of section
937 and other sections of the Code relating to the territories requires a balance between implementing the policies Congress
intended in section 937(b) while recognizing the territories’ efforts to retain and attract workers and businesses. As discussed
in more detail in this preamble, the final
regulations seek to achieve this balance.
For example, the final regulations allow
an individual to elect, under the special

May 19, 2008

gain rule that applies to property owned
by an individual before the individual became a bona fide resident of the territory,
to treat as territory source the portion of the
gain that accrued while the individual was
a bona fide resident of the territory. The
Treasury Department and the IRS will continue to consider comments received and
anticipate that additional changes to the final regulations may be made.
I. Territory Source Income and Territory
ECI
A. Territory source income
Section 937(b)(1) expressly grants the
Treasury Department and the IRS the regulatory authority to provide exceptions to
the general territory source rule, which
otherwise applies sourcing principles similar to those of the U.S. source rules. The
legislative history to section 937 indicates
that Congress intended that the Treasury
Department and the IRS use this authority
to provide exceptions to the general rules
regarding territory source income and territory ECI as appropriate. H.R. Conf. Rep.
108–755, at 795 (2004). The legislative
history indicates that Congress anticipated
that the regulatory authority would be used
to continue the existing treatment of income from the sale of goods manufactured
in a territory and to prevent abuse, such as
acquiring residence in a territory just prior
to the disposition of appreciated property
in order to avoid U.S. tax on such disposition. Id.
Under the temporary and proposed regulations, except as otherwise specifically
provided, the principles of sections 861
through 865 and the regulations under
those provisions generally apply for purposes of determining the gross and taxable
income from sources within and without
a territory. The temporary and proposed
regulations further state that in the application of such principles, the name of the
relevant territory will be used instead of
the term “United States”; the term “bona
fide resident of” followed by the name of
the relevant territory will be used instead
of the term “United States resident”; and
the term “domestic” will be construed to
mean created or organized in the relevant
territory.
The temporary and proposed regulations also provide exceptions to the general

May 19, 2008

rule for determining whether income is
from sources within a territory. In accordance with the legislative history to the
2004 Act, the temporary and proposed regulations preserve the manufacturing-sales
income rules in §1.863–3(f). In addition,
the temporary and proposed regulations
provide special rules preventing dividends
and interest paid by certain closely held
territory corporations from being territory
source income. Similarly, the temporary
and proposed regulations provide that
gains from dispositions of appreciated
property owned by an individual prior to
becoming a resident is not territory source
income under a special 10-year look-back
rule, and there are special rules regarding
compensation for military service. As
discussed in more detail in part I.C., the
temporary and proposed regulations also
reflect section 937(b)(2), which is the
statutory exception to the general territory
source rule.
1. General territory source rule
In response to the temporary and
proposed regulations, commentators requested further guidance regarding the
application of the general rule for determining whether income is from sources
within a territory. In particular, commentators questioned whether, in applying the
principles of sections 861 through 865,
the only permissible modifications to the
U.S. source rules were the substitutions
described in §1.937–2T(b).
The Treasury Department and the IRS
agree that the general rule for determining whether income is from sources within
a territory should be modified to provide
greater flexibility in applying the principles of sections 861 through 865 as well as
to prevent abuse. Consequently, the final
regulations provide that it generally will be
sufficient to make certain specified substitutions described in §1.937–2(b) when determining whether income is from within
or without a territory. However, the final
regulations provide that additional substitutions may be necessary to accomplish the
intent of section 937(b).
The final regulations also provide a necessary limitation and rule of application to
reflect the Congressional intent in enacting
the rules of section 937(b)(1). Under this
limiting rule, in no event will a bona fide
resident of a territory or other person have,

946

as a result of the application of the principles of the U.S. source rules, more income
from sources within the relevant territory
than the amount of income from sources
within the United States that a similarly situated U.S. person who is not a bona fide
resident of a territory would have under the
U.S. source rules.
Conforming amendments are made
to the territory ECI rules to reflect these
amendments to the territory source rules.
See part I.B. Taxpayers may choose to apply the amendments to the territory source
and ECI rules retroactively to open taxable
years ending after October 22, 2004.
2. Space and ocean income and
international communications income
Section 863(d) provides that income
derived from space or ocean activity is
sourced within the United States if it is
derived by a U.S. person and is sourced
without the United States if derived by
a foreign person. Section 863(e) generally provides that income derived from
international telecommunications activity
by a U.S. person is treated as one-half
from sources within the United States and
one-half from sources without the United
States. Commentators specifically requested greater clarity regarding how the
principles of section 863(d) and (e) were
to be applied to determine whether income
from space and ocean activity and international communications is from sources
within a territory.
The Treasury Department and the IRS
agree that the kinds of further modifications to the general rule that are discussed
in part I.A.1. would be specifically warranted with respect to applying the principles of the space and ocean and international communications source rules in the
territories. Consequently, the final regulations provide that in applying the principles of section 863(d) and (e) to determine whether a bona fide resident’s income is within or without a territory, the
term “bona fide resident of a possession”
will be used instead of the term “United
States person.”
3. Transportation income
Under section 863(c)(1), transportation
income is treated as U.S. source if it is
attributable to transportation beginning

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and ending in the United States. However, section 863(c)(2) provides that if
the transportation begins or ends in the
United States but is not described in section 863(c)(1), then one-half of the income
is U.S. source (the 50–50 source rule).
Section 863(c)(2) provides an exception to
the 50–50 source rule in the case of transportation income derived from personal
services of a taxpayer, unless such income
is attributable to transportation that begins
(or ends) in the United States and ends (or
begins) in a territory. In the case of transportation income derived in connection
with a vessel, the rules of section 863(c)(2)
apply only in the case of taxpayers who
are citizens or resident aliens.
Commentators argued that the rules of
section 863(c)(2) should not apply to transportation income derived from personal
services of bona fide residents of the U.S.
Virgin Islands. These commentators argued that the application of these rules
to a bona fide resident of the U.S. Virgin Islands is contrary to Congressional intent in enacting section 934(b), as interpreted by the commentators. Accordingly,
they maintained, the Treasury Department
and the IRS should exercise their regulatory authority under section 937(b)(1) to
provide that transportation income that is
derived from personal services of a bona
fide resident of the U.S. Virgin Islands
and that otherwise would be sourced under the 50–50 source rule principles of section 863(c)(2), should be sourced entirely
within the U.S. Virgin Islands, regardless
of the beginning or endpoint of the transportation to which the income is attributable.
The Treasury Department and the IRS
believe that their regulatory authority under section 937(b)(1) does not extend to
deviating from the source rules of section
863(c)(2). Congress clearly contemplated
territorial tax issues when enacting section 863(c) as it provided special source
rules in the case of transportation income
derived from transportation between the
United States and the territories. See H.R.
Conf. Rep. 98–861, at 1622 (1984). Congress intended that these rules also would
apply for purposes of determining the
source of income in territories that mirror
the U.S. income tax. Id. When section
863(c)(2) was amended by the 1986 Act,
the same legislation that enacted sections

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932 and 934(b) applicable to the U.S.
Virgin Islands, Congress preserved the
special 50–50 source rule applicable to
transportation between the United States
and a territory and specifically applied the
rule to such income that is derived from
personal services. See H.R. Conf. Rep.
99–841, at II–599 (1986).
Furthermore,
the
commentators
premised their argument for changing the
source of transportation income on section 934, which only applies to the U.S.
Virgin Islands. In the 2004 Act, Congress
sought to rationalize the source of income
rules applicable to the territories. See H.R.
Conf. Rep. 108–755, at 794 (2004). Thus,
the rules set forth in section 937 for determining bona fide residency and source
of income are intended to apply uniformly
to the territories rather than to provide tailored exceptions applicable to only certain
territories such as the U.S. Virgin Islands.
Consequently, §1.937–2 does not incorporate special rules with respect to
transportation income between the United
States and the U.S. Virgin Islands.
4. De minimis rule
Section 861(a)(3) generally provides
that compensation for labor or personal
services performed in the United States is
U.S. source income. Under the principles
of section 861(a)(3), income from services performed in a territory is treated as
territory source income. However, while
section 861(a)(3) provides a de minimis
exception to this general rule for services
performed by nonresident aliens in the
United States for minimal compensation
over a short period of time, the temporary
and proposed regulations specifically provide that the de minimis exception does
not apply for determining whether income
from services is from sources within a
territory. Consequently, a U.S. citizen
or resident alien who is not a bona fide
resident of the U.S. Virgin Islands, for
example, may have to file an income tax
return with and pay tax to the U.S. Virgin
Islands under section 932(a) even if the
individual is engaged in only de minimis
personal services in the territory. In this
regard, the temporary and proposed regulations carry over the pre-existing rules
in former §1.863–6 for determining income within and without a territory. See
§1.863–6 (2004).

947

Several commentators requested a de
minimis exception to the general rules for
the sourcing of income from personal services in a territory. The Treasury Department and the IRS agree that such a rule reduces taxpayer burden and promotes efficient tax administration. Accordingly, the
final regulations eliminate the rule in the
temporary and proposed regulations that
specifically provides that in applying the
principles of section 861(a)(3), the de minimis exception does not apply. An example in the final regulations illustrates that a
U.S. citizen or resident who is not a bona
fide resident of a territory but who performs services in a territory temporarily
for no more than 90 days during the taxable year and for no more than $3,000 (in
the aggregate) generally will not have income from sources within the territory.
5. Gains from certain dispositions of
personal property
The temporary and proposed regulations provide a special rule for gains from
dispositions of certain property held by a
U.S. person prior to becoming a resident
of a territory. See §1.937–2T(f)(1). Under
this rule, gains from dispositions of such
property within 10 years after becoming a
territory resident generally are treated as
income from sources outside of the territory. The special gain rule supplements,
and does not supersede, the similar special
gain rule of section 1277(e) of the 1986
Act, which applies to individuals who
become residents of American Samoa,
Guam, or the Northern Mariana Islands
(NMI) (collectively, the Pacific territories).
Commentators noted that the special
gain rule characterizes all gain from property of former U.S. residents as non-territory source income, including any gain
attributable to appreciation that occurs
while the individual is a bona fide resident
of the relevant territory. For example, if
a U.S. citizen and lifelong resident of a
territory who owns stock in a corporation
moves to the United States for a few years
and then re-establishes bona fide residence
in the territory and sells the stock within
10 years, most of the appreciation in the
stock may be attributable to the period
in which the individual was a bona fide
resident of the territory. However, under
the special gain rule, because of the period

May 19, 2008

of U.S. residence, none of the gain would
qualify as territory source income.
The Treasury Department and the IRS
agree that the special gain rule should be
modified to target more precisely gain attributable to appreciation occurring during the time that an individual was not
a bona fide resident of the relevant territory. Accordingly, the final regulations
provide that an individual may elect to
split the source of gains from the sale or
other disposition of appreciated property
subject to the special gain rule by using
a mark-to-market allocation in the case of
marketable securities and a time-based allocation rule in the case of other personal
property. This election will more accurately target the abuse that the special gain
rule was intended to address. The election also operates to modify the special
gain rule of the 1986 Act, as authorized
therein. Individuals may retroactively apply the election to dispositions made after
April 11, 2005.
B. Territory ECI
Section 937(b)(1) provides that rules
similar to those for determining whether
income is effectively connected with the
conduct of a trade or business within the
United States should also apply in determining whether income is territory ECI,
except as provided in regulations. Accordingly, the temporary and proposed regulations generally provide that the principles
of section 864(c)(4) apply for purposes
of determining whether any income from
sources without a territory (U.S. source
or other non-territory source income) is
treated as territory ECI.
Section 864(c)(4) limits the types of
income from foreign sources that can be
effectively connected income to certain
rents or royalties; dividends or interest
connected with the conduct of a banking or financial business; gain from the
sale or exchange of inventory; and insurance company income. Personal services
income that is foreign source cannot be effectively connected income under section
864(c)(4).
Commentators requested that, instead
of applying the principles of section
864(c)(4), the final regulations adopt the
principles of section 864(c)(2) and (c)(5)
for purposes of determining whether income from sources without a territory is

May 19, 2008

territory ECI. This would expand the types
of non-territory source income that could
be treated as territory ECI and particularly would include income from personal
services. For territories such as the U.S.
Virgin Islands this would mean that additional types of non-territory source income
may be eligible for reductions of territorial income tax because section 934(b)
allows the U.S. Virgin Islands to reduce
its territorial income tax on income that
is effectively connected with the conduct
of a trade or business in the U.S. Virgin
Islands. These commentators believe that
Congress intended for section 934 (and
similar provisions applicable to other territories) to promote economic activity in
the territories and that the section 937
regulations should better reflect the policy
choices that these commentators believe
were made in section 934(b).
Congress provided in section 937(b)(1)
that rules similar to those for determining
whether income is effectively connected
with the conduct of a trade or business
within the United States should also apply
in determining whether income is territory
ECI, except as provided in regulations.
The legislative history to section 937 indicates that Congress was concerned about
U.S. citizens and residents claiming to be
exempt from U.S. tax on their worldwide
income and claiming reductions from territorial income tax when they did not live
and work in the territories. H.R. Conf.
Rep. 108–755, at 793–94. Adopting the
principles of section 864(c)(2) and (c)(5)
to determine whether income is territory
ECI would allow personal services income
derived from sources outside a territory
(for example, U.S. source income) to
be treated as territory ECI, contrary to
Congressional intent. The Treasury Department and the IRS do not believe their
regulatory authority extends to prescribing the use of the principles of section
864(c)(2) and (c)(5) for purposes of determining whether income from sources
without a territory is territory ECI.
Furthermore, section 934 does not provide a basis for interpreting the regulatory
authority under section 937(b) in such a
liberal manner. In enacting section 937,
Congress amended the rules related to the
territories notwithstanding section 934.
Moreover, the legislative history to section
934 does not reflect these commentators’
view of Congressional intent in enacting

948

section 934. Even while recognizing the
goal of encouraging economic development in the U.S Virgin Islands through
appropriate territorial income tax reductions, the legislative history of section 934
indicates that the statute was enacted in
part because of concerns that certain territorial income tax programs, which were
intended to provide incentives to corporations and residents of the U.S. Virgin
Islands that made new investments in the
U.S. Virgin Islands, were having the effect
of reducing the tax liability attributable
to not only income from sources within
the territory but also income from sources
within the United States. S. Rep. No.
1767, 86th Cong. 2nd Sess. 4 (1960); see
also H.R. Rep. No. 99–426, at 485–486
(1985); and S. Rep. No. 99–313, at 479
(1986). The legislative history to section
934 indicates that economic development
in the U.S. Virgin Islands should not be
attained by granting tax reductions to
taxpayers (other than certain U.S. Virgin Islands corporations) with respect to
income derived from investments from
sources outside of the territory. Id.
Other commentators suggested that
U.S. source services income should be
treated differently from other non-territory source services income. Specifically,
they suggested that the rules of section
864(c)(4) should apply to U.S. source personal services income while the principles
of section 864(c)(2) and (c)(5) should apply to other non-territory source personal
services income. The Treasury Department and the IRS note that the legislative
history to section 937 indicates that Congress was concerned about U.S. citizens
and residents claiming reduced rates of
territorial income taxation on personal
services income by individuals that were
not living and working in the territories.
H.R. Conf. Rep. 108–755, at 793–94.
Congress also expressed concern about
possible opportunities for erosion of the
U.S. tax base associated with the territory
ECI rule. Id.
For these reasons, the Treasury Department and the IRS have not adopted the
commentators’ suggestions regarding the
determination of whether income is effectively connected with the conduct of a
trade or business in a territory under section 937(b)(1). Accordingly, the general
rule in the temporary and proposed regulations for determining territory ECI is

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adopted in the final regulations with minor
modifications.
Similar to the modifications made to the
general rule for determining whether income is from sources within a territory,
the final regulations amend the general territory ECI rule to provide that additional
substitutions beyond the routine substitution of the name of the relevant territory
for the term “United States” may be necessary in some cases to accomplish the intent
of section 937(b)(1). The final regulations
also adopt a limitation similar to its counterpart in the general territory source rule,
precluding any application of the principles of section 864(c) from resulting in a
greater amount of territory ECI than the
amount of U.S. effectively connected income that a similarly situated U.S. person
who is not a bona fide resident of a territory would have under U.S. rules. Taxpayers may choose to apply these rules in
§1.937–3(b) retroactively to open taxable
years ending after October 22, 2004.
C. U.S. income rule
Section 937(b)(2) provides that
notwithstanding the general territory
source rule, any income from sources
within the United States or effectively
connected with the conduct of a trade or
business within the United States is not
treated as income from sources within
a territory or as territory ECI (the U.S.
income rule). The legislative history to
section 937(b)(2) indicates that Congress
wanted the Treasury Department and the
IRS to create regulatory exceptions to
the general rules for determining territory
source and territory ECI and to the U.S.
income rule “as appropriate.” H.R. Conf.
Rep. 108–755, at 794. Congress anticipated that these exceptions would be used
“to prevent abuse.” Id. at 795. Congress
was “concerned that the general rules for
determining whether income is effectively
connected with the conduct of a trade or
business in a [territory] present numerous
opportunities for erosion of the U.S. tax
base.” Id. at 794.
The temporary and proposed regulations generally adopt the U.S. income rule
without exception. However, the temporary and proposed regulations tighten the
provision by adding an anti-conduit rule to
prevent the avoidance of the U.S. income
rule.

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In response to the temporary and
proposed regulations, commentators requested that the Treasury Department and
the IRS exercise their regulatory authority
to provide additional exceptions to the
U.S. income rule.
1. Scope of the U.S. income rule
Numerous commentators argued that
the scope of the U.S. income rule should
be narrowed. The commentators argued
that without additional regulatory exceptions, the U.S. income rule will hamper
efforts to promote private sector economic
development in the territories because
it does not permit a territory to provide
tax reductions for U.S. source business
income even if all of the activity generating that income occurs in the territory.
In addition, these commentators argued
that Congress intended to encourage the
economic development of the territories
by allowing, for example, the U.S. Virgin
Islands to provide territory tax incentives
under section 934 with respect to income
effectively connected with the conduct
of a trade or business in the U.S. Virgin
Islands, even where that income is from
U.S. sources.
Commentators
proposed
various
amendments to the general scope of the
U.S. income rule. For example, one commentator essentially suggested that the
U.S. income rule should not apply to income that is already treated as territory
ECI under the general rule of section
937(b)(1), which applies the principles
of section 864(c)(4) to income from U.S.
sources. Thus, under this suggestion, the
U.S. income rule would have no application to the determination of whether U.S.
source income may be treated as territory ECI. The commentator further argued
that Congress was only concerned about
U.S. source personal services income being treated as territory ECI and that such
income is already prevented from being
treated as territory ECI if the principles of
section 864(c)(4) apply under the general
rule.
This purportedly limited purpose for
enacting section 937(b)(2) is difficult to
reconcile with the statute’s breadth, as a
broad application to U.S. source income
appears to be the most significant effect
of the U.S. income rule. If adopted, such
a rule would render the U.S. income rule

949

largely unnecessary. The legislative history to section 937 indicates that Congress
clearly intended that the U.S. income rule
would apply to prevent U.S. source income from being treated as territory ECI.
The legislative history also indicates that
Congressional concern about the erosion
of the U.S. tax base through the source and
effectively connected income rules was a
more general concern and not limited to
personal services income. Consequently,
the Treasury Department and the IRS do
not believe that their regulatory authority
under section 937(b)(2) extends to providing such a broad exception to the U.S.
income rule.
Other commentators suggested that the
U.S. income rule should apply only when
an item of income is U.S. source or attributable to a U.S. permanent establishment, as determined under the U.S. model
treaty rules, as opposed to income effectively connected with the conduct of a U.S.
trade or business. In the case of territory
source income or territory ECI, this suggested change would essentially limit the
application of the U.S. income rule to income that is attributable to a fixed place of
business in the United States.
This suggestion would permit a trade
or business to carry on significant activities in the United States as long as it does
not do so through a fixed physical location, such as an office, branch, factory, or
place of management, or as long as it maintains a facility in the U.S. that is used for
certain permissible activities such as storing, displaying, or delivering goods, purchasing or collecting information, or other
activities of a preparatory or auxiliary nature, such as advertising or supplying information. See U.S. Treasury Department,
Model Income Tax Treaty art. 5 (2006). A
territory business could also utilize independent agents to carry on business in the
United States without triggering the U.S.
income rule. Id.
If the U.S. income rule did not apply, income attributable to these activities could
be eligible for territory tax incentives, a result that potentially could lead to an erosion of the U.S. tax base with respect to
income that is from U.S. sources or effectively connected with the conduct of a U.S.
trade or business. In light of the Congressional concerns with U.S. base erosion and
the consequent lack of authority to provide
such a broad regulatory exception, the fi-

May 19, 2008

nal regulations do not adopt a permanent
establishment standard as part of the U.S.
income rule.
Some commentators similarly suggested that the U.S. income rule should
apply only when an item of income is
both U.S. source and attributable to a U.S.
office or fixed place of business. Thus,
any U.S. source income not effectively
connected with a trade or business in the
United States could be treated as territory
ECI and therefore qualify for tax incentives in certain territories. This suggested
change also would render the U.S. income
rule inapplicable to all territory source
income that is effectively connected with
the conduct of a U.S. trade or business.
The legislative history to section 937 does
not suggest that Congress intended the
Treasury Department to exercise its regulatory authority to allow income earned by
a U.S. trade or business to receive territory
tax benefits. Therefore, the Treasury Department and the IRS do not believe there
is adequate regulatory authority to adopt
this suggestion.
Other commentators requested exceptions to the U.S. income rule for certain
classes of non-territory source income that
may otherwise be territory ECI. For example, commentators requested that insurance income from insuring U.S. risks, interest income from U.S. payors to finance
centers, or rents and royalties from the use
of intangible property in the United States
be excepted from the scope of the U.S. income rule to the extent income is territory
ECI. These commentators asserted that,
notwithstanding that such income is generally U.S. source, the economic activity
that gives rise to the income occurs in the
territories. Accordingly, these commentators argued, this income does not provide
the opportunities to erode the U.S. tax base
that the U.S. income rule was intended to
prevent.
Even though the activities giving rise to
these classes of income may result from
sufficient economic activity in the territory
so that the income otherwise would constitute territory ECI, the Treasury Department and the IRS note that these classes of
income often arise in part from U.S.-based
activities such as marketing. Thus, the
Treasury Department and the IRS do not
believe that their regulatory authority extends to removing income derived from the
specified activities from the express cov-

May 19, 2008

erage of the U.S. income rule under section 937(b)(2). However, the final regulations do provide additional examples illustrating that income from personal services
that, for example, lead to the development
of intangible property is not subject to the
U.S. income rule if such services income
is from territory sources. See part I.C.2.
2. Examples illustrating the U.S. income
rule
Although the proposed and temporary
regulations include several examples applying section 937(b) and temporary regulations §§1.937–2T and –3T, comments received by the Treasury Department and the
IRS indicated a need for additional examples illustrating the operation of the U.S.
income rule. In Notice 2006–76, 2006–2
C.B. 459 (see §601.601(d)(2)(ii)(b)), the
Treasury Department and the IRS provided
two additional examples in response to this
concern and explained that taxpayers may
treat the examples set forth in the notice
as illustrative of the rules in the temporary
regulations. The Treasury Department and
the IRS also signaled in the notice that
these two additional examples, or substantially similar examples, would be included
in the final regulations.
Commentators responded positively to
the publication of the examples in Notice 2006–76, and the Treasury Department and the IRS did not receive any substantive questions or comments. Accordingly, the examples in Notice 2006–76 are
included in the final regulations.
The final regulations also provide a new
example with respect to the provision of
contingent-payment contractual terms for
services performed in a territory. This example clarifies that compensation income
received for providing personal services
that lead to the development of intangible property for the service recipient is not
subject to the U.S. income rule to the extent that the compensation income is from
sources within the territory.
II. Operative Provisions
A. American Samoa
Under section 931(a), income from
sources in a section 931 possession generally is excluded from the gross income
of a bona fide resident of a section 931

950

possession. (American Samoa currently is
the only section 931 possession because
it is the only territory that has entered
into an implementing agreement under
sections 1271(b) and 1277(b) of the 1986
Act.) However, under section 931(d),
the exclusion does not apply to amounts
received for services performed as an employee of the United States or any agency
thereof. The final regulations clarify that
for this purpose under current law, an
employee of the government of a section 931 possession is not an employee
of the United States or of an agency of
the United States. Thus, compensation
received as an employee of the territorial
government of a section 931 possession
is properly excluded from U.S. gross income. A conforming clarification with
respect to Puerto Rico is included in the
final regulations under section 933.
The effect of this rule change will be
mainly administrative. Employees of the
territorial government now will report
their compensation as gross income on
only the territorial income tax return and
thus, depending on their other income,
may be spared a U.S. filing obligation, and
all tax on such compensation will be paid
directly to the territorial government rather
than potentially through a cover-over
mechanism under section 7654. The Treasury Department and the IRS believe that
this change will reduce overall taxpayer
burden and enhance the efficiency of Federal tax administration, while also more
fully reflecting the independent operation
of the territorial taxing authority.
Rev. Rul. 56–127, 1956–1 C.B. 323
(see §601.601(d)(2)(ii)(b)), which held under prior law that employees of the government of American Samoa are considered employees of the United States or an
agency thereof, is no longer determinative
and is obsoleted by this Treasury decision.
B. Guam and the Northern Mariana
Islands
Although section 935 was repealed by
the 1986 Act, neither Guam nor the NMI
has agreed to the entry into force of the implementing agreement required under sections 1271(b) and 1277(b) of the 1986 Act,
and therefore neither of those territories
is a section 931 possession as defined in
§1.931–1(c)(1). Rather, section 935 remains in effect with respect to bona fide

2008–20 I.R.B.

residents of Guam and the NMI. The final regulations under section 935 generally retain the provisions of the temporary
and proposed regulations without modification.
C. Puerto Rico
The final regulations generally retain
the provisions of the temporary and proposed regulations under section 933 without modification. However, the final regulations explicitly provide that for purposes
of the section 933 exclusion, employees
of the Puerto Rico territorial government
are not treated as employees of the United
States or of a Federal agency. This language, which comports with the consistent historical understanding that the compensation of such employees is excludable from Federal gross income, is added
only for conformity with the revision being
made to the final section 931 regulations to
address certain obsolete guidance with respect to American Samoa, as explained in
part II.A.
D. United States Virgin Islands
Section 932(c) generally provides that
an individual (whether a U.S. citizen or
alien) who is a bona fide resident of the
U.S. Virgin Islands must file an income
tax return with the U.S. Virgin Islands tax
authorities. If the individual properly reports income from all sources identifying
the source of each item of income on this
return and pays all tax properly due with
respect to such income, then such income
is excluded from gross income for Federal
income tax purposes. Consequently, such
individuals have a Federal income tax return filing obligation if they fail to report
or properly identify the source of any of
their income on their U.S. Virgin Islands
income tax return or if they fail to pay all
of the tax properly due with respect to their
income. The temporary and proposed regulations reflect this statutory filing regime.
Commentators asked for additional
guidance with respect to the U.S. filing
obligations of individuals who take the
position that they are bona fide residents
of the U.S. Virgin Islands and file their
income tax returns with the U.S. Virgin
Islands under section 932(c). In particular,
commentators asked for clarification with
respect to correcting inadvertent errors on
U.S. Virgin Islands income tax returns,

2008–20 I.R.B.

determining the amount of any residual
Federal income tax liability for individuals
who fail to pay all the tax properly due to
the U.S. Virgin Islands, and clarification
of the application of the statute of limitations on assessments of Federal income
tax by the IRS.
Although the final regulations generally continue to reflect the statutory
regime under 932(c) as set forth in the
temporary and proposed regulations, the
Treasury Department and the IRS agree
that additional guidance with respect to
the Federal filing requirements and obligations under section 932(c) is warranted.
The final regulations provide an example
illustrating that a bona fide resident of the
U.S. Virgin Islands will not be subject to
any U.S. filing requirement if, in order to
correct a return previously filed with the
U.S. Virgin Islands, that individual timely
files an amended return with the U.S. Virgin Islands. The Treasury Department and
the IRS believe that individuals generally
should first avail themselves of similar administrative remedies that the U.S. Virgin
Islands may provide.
The final regulations also provide a new
rule for purposes of determining the residual Federal income tax liability, if any, of
individuals who are bona fide residents of
the U.S. Virgin Islands. Under this new
rule, such individuals are allowed a credit
for amounts already paid to the U.S. Virgin Islands. Thus, their residual Federal
income tax liability should equal the difference between their entire income tax liability and the amount of income tax already paid to the U.S. Virgin Islands.
Section 932(b) provides a similar credit
for U.S. citizens and resident aliens who
are not bona fide residents of the U.S.
Virgin Islands. If such individuals have
income from sources within the U.S. Virgin Islands or income that is effectively
connected with the conduct of a trade or
business in the U.S. Virgin Islands, then
sections 932(a) and (b) generally require
such individuals to file an income tax return with both the IRS and the U.S. Virgin
Islands tax authorities, paying an applicable percentage of taxes attributable to
such income to the U.S. Virgin Islands.
The individual may claim a credit for the
tax required to be paid to the U.S. Virgin
Islands, so that only the balance is due
to the United States. Like the temporary
and proposed regulations, the final reg-

951

ulations reflect these statutory rules. In
the event that an individual who is not
a bona fide resident pays more tax to
the U.S. Virgin Islands than is required,
Rev. Proc. 2006–23, 2006–1 C.B. 900,
(see §601.601(d)(2)(ii)(b)) provides procedures for requesting U.S. competent
authority assistance for resolving inconsistent tax treatment with respect to such
payments by the IRS and the U.S. Virgin
Islands tax authorities.
With respect to the Federal statute of
limitations, the final regulations incorporate the interim rules announced in Notice
2007–31, 2007–16 I.R.B. 971, under the
authority of section 7654(e). Accordingly,
the final regulations under section 932(c)
provide that the Federal statute of limitations under section 6501(a) for a U.S. citizen or resident alien who claims to be a
bona fide resident of the U.S. Virgin Islands generally will start running upon the
filing of an income tax return with the U.S.
Virgin Islands. This general rule applies
as long as the IRS and U.S. Virgin Islands
have in place an agreement for the automatic exchange of information satisfying the requirements of the Commissioner
of the IRS. Because the working arrangement announced in Notice 2007–31 satisfies this condition, this general rule applies to years ending on or after December 31, 2006. In the event that the working arrangement is terminated and in the
absence of a successor agreement, an individual claiming to be a bona fide resident of the U.S. Virgin Islands generally
must file an income tax return with the
IRS in order to start the Federal statute of
limitations period. In such circumstances,
however, the Commissioner may by administrative pronouncement specify other
rules for this purpose. For years ending
before December 31, 2006, the U.S. filing
requirements provided in Notice 2007–19,
2007–11 I.R.B. 689, continue to apply. See
§601.601(d)(2)(ii)(b).
The temporary and proposed regulations amend the regulations under section
6688 (concerning assessable penalties
with respect to information reporting under section 7654) to conform to changes
made by the 2004 Act. The temporary
and proposed regulations provide that the
penalty applies to individuals who are subject to reporting requirements promulgated
under the authority of section 937(c) (concerning individuals who become or cease

May 19, 2008

to be bona fide residents of a territory) or
section 7654 (concerning the coordination
of United States and territorial income
taxes). This information reporting includes the requirement to file Form 8689,
“Allocation of Individual Income Tax to
the U.S. Virgin Islands,” and the requirement to file Form 8898, “Statement for
Individuals Who Begin or End Bona Fide
Residence in a U.S. Possession.”
One commentator noted that section
6688 applies only to “individuals described in section 7654(a)” and therefore
should not extend to Form 8689, which
is required of only U.S. citizens or residents (other than bona fide residents of
the U.S. Virgin Islands) who have income
derived from sources within the U.S. Virgin Islands or effectively connected with
the conduct of a trade or business in the
U.S. Virgin Islands, or spouses who file
joint returns with such individuals. The
Treasury Department and the IRS agree
that such individuals are not described in
section 7654(a), which generally applies
only to bona fide residents of an applicable territory. The final regulations under
section 6688 are amended accordingly.
E. Application of subpart F to bona fide
residents of a territory
In general, corporations created or organized in a territory are treated as foreign corporations for Federal income tax
purposes, including the subpart F provisions relating to controlled foreign corporations. Section 957(c), however, provides
a significant exception for bona fide residents of Puerto Rico and section 931 possessions. In cases where the exception applies, such an individual is not treated as a
U.S. person for purposes of subpart F. Consequently, such an individual is not treated
as a U.S. shareholder under section 951(b),
and where such individuals own more than
50 percent of the vote or value of a corporation created or organized under the laws
of Puerto Rico (a Puerto Rico corporation)
or a section 931 possession (a section 931
corporation), as the case may be, such a
corporation is not treated as a controlled
foreign corporation under section 957(a).
In the case of a bona fide resident of
Puerto Rico, the exception applies under
section 957(c)(1) with respect to a Puerto
Rico corporation if a dividend received
by such individual during the taxable year

May 19, 2008

from such corporation would, for purposes
of section 933(1), be treated as income
derived from sources within Puerto Rico.
With respect to bona fide residents of a
section 931 possession, the exception applies under section 957(c)(2) with respect
to a corporation organized or created in
the section 931 possession if: (1) 80 percent or more of the gross income of the
corporation during the three-year testing
period ending at the close of the taxable
year (or applicable part) was derived from
sources within such territory or was effectively connected with the conduct of a
trade or business in such a territory; and
(2) 50 percent of 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 territory (the
80/50 conditions).
For purposes of determining whether
income is from sources within Puerto Rico,
the temporary and proposed regulations
generally apply the territory source rules
in §1.937–2T, including the special rules
for determining whether dividends to individuals who own more than 10 percent
of the total voting stock of a territory corporation are from sources within the relevant territory. Those dividend source rules
treat only a ratable portion of any dividend paid or accrued by a territory corporation to such a shareholder as territory source income unless the corporation
meets the same 80/50 conditions as those
applied under section 957(c)(2). Consequently, under the temporary and proposed
regulations, unless a Puerto Rico corporation’s gross income is derived entirely
from sources within Puerto Rico, the corporation must meet the same 80/50 conditions applicable to a section 931 corporation in order for section 957(c)(1) to apply.
Commentators from Puerto Rico objected to the effect of the temporary and
proposed regulations with respect to the
application of section 957(c)(1). The
commentators noted that since 1986, all
dividends from Puerto Rico corporations
were treated as income from sources
within Puerto Rico, and therefore such
corporations were not treated as controlled
foreign corporations for 10 percent shareholders who were bona fide residents of
Puerto Rico. Commentators noted that the
legislative history to neither the 2004 Act
nor the 1986 Act, which amended section
957(c) by applying the 80/50 conditions

952

with respect to section 931 corporations
but did not specifically apply those conditions to Puerto Rico corporations, makes
any reference to Congressional intent to
apply the 80/50 conditions to Puerto Rico
corporations.
The Treasury Department and the IRS
believe that given the distinct statutory
tests under section 957(c)(1) and (c)(2),
the 80/50 conditions should apply only to
section 931 corporations. Therefore, the
final regulations provide that the special
dividend source rules of §1.937–2(g)(1)
(including the 80/50 conditions) will not
apply when determining, for purposes of
section 957(c)(1), whether a dividend received by the Puerto Rico corporation during the taxable year would be treated under
section 933(1) as derived from sources
within Puerto Rico. Rather, the principles
of section 861(a)(2)(A) under the general territory source rules will apply, and
consequently dividends from Puerto Rico
corporations generally will be treated as
income from sources within Puerto Rico
for purposes of applying section 957(c)(1)
unless the U.S. income rule prevents the
dividends from being sourced to Puerto
Rico because, for example, the dividends
are from sources within the United States
under section 861(a)(2)(B).
The temporary and proposed regulations contain related rules under sections
6038 and 6046 with respect to information
reporting requirements concerning certain
foreign corporations owned by a United
States person who is a bona fide resident
of Puerto Rico or a section 931 possession. Under the temporary regulations,
the special definition of United States
person under section 957(c) also applies
for purposes of sections 6038 and 6046.
However, because the final regulations
no longer apply the 80/50 conditions to
bona fide residents of Puerto Rico (for
purposes of subpart F), the Treasury Department and the IRS are concerned that
such individuals may no longer have to
provide information concerning their controlled foreign corporations, including
those formed in Puerto Rico.
The Treasury Department and the IRS
believe that the information required under sections 6038 and 6046 is necessary
for purposes of determining whether such
individuals have a Federal income tax
liability. Thus, the final regulations continue to apply the 80/50 conditions of

2008–20 I.R.B.

§1.937–2(g)(1) when defining United
States person for purposes of the information reporting requirements under sections
6038 and 6046.
With respect to bona fide residents of
a section 931 possession, the final regulations continue to apply the same exception
(with the 80/50 conditions) for purposes of
section 957(c) and sections 6038 and 6046.
F. Entity status
With respect to section 935 possessions
and the U.S. Virgin Islands (mirror code
territories), the temporary and proposed
regulations contain special rules requiring
consistent treatment of certain business
entities for U.S. and mirror code tax purposes. The rules generally apply to elections under section 1362(a) (subchapter
S corporations), §301.7701–3(c) (eligible
entities), and other similar elections. The
rules provide, among other things, that if
an entity files an election with the IRS but
not with the relevant mirror code territory,
then the appropriate tax authority of the
mirror code territory may, at its 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
territory but not with the IRS, the Commissioner may, at his or her discretion,
deem the election to have been made for
U.S. Federal income tax purposes.
The Treasury Department and the IRS
specifically requested comments relating
to elections that should be specifically
mentioned or excluded from the entity
status election rules. Commentators requested two limited exceptions to the
requirement for making consistent elections in the case of a U.S. entity that files
an election with the IRS but not with the
relevant mirror coder territory.
The first comment related to a U.S. entity that elects to be treated as a real estate mortgage investment conduit under
section 860D(b) (a REMIC) for U.S. tax
purposes. The commentator noted that a
REMIC would be classified as a foreign
corporation for mirror code tax purposes
unless it either files an election in the mirror code territory or the appropriate tax authority of the relevant mirror code territory
exercises his or her discretion to treat the
entity as if an election had been made. The
commentator requested that the entity consistency rules be restricted so as not to ap-

2008–20 I.R.B.

ply to a publicly traded REMIC unless five
percent or more of the REMIC’s ownership is held by a bona fide resident of the
relevant territory or a corporation created
or organized in the relevant territory.
The second comment similarly requested an exception to the consistent
election requirement in the case of a U.S.
corporation that, prior to the temporary
and proposed regulations, made an election with the IRS under section 1362(a) to
be an S corporation but had a shareholder
who was a bona fide resident of a mirror
code territory who treated the entity as a
foreign C corporation for purposes of the
individual’s taxation in the territory. The
commentator requested that such individuals be allowed under these circumstances
to make a one-time election in the mirror
code territory to treat the U.S. entity for
purposes of mirror code taxation as either
a domestic S corporation or a foreign C
corporation (as it would be in the absence
of an affirmative election under section
1362(a) by the entity or a deemed election
by the mirror code tax authority).
The Treasury Department and the IRS
are concerned about the possibility of inappropriate tax results from inconsistent
treatment of entities in the United States
and mirror code jurisdictions and believe
that this problem exists even in circumstances in which the owners of the entity
hold less than five percent of the interests
in the entity. Furthermore, the Treasury
Department and the IRS believe that treating the entity consistently in the territory
and the United States should not impose
an undue burden on the entity. Thus, the
Treasury Department and the IRS do not
believe that a special exception in the entity consistency rules is necessary in either
case.
As provided in the temporary and proposed regulations, which are finalized
here without change, the ability of the tax
authority in a mirror code jurisdiction to
deem an election to have been made for
territorial tax purposes is discretionary.
The Treasury Department and the IRS
anticipate that, to the extent the entity
status rules apply, this discretion will be
exercised in situations where taxpayers
treat a business entity in an inconsistent
manner with the result that it reduces
their overall tax liability below what otherwise would be due in the absence of
the mirror system. In addition, and as a

953

general matter, the Treasury Department
and the IRS encourage taxpayers to take
consistent positions in both jurisdictions
or, if this is not possible, to seek available administrative assistance from the
relevant jurisdiction including, for example, requesting a pre-filing or similar
agreement with respect to an entity’s classification as well as requesting competent
authority assistance concerning any inconsistent positions taken by the IRS and
a territory with respect to the entity classification of an entity. See, for example,
Rev. Proc. 2007–17, 2007–4 I.R.B. 368,
(IRS pre-filing agreement procedures)
and Rev. Proc. 2006–23, 2006–1 C.B.
900, (U.S. competent authority assistance
procedures with respect to the territories).
See §601.601(d)(2)(ii)(b).
III. Miscellaneous Changes
The final regulations also reflect various nonsubstantive stylistic edits to the
proposed and temporary regulations to enhance clarity and readability.
Effect on Other Documents
Rev. Rul. 56–127, 1956–1 C.B. 323, is
obsolete as of April 9, 2008.
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. Because the
regulations do not impose a collection of
information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section 7805(f)
of the Internal Revenue Code, the notice of
proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact
on small business.
Drafting Information
The principal author of these regulations is J. David Varley, Office of the Associate Chief Counsel (International), IRS.
However, other personnel from the IRS

May 19, 2008

and Treasury Department participated in
their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 301
are amended as follows:
PART 1—INCOME TAXES
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 1.931–1 also issued under 26
U.S.C. 7654(e).
Section 1.932–1 also issued under 26
U.S.C. 7654(e). * * *
Section 1.934–1 also issued under 26
U.S.C. 934(b)(4). * * *
Section 1.935–1 also issued under 26
U.S.C. 7654(e). * * *
Section 1.937–2 also issued under 26
U.S.C. 937(b).
Section 1.937–3 also issued under 26
U.S.C. 937(b). * * *
Section 1.957–3 also issued under 26
U.S.C. 957(c). * * *
Par. 2. Section 1.1–1 is amended by
revising the second sentence of paragraph
(b) and adding a new paragraph (d) to read
as follows:
§1.1–1 Income tax on individuals.
*****
(b) * * * Pursuant to section 876, a nonresident alien individual who is a bona fide
resident of a section 931 possession (as defined in §1.931–1(c)(1) of this chapter) or
Puerto Rico during the entire taxable year
is, except as provided in section 931 or 933
with respect to income from sources within
such possessions, subject to taxation in the
same manner as a resident alien individual.
***
*****
(d) Effective/applicability date. The
second sentence of paragraph (b) of this
section applies to taxable years ending
after April 9, 2008.
Par. 3. Section 1.170A–1 is amended
by revising paragraph (j)(9) and the heading for paragraph (k) and adding a new
sentence at the end of paragraph (k) to read
as follows:

May 19, 2008

§1.170A–1 Charitable, etc., contributions
and gifts; allowance of deduction.
*****
(j)(9) Charitable contributions paid by
bona fide residents of a section 931 possession as defined in §1.931–1(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.
*****
(k) Effective/applicability date. * * *
Paragraph (j)(9) of this section is applicable for taxable years ending after April 9,
2008.
§1.170A–1T [Removed]
Par. 4. Section 1.170A–1T is removed.
Par. 5. Section 1.861–3 is amended
by revising paragraph (a)(2) and revising
the heading for paragraph (d) and adding a
new sentence at the end of paragraph (d) to
read as follows:
§1.861–3 Dividends.
*****
(a) * * *
(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 that
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.
*****
(d) Effective/applicability date. * * *
Paragraph (a)(2) of this section applies to
taxable years ending after April 9, 2008.
§1.861–3T [Removed]

(vi) * * *
(E) The tax base for individuals entitled
to the benefits of section 931 and the section 936 tax credit of a domestic corporation that has an election in effect under section 936;
(F) The exclusion for income from
Puerto Rico for bona fide residents of
Puerto Rico under section 933;
*****
(H) The income derived from the U.S.
Virgin Islands or from a section 935 possession (as defined in §1.935–1(a)(3)(i)).
*****
(h) Effective/applicability date. Paragraphs (f)(1)(vi)(E), (f)(1)(vi)(F), and
(f)(1)(vi)(H) of this section apply to taxable years ending after April 9, 2008.
Par. 8. Section 1.871–1 is amended by
revising paragraph (b)(1)(iii) and revising
the heading for paragraph (c) and adding a
new sentence at the end of paragraph (c) to
read as follows:
§1.871–1 Classification and manner of
taxing alien individuals.
*****
(b) * * * (1) * * *
(iii) Nonresident alien individuals who
are bona fide residents of a section 931
possession (as defined in §1.931–1(c)(1)
of this chapter) or Puerto Rico during
the entire taxable year. An individual
described in paragraph (b)(1)(i) or (ii)
of this section is subject to tax pursuant
to the provisions of subpart A (section
871 and following), part II, subchapter N,
chapter 1 of the Code, and the regulations
under those provisions. The provisions
of subpart A do not apply to individuals
described in this paragraph (b)(1)(iii), but
such individuals, except as provided in
section 931 or 933, are subject to the tax
imposed by section 1 or 55. See §1.876–1.

Par. 6. Section 1.861–3T is removed.
Par. 7. Section 1.861–8 is amended
by adding paragraphs (f)(1)(vi)(E),
(f)(1)(vi)(F), (f)(1)(vi)(H), and (h) to read
as follows:

*****
(c) Effective/applicability date. * * *
Paragraph (b)(1)(iii) of this section applies
to taxable years ending after April 9, 2008.
Par. 9. Section 1.876–1 is revised to
read as follows:

§1.861–8 Computation of taxable income
from sources within the United States and
from other sources and activities.

§1.876–1 Alien residents of Puerto Rico,
Guam, American Samoa, or the Northern
Mariana Islands.

*****
(f) * * * (1) * * *

(a) Scope. Section 876 and this section
apply to any nonresident alien individual

954

2008–20 I.R.B.

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 under that section, 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 under that section.
(c) Exceptions. Though subject to the
tax imposed by section 1, an individual to
whom this section applies will nevertheless be treated as a nonresident alien individual for the purpose of many provisions of the Internal Revenue Code (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
Code (for example, 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 allow-

2008–20 I.R.B.

able to the extent provided under such sections 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
§1.937–1; and
(2) “Section 931 possession” is defined
in §1.931–1(c)(1).
(f) Effective/applicability date. This
section applies to taxable years ending after April 9, 2008.
§1.876–1T [Removed]
Par. 10. Section 1.876–1T is removed.
Par. 11. Section 1.881–1 is amended by
revising the last sentence of paragraph (c)
and the heading of paragraph (f) to read as
follows:
§1.881–1 Manner of taxing foreign
corporations.
*****
(c) * * * However, for special rules relating to possessions of the United States,
see §1.881–5.
*****
(f) Effective/applicability date. * * *
Par. 12. Section 1.881–5 is amended as
follows:

955

1. Revise paragraphs (a), (b), (c), (d),
(e), (f), (f)(1), (f)(2), (f)(3), (f)(5), (f)(6),
(f)(7), (g), (h), and (i).
2. Remove paragraph (f)(8).
The revisions read as follows:
§1.881–5 Exception for certain
possessions corporations.
(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
§1.884–0(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. Virgin Islands and section 931
possessions. A corporation created or organized in, or under the law of, the U.S.
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

May 19, 2008

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
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 (c)(3) of this section
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 §1.931–1(c)(1); and
(2) “Section 935 possession” is defined
in §1.935–1(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
under that section); 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.
*****
(5) Source. The rules of §1.937–2 will
apply for determining whether income is
from sources within a possession.
(6) Effectively connected income. The
rules of §1.937–3 (other than paragraph (c)

May 19, 2008

of that section) will 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) will apply except that the
language “5 percent” will 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 U.S. Virgin Islands—
(1) The rules of paragraphs (b) through
(d) of this section will not apply; and
(2) A corporation created or organized
in, or under the law of, such possession or
the United States will not be considered a
foreign corporation.
(h) Example. The principles of this section are illustrated by the following example:
Example. X is a corporation organized under the
law of the U.S. Virgin Islands 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 U.S. Virgin Islands 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 U.S.
Virgin Islands. Seventy-four percent of the stock of
X is owned by unrelated individuals who are residents
of the United States or the U.S. Virgin Islands. 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/applicability dates. Except
as otherwise provided in this paragraph (i),
this section applies to payments made in
taxable years ending after April 9, 2008.
If, on or after April 9, 2008, there takes
effect an increase in the Commonwealth
of Puerto Rico’s withholding tax 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, the rules of paragraphs (b)(2) and (e) of this section will not
apply to dividends received on or after the
effective date of the increase. Paragraph
(f)(4) of this section applies to payments
made after January 31, 2006. Taxpayers
may choose to apply paragraph (f)(4) of

956

this section to payments made after October 22, 2004.
Par. 13. Section 1.884–0 is amended by
revising paragraph (b) to read as follows:
§1.884–0 Overview of regulation
provisions for section 884.
*****
(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 U.S. Virgin Islands, provided that the conditions of
§1.881–5(c)(1) through (c)(3) are satisfied
with respect to such corporation. The preceding sentence applies for taxable years
ending after April 9, 2008.
(2) Section 884 does not apply for purposes of determining tax liability incurred
to a section 935 possession or the U.S. 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 9, 2008.
*****
§1.884–0T [Removed]
Par. 14. Section 1.884–0T is removed.
Par. 15. Section 1.901–1 is amended
by revising paragraph (g) and adding new
paragraph (j) to read as follows:
§1.901–1 Allowance of credit for taxes.
*****
(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 under that section) of
Puerto Rico during the entire taxable year
(see sections 901(b)(3) and (4)).
(4) A U.S. citizen or resident alien individual who is a bona fide resident of
a section 931 possession (as defined in
§1.931–1(c)(1)), the U.S. Virgin Islands,

2008–20 I.R.B.

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)).
*****
(j) Effective/applicability date. Paragraph (g) of this section applies to taxable
years ending after April 9, 2008.
§1.901–1T [Removed]
Par. 16. Section 1.901–1T is removed.
Par. 17. 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.
(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, will 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
performed as an employee of the United
States or any agency thereof. For purposes of section 931(d) and this section, an
employee of the government of a section
931 possession will not be considered an
employee of the United States or of an
agency of the United States.
(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 2008, D moves to
American Samoa, where he purchases a house and accepts a permanent position with a local employer. For
the remainder of the year and for the following three
taxable years, D continues to live and work in American Samoa and has a closer connection to American Samoa than to the United States or any foreign
country. Assuming that D otherwise meets the requirements under section 937(a) and §1.937–1(b) and
(f)(1) (year-of-move exception), D is considered a
bona fide resident of American Samoa for 2008. Accordingly, under section 931 and paragraph (a)(1) of
this section, D should exclude from his 2008 Federal
gross income any income from sources within American Samoa and any income that is effectively connected with the conduct of a trade or business within
American Samoa, as determined under section 937(b)
and §§1.937–2 and 1.937–3, as applicable.

2008–20 I.R.B.

(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 will 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
will 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 §1.937–1 will apply
for determining whether an individual is a
bona fide resident of a section 931 possession;
(4) The rules of §1.937–2 will apply
for determining whether income is from
sources within a section 931 possession;
and
(5) The rules of §1.937–3 will apply for
determining whether income is effectively
connected with the conduct of a trade or
business within a section 931 possession.
(d) Effective/applicability date. This
section applies to taxable years ending after April 9, 2008.
§1.931–1T [Removed]
Par. 18. Section 1.931–1T is removed.
Par. 19. Section 1.932–1 is revised to
read as follows:
§1.932–1 Coordination of United States
and Virgin Islands income taxes.
(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

957

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
will 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 §1.937–1 will apply
for determining whether an individual is a
bona fide resident of the Virgin Islands;
(ii) The rules of §1.937–2 will apply
for determining whether income is from
sources within the Virgin Islands; and
(iii) The rules of §1.937–3 will apply
for determining whether income is effectively connected with the conduct of a
trade or business within the Virgin Islands.
(b) U.S. individuals with Virgin Islands
income—(1) Dual filing requirement.
Subject to paragraph (d) of this section, an
individual described in paragraph (a)(2)(ii)
of this section must 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 U.S. 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 must 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) A credit against the tax imposed by
this chapter for the taxable year will be allowed in an amount equal to the taxes that
are required to be paid to the Virgin Is-

May 19, 2008

lands under paragraph (b)(2)(i) of this section and are so paid. Such taxes will be
considered creditable in the same manner
as taxes paid to the United States (for example, under section 31) and not as taxes
paid to a foreign government (for example,
under sections 27 and 901).
(iii) For purposes of this paragraph
(b)(2)—
(A) The term applicable percentage
means the percentage that 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 to such income. For
purposes of the preceding sentence, the
rules of §1.861–8 will apply; and
(C) Pursuant to §1.937–2(a), the rules
of §1.937–2(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 will be subject to
the following income tax return filing requirements:
(1) Virgin Islands filing requirements.
An individual to whom this paragraph (c)
applies must file an income tax return for
the taxable year with the Virgin Islands.
On this return, the individual must report
income from all sources and identify the
source of each item of income shown on
the return.
(2) U.S. filing requirements. (i) For purposes of calculating the income tax liability to the United States of an individual to
whom this paragraph (c) applies, gross income will 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 will not be taken
into account, provided that—
(A) The individual fully satisfied the
reporting requirements of paragraph (c)(1)
of this section; and
(B) The individual fully paid the tax
liability referred to in section 934(a) to the
Virgin Islands with respect to such income.
(ii) For purposes of the U.S. statute of
limitations under section 6501(a), an income tax return filed with the Virgin Islands by an individual who takes the posi-

May 19, 2008

tion that he or she is a bona fide resident
of the Virgin Islands described in paragraph (a)(2)(i) of this section (or an individual who files a joint return with such
an individual under paragraph (d) of this
section) will be deemed to be a U.S. income tax return, provided that the United
States and the Virgin Islands have entered
into an agreement for the routine exchange
of income tax information satisfying the
requirements of the Commissioner. The
working arrangement announced in Notice 2007–31 satisfies the condition of the
preceding sentence. See Notice 2007–31,
2007–16 I.R.B. 971, (applicable to taxable years ending on or after December 31,
2006, unless and until arrangement terminates). In the absence of such an agreement, individuals to whom this paragraph
(c) applies generally must file an income
tax return for the taxable year with the
United States to begin the period of limitations for Federal income tax purposes as
provided in section 6501(a), and in such
circumstances the Commissioner may by
revenue procedure, notice, or other administrative pronouncement specify U.S.
filing and other information reporting requirements for such individuals. For taxable years ending before December 31,
2006, the rules provided in section 3 of Notice 2007–19, 2007–11 I.R.B. 689, will apply. See §601.601(d)(2)(ii)(b).
(3) U.S. tax payments. In the case of
an individual who is required to file an
income tax return with the United States
as a consequence of failing to satisfy the
requirements of paragraphs (c)(2)(i)(A) or
(B) of this section, there will be allowed
as a credit against the tax imposed by this
chapter for the taxable year an amount
equal to the amount of the tax liability referred to in section 934(a) to the extent
paid to the Virgin Islands. Such taxes shall
be considered creditable in the same manner as taxes paid to the United States (for
example, under section 31) and not as taxes
paid to a foreign government (for example,
under sections 27 and 901).
(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 must 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

958

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 under that section
but without regard to community property
laws; and, if one of the spouses dies, the
taxable year of the surviving spouse will be
treated as ending on the date of such death.
(e) Place for filing returns—(1) U.S. returns. Except as otherwise provided for returns filed under paragraph (c)(4) of this
section, a return required under the rules of
paragraphs (b) and (c) of this section to be
filed with the United States must be filed
as directed in the applicable forms and instructions.
(2) Virgin Islands returns. A return required under the rules of paragraphs (b)
and (c) of this section to be filed with the
Virgin Islands must 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
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), the terms—
(i) 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;

2008–20 I.R.B.

(ii) 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; and
(iii) 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 (Code), the United
States generally will 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 Code.
(ii) Application of general rule. Contexts in which the general rule of paragraph
(g)(1)(i) of this section apply include—
(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 (for example, 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 will be treated as income

2008–20 I.R.B.

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 will be treated as a domestic
corporation and a shareholder to whom
section 932(a) applies will not be treated
as a nonresident alien individual with respect to such corporation. While such
an election is in effect, the corporation
will 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 taxable 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 carryback or carryover
was required to be filed with the Virgin Islands under section 932(c); and
(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 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 (for example, sections 931 through 937, 7651, and 7654).

959

(B) The determination of any aspect
of an individual’s residency (for example,
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 (for example, 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 (that is, mirrored
sections of the Code), the Virgin Islands
generally will be treated, in a geographical and governmental sense, as 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 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 (for example, 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 will be

May 19, 2008

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 will
be treated as a domestic corporation and
a shareholder to whom section 932(c)
applies will not be treated as a nonresident alien individual with respect to such
corporation. While such an election is in
effect, the corporation will 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 taxable 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 carryover 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; and
(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—

May 19, 2008

(A) The determination of any aspect
of an individual’s residency (for example,
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 (for example, 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); and
(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 (IRS)
but not with the Virgin Islands Bureau of
Internal Revenue (BIR), the Director of the
BIR or 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 IRS, the
Commissioner, at his discretion, may
deem the election also to have been made
for Federal tax purposes; and
(iii) If inconsistent entity status elections are filed with the BIR and the IRS,
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. 2006–23, 2006–1 C.B. 900,
(see §601.601(d)(2)(ii)(b) of this chapter)
for procedures for requesting the assistance of the IRS when a taxpayer is or may

960

be subject to inconsistent tax treatment by
the IRS 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 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) of this
chapter and under that section as mirrored
in the Virgin Islands, an eligible entity subject to this paragraph (h) will be classified
for both 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)
of this section will 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) of this section 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 will ap-

2008–20 I.R.B.

ply 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 will take effect for
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. For 2008, A files with the IRS a Form
1040, “U.S. Individual Income Tax Return,” reporting

adjusted gross income of $90x, which includes $30x
from sources in the Virgin Islands. The income tax
liability reported on A’s Form 1040 is $18x. A files
a copy of his Form 1040 with the Virgin Islands as
required by section 932(a)(2) and paragraph (b)(1) of
this section. A pays to the Virgin Islands the applicable percentage of his Federal income tax liability
as required by section 932(b) and paragraph (b)(2) of
this section, computed as follows:

$30x / $90x × $18x = $6x income tax liability to the Virgin Islands
(ii) A claims a credit in the amount of $6x against
his Federal income tax liability reported on his Form
1040. A attaches a Form 8689, “Allocation of Individual Income Tax to the U.S. Virgin Islands,” to the
Form 1040 filed with the IRS and to the copy filed
with the Virgin Islands.
Example 2. (i) B, a U.S. citizen, files returns on a
calendar year basis. In November 2008, B moves to
the Virgin Islands, purchases a house, and accepts a
permanent position with a local employer. For the remainder of the year and throughout 2009, B continues
to live and work in the Virgin Islands and has a closer
connection to the Virgin Islands than to the United
States or any foreign country. As a consequence of
his employment in the Virgin Islands, B earns income
from the performance of services in the Virgin Islands
during 2008 and 2009.
(ii) For 2008, B does not qualify as a bona fide
resident under section 937(a) and §1.937–1(b) and
(f)(1). Therefore, B is subject to the rules of sections 932(a) and (b) and paragraph (b) of this section for 2008 because he has income derived from

sources within the Virgin Islands as determined under the rules of section 937(b) and §1.937–2.
(iii) For 2009, assuming that B otherwise satisfies
the requirements of section 937(a) and §1.937–1(b),
B qualifies as a bona fide resident of the Virgin Islands. Therefore, section 932(c) and paragraph (c) of
this section apply to B for 2009, and he must file his
income tax return with the Virgin Islands under paragraph (c)(1) of this section. Provided that B fully satisfies the reporting requirements of paragraph (c)(1)
of this section and fully pays the tax liability referred
to in section 934(a), B will have no Federal income
tax filing requirement or liability under paragraphs
(c)(2) and (3) of this section.
Example 3. H and W are U.S. citizens. H resides
in State T and W is a bona fide resident of the Virgin
Islands. For 2008, H and W prepare a joint Form
1040, “U.S. Individual Income Tax Return,” reporting
total adjusted gross income of $75x, of which $40x
is attributable to compensation that W received for
services performed in the Virgin Islands and $35x to
compensation that H received for services performed
in State T. Pursuant to section 932(d) and paragraph

(d) of this section, because W would have the greater
adjusted gross income if computed separately, H and
W must file their joint Form 1040 with the Virgin
Islands as required by section 932(c) and paragraph
(c)(1) of this section. H and W may claim a tax credit
on such return for income tax withheld during 2008
and paid to the IRS.
Example 4. (i) The facts are the same as in Example 3, except that H also earns $25x for services
performed in the Virgin Islands, 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, because H would have the greater adjusted gross income if computed separately, H and W
must file their joint Form 1040 with the IRS and must
file a copy of that joint Form 1040 with the Virgin Islands as required by section 932(a)(2) and paragraph
(b)(1) of this section. H and W must pay the applicable percentage of their Federal income tax liability to
the Virgin Islands as required by section 932(b) and
paragraph (b)(2) of this section, computed as follows:

$65x / $100x × $20x = $13x income tax liability to the Virgin Islands
(iii) H and W claim a credit against their Federal
income tax liability reported on their joint Form 1040
in the amount of $13x, the portion of their Federal
income tax liability required to be paid to the Virgin
Islands. H and W attach a Form 8689, “Allocation of
Individual Income Tax to the U.S. Virgin Islands,” to
their joint Form 1040 filed with the IRS and to the
copy filed with the Virgin Islands.
Example 5. N, a U.S. citizen and calendar year
taxpayer, takes the position that he is a bona fide resident of the Virgin Islands for the 2007 taxable year.
On April 15, 2008, N files a Form 1040, “U.S. Individual Income Tax Return,” with the Virgin Islands
for his 2007 taxable year. N does not file a Form
1040 with the IRS. Because there is an agreement
in force between the United States and the Virgin
Islands for the routine exchange of income tax information, under paragraph (c)(2)(ii) of this section,
the Federal 3-year period of limitations under section
6501(a) will expire on April 15, 2011, and the IRS
will make no further assessment of income tax after
that date for N’s 2007 taxable year except as otherwise authorized by section 6501.
Example 6. (i) J is a U.S. citizen and a bona fide
resident of the Virgin Islands. In 2008, J receives
compensation for services performed as an employee
in the Virgin Islands in the amount of $40x. J files
with the Virgin Islands a Form 1040, “U.S. Individual

2008–20 I.R.B.

Income Tax Return,” reporting gross income of only
$30x. Based on these facts, J has not satisfied the
conditions of section 932(c)(4) and paragraph (c) of
this section for an exclusion from gross income for
Federal income tax purposes.
(ii) The facts are the same as in paragraph (i)
of this Example 6 except that on or before the last
day prescribed for filing an income tax return for J’s
2008 taxable year, J files with the Virgin Islands an
amended Form 1040 for 2008, correctly reporting the
full $40x of compensation. Provided that J otherwise
fully satisfies the reporting requirements of paragraph
(c)(1) of this section and fully pays the tax liability
referred to in section 934(a), J will have no Federal
income tax filing requirement or liability under paragraphs (c)(2) and (3) of this section.
Example 7. (i) N is a U.S. citizen and a bona fide
resident of the Virgin Islands. In 2008, N receives
compensation for services performed in Country M.
N files with the Virgin Islands a Form 1040, “U.S. Individual Income Tax Return,” reporting the compensation as income effectively connected with the conduct of a trade or business in the Virgin Islands. N
claims a special credit against the tax on this compensation pursuant to a Virgin Islands 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

961

§1.937–3(b), compensation for services performed
outside the Virgin Islands may not be treated as
income effectively connected with the conduct of a
trade or business in the Virgin Islands for purposes
of section 934(b). Consequently, N is not entitled
to claim the special credit under Virgin Islands law
with respect to N’s income from services performed
in Country M. Because 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 Federal income tax purposes. Therefore,
income reported on the Form 1040 as filed with the
Virgin Islands must be included in N’s Federal gross
income. Under paragraph (c)(3) of this section, the
amount of tax paid to the Virgin Islands on such income will be allowed as a credit against N’s Federal
income tax liability.

(j) Effective/applicability date. Except
as otherwise provided in this paragraph (j),
this section applies to taxable years ending
after April 9, 2008. Taxpayers may choose
to apply paragraph (c)(2)(ii) of this section
to open taxable years ending on or after
December 31, 2006.

May 19, 2008

§1.932–1T [Removed]
Par. 20. Section 1.932–1T is removed.
Par. 21. Section 1.933–1 is amended by
revising paragraphs (a), (c), (d), and (e) to
read as follows:
§1.933–1 Exclusion of certain income
from sources within Puerto Rico.
(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,
will 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. For
purposes of section 933 and this section,
an employee of the government of Puerto
Rico will not be considered an employee
of the United States or of an agency of the
United States.
(2) The following example illustrates
the application of the general rule in paragraph (a)(1) of this section:
Example. E, a United States citizen, files returns
on a calendar year basis. In April 2008, E moves to
Puerto Rico, where he purchases a house and accepts
a permanent position with a local employer. For the
remainder of the year and for the following three taxable years, E continues to live and work in Puerto
Rico and has a closer connection to Puerto Rico than
to the United States or any foreign country. Assuming
that E otherwise meets the requirements under section 937(a) and §1.937–1(b) and (f)(1) (year-of-move
exception), E is considered a bona fide resident of
Puerto Rico for 2008. Accordingly, under section
933(1) and paragraph (a)(1) of this section, E should
exclude from his 2008 Federal gross income any income from sources within Puerto Rico, as determined
under section 937(b) and §1.937–2.

*****
(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 will 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
will apply (with creditable expenditures
treated in the same manner as deductible
expenditures).

May 19, 2008

(d) Definitions. For purposes of this
section—
(1) The rules of §1.937–1 will apply
for determining whether an individual is a
bona fide resident of Puerto Rico; and
(2) The rules of §1.937–2 will apply
for determining whether income is from
sources within Puerto Rico.
(e) Effective/applicability date. Paragraphs (a), (c), (d), and (e) of this section
apply to taxable years ending after April 9,
2008.
§1.933–1T [Removed]
Par. 22. Section 1.933–1T is removed.
Par. 23. 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.
(a) General rule. Section 934(a) provides that tax liability incurred to the
United States Virgin Islands (Virgin Islands) must 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 (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 Virgin Islands 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

962

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 under that section.
(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 will 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 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.
(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, will 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
§1.937–1 will apply for determining
whether an individual is a bona fide resident of the Virgin Islands;
(ii) Source. The rules of §1.937–2 will
apply for determining whether income is
from sources within the Virgin Islands; and
(iii) Effectively connected income. The
rules of §1.937–3 will apply for determining whether income is effectively

2008–20 I.R.B.

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 that is derived
from sources outside the United States and
that 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 one
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 that is derived

from sources outside the United States and
that is not effectively connected with the
conduct of a trade or business within the
United States will 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 that is
derived from sources outside the United
States and that 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.
(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 Federal
income tax purposes under section 906 of
the Code).
(ii) Limitation. Tax liability incurred to
the Virgin Islands attributable 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 within the United States, as computed in this paragraph (c)(3), however,
will 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 under those provisions will
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 will
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 Virgin Islands. For 2008, S files a
Form 1040INFO, “Non-Virgin Islands Source Income
of Virgin Islands Residents,” with the Virgin Islands
on which S reports total gross income as follows:

Compensation for services performed in the Virgin Islands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Compensation for services performed in the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Compensation for services performed in Mexico . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income from inventory sales in Latin America attributable to Virgin Islands office. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest on a U.S. bank account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest on a V.I. bank account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends from a U.S. corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(ii) Accordingly, S has total gross income of
$155,000, comprising income from sources within
the Virgin Islands or effectively connected to the
conduct of a trade or business in the Virgin Islands (Virgin Islands ECI) of $75,000, income from
sources within the United States of $50,000, and income from other sources (not Virgin Islands 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 sources within the
Virgin Islands, $15,000 is taxable income from other

sources that is Virgin Islands ECI under the rules
of section 937(b) and §§1.937–2 and 1.937–3, and
$22,500 is taxable income from sources outside the
Virgin Islands (and outside the United States) that is
not Virgin Islands ECI. S’s tax liability incurred to the
Virgin Islands pursuant to the Internal Revenue Code
as applicable in the Virgin Islands (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.

$50,000
40,000
30,000
20,000
6,000
5,000
4,000

(iii) Pursuant to a Virgin Islands 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 Virgin Islands. 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) × (($45,000 + $15,000) / $120,000)] - [$10,000 × ($15,000 / ($15,000 + $22,500))] = [$30,000 × ($60,000 /
$120,000)] - [$10,000 × ($15,000 / $37,500)] = ($30,000 × 0.5) - ($10,000 × 0.4) = $15,000 - $4,000 = $11,000
(iv) Accordingly, S’s net tax liability incurred to
the Virgin Islands must be at least $19,000 ($30,000 $11,000), prior to taking into account any foreign tax
credit.

2008–20 I.R.B.

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 Virgin Islands a copy of his Federal
income tax return and pays to the Virgin Islands the

963

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 Virgin
Islands law relating to business activities like his in

May 19, 2008

the Virgin Islands to reduce any of his tax liability
payable to the Virgin Islands under section 932(b).
Example 3. (i) Z is a nonresident alien who resides in Country FC. In 2008, Z receives dividends
from a corporation organized under the law of the Virgin Islands in the amount of $90x. Z’s tax liability incurred to the Virgin Islands pursuant to section 871(a)
of the Code as applicable in the Virgin Islands (mirror
code) is $27x.
(ii) Pursuant to a Virgin Islands 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 Virgin Islands. 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 Virgin Islands law, Z’s

net tax liability incurred to the Virgin Islands may be
reduced or eliminated entirely.
Example 4. (i) A Corp is organized under the laws
of the Virgin Islands 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 Virgin Islands. During 2008, A Corp had $50x in gross income from sources within the Virgin Islands (as determined under section 937(b) and §1.937–2) 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 Virgin Islands
to reduce or remit the income tax liability of a qualified foreign corporation arising under the Code as
applicable in the Virgin Islands (mirror code) with re-

spect 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 Virgin Islands 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 Virgin Islands.
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 Virgin Islands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. citizens who are not bona fide residents of the Virgin Islands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonresident aliens who are bona fide residents of the Virgin Islands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonresident aliens who are not bona fide residents of the Virgin Islands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(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 Virgin Islands may reduce or remit A Corp’s mirror code income tax liability with respect to its $50x
in gross income from sources within the Virgin Islands 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 Virgin Islands
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.

(e) Effective/applicability date. This
section applies for taxable years ending after April 9, 2008.
§1.934–1T [Removed]
Par. 24. Section 1.934–1T is removed.
Par. 25. Section 1.935–1 is amended
by revising paragraphs (a), (b)(1), (b)(3),
(b)(5), (b)(6), (b)(7), (c), (d), (e), (f), and
(g) to read as follows:
§1.935–1 Coordination of individual
income taxes with Guam and the Northern
Mariana Islands.
(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,

May 19, 2008

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
applies 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, the following definitions apply:
(i) The term section 935 possession
means Guam or the Northern Mariana
Islands, unless such possession has entered into an implementing agreement, as

964

5%
3%
42%
50%

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;
(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; and
(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 §1.937–1 will apply
for determining whether an individual is a
bona fide resident of a section 935 possession.
(iv) The rules of §1.937–2 generally
will apply for determining whether income
is from sources within a section 935 possession. Pursuant to §1.937–2(a), however, the rules of §1.937–2(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

2008–20 I.R.B.

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 must 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—
(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.
*****
(3) Place for filing returns—(i) U.S. returns. A return required under this paragraph (b) to be filed with the United States
must 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 must 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 must be filed as
directed in the applicable forms and instructions.
*****

2008–20 I.R.B.

(5) Tax payments. The tax shown on
the return must be paid to the jurisdiction
with which such return is required to be
filed and must 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) [Reserved].
(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 (Code), the United States generally will 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 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 posses-

965

sion 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 (for example, 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 will 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 will be treated as a domestic corporation and a U.S. taxpayer
shareholder will not be treated as a nonresident alien individual with respect to such
corporation. While such an election is in
effect, the corporation will be treated as a
domestic corporation for all purposes of
the Code. For the consistency requirement
with respect to entity status elections, see
paragraph (e) of this section;
(D) The treatment of items carried over
from other taxable 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; and
(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

May 19, 2008

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 (for example, sections 931 through 937, 7651, and 7654);
(B) The determination of any aspect
of an individual’s residency (for example,
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 (for example, sections 935, 937,
and 7654). Thus, for example, income
determined to be derived from sources
within the relevant possession under section 937(b) will 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 (CNMI)”;
(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); and
(E) The characterization of a corporation for purposes other than subchapter S (for example, 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).

May 19, 2008

(2) Application in relevant possession.
In applying the territorial income tax of the
relevant possession, such possession generally will 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 Guam 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
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

966

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 must 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 must 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 determined under section 6654, will 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 (IRS)
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 filed with
the relevant possession but not with the
IRS, the Commissioner, at his discretion,
may deem the election also to have been
made for Federal tax purposes; and

2008–20 I.R.B.

(iii) If inconsistent entity status elections are filed with the relevant possession
and the IRS, 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. 2006–23, 2006–1 C.B. 900, (see
§601.601(d)(2)(ii)(b) of this chapter) for
procedures for requesting the assistance
of the IRS when a taxpayer is or may be
subject to inconsistent tax treatment by the
IRS 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 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
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; and
(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) of this
chapter and under that section as mirrored
in the relevant possession, an eligible entity subject to this paragraph (e) will be
classified for both 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 will apply as of the first
day of the first taxable year of the entity
beginning after April 11, 2005.

2008–20 I.R.B.

(ii) In the unlikely circumstance that inconsistent elections described in paragraph
(e)(1)(iii) of this section 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 will 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 will take effect for
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.
(f) Examples. The application of this
section is illustrated by the following examples:
Example 1. (i) B, a United States citizen, files returns on a calendar year basis. In November 2008, B
moves to Possession G, a section 935 possession; purchases a house; and accepts a permanent position with
a local employer. For the remainder of the year and
throughout 2009, B continues to live and work in Possession G and has a closer connection to Possession
G than to the United States or any foreign country.
As a consequence of his employment in Possession
G, B earns income from the performance of services
in Possession G during 2008 and 2009.
(ii) For 2008, B does not qualify as a bona fide
resident of Possession G under section 937(a) and
§1.937–1(b) and (f)(1). Therefore, B is subject to
the rules applicable to individuals described in paragraph (a)(2)(iii) of this section for 2008 because he
has income derived from sources within Possession
G as determined under the rules of section 937(b) and
§1.937–2.
(iii) For 2009, assuming that B otherwise satisfies
the requirements of section 937(a) and §1.937–1(b),
B qualifies as a bona fide resident of Possession
G. Therefore, section 935(b)(1)(B) and paragraph
(b)(1)(ii) of this section apply to B for 2009, and he
must file his income tax return with Possession G
under paragraph (b)(1) of this section. Provided that
B properly files such return and pays his income tax
liability to Possession G, B is relieved of liability to
file an income tax return with, and to pay an income

967

tax to, the United States for 2009 under paragraph
(b)(6) of this section.
Example 2. (i) The facts are the same as in Example 1 except that B’s employment terminates in June
2011. B properly pays his April 2008 estimated tax to
the United States, continues to pay estimated tax for
the 2008 taxable year to the United States under paragraph (d) of this section, and properly files his 2008
return with the United States.
(ii)(A) On the date of each payment of estimated
tax in 2009, B reasonably believes that he would be
required to file his return for 2009 with Possession G
under paragraph (b)(1) of this section.
(B) In August 2009, B determines that he has
overpaid tax for the previous year in the amount of
$1,000. B properly pays all estimated taxes to Possession G for 2009, subtracting the $1,000 overpayment
from his estimated tax payments pursuant to section
6402(b), and properly files his tax return with Possession G.
(iii) In April 2010, B reasonably believes that
he would be returning to the United States in the
Fall of 2010, and properly pays estimated tax to the
United States. By June 2010, 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 2010
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.
(iv) In April 2011, B reasonably believes that he
would be a bona fide resident of Possession G for
the entire taxable year 2011 and properly pays estimated taxes to Possession G. By the time B pays his
estimated taxes for June 2011, 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 2011, properly filed with the
United States, B determines that he has underpaid estimated taxes throughout 2011 in an amount subject to
penalty under section 6654. B owes the United States
an estimated tax penalty under section 6654.

(g) Effective/applicability date. Paragraphs (a), (b)(1), (b)(3), (b)(5) through
(b)(7), and (c) through (f) of this section
apply to taxable years ending after April 9,
2008.
§1.935–1T [Removed]
Par. 26. Section 1.935–1T is removed.
Par. 27. Section 1.937–1 is amended by
revising paragraph (h)(3) and the heading
of paragraph (i) to read as follows:
§1.937–1 Bona fide residency in a
possession.
*****
(h)(3) Bona fide residents of Puerto
Rico or a section 931 possession (as
defined in §1.931–1(c)(1)) who take a
position for U.S. tax reporting purposes
that they qualify as bona fide residents

May 19, 2008

of that 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 U.S. Virgin Islands
or a section 935 possession (as defined in
§1.935–1(a)(3)(i)).
(i) Effective/applicability date. * * *
Par. 28. Section 1.937–2 is added to
read as follows:
§1.937–2 Income from sources within a
possession.
(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 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 under those provisions (relating to the determination of
the gross and the taxable income from
sources within and without the United
States) generally will be applied in determining the gross and the taxable income
from sources within and without the relevant possession. In the application of
such principles, it generally will be sufficient to substitute, where appropriate,
the name of the relevant possession for
the term “United States,” and to substitute, where appropriate, the term “bona
fide resident of” followed by the name
of the relevant possession for the term

May 19, 2008

“United States resident.” Furthermore,
the term domestic will be construed to
mean created or organized in the relevant
possession. In applying these principles,
additional substitutions may be necessary
to accomplish the intent of section 937(b)
and this section. For example, in applying
the principles of sections 863(d) and (e) to
individuals under this paragraph (b), the
term “bona fide resident of a possession”
will be used instead of the term “United
States person.” In no case, however, will
a bona fide resident or other person have,
as a result of the application of these principles, more income from sources within
the relevant possession than the amount
of income from sources within the United
States that a similarly situated U.S. person
who is not a bona fide resident would have
under sections 861 through 865.
(c) U.S. income—(1) In general. Except as provided in paragraph (d) of this
section, income from sources within the
relevant possession will not include any
item of income determined under the rules
of sections 861 through 865 and the regulations under those provisions 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 will
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).
(e) Service in the Armed Forces. In the
case of a member of the Armed Forces of
the United States, the following rules will
apply for determining the source of compensation for services performed in compliance with military orders:

968

(1) 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).
(2) 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) Except to the extent an election is made under paragraph (f)(1)(vi) of
this section, income from sources within
the relevant possession will 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 the Tax Reform Act
of 1986, Public Law 99–514 (100 Stat.
2085) (providing that gains from the disposition of certain property by individuals
who acquired residency in certain possessions will 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
(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 trans-

2008–20 I.R.B.

action 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 will 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
will 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.
(vi) Notwithstanding the general rule
of paragraph (f)(1)(i) of this section and
section 1277(e) of the Tax Reform Act
of 1986, Public Law 99–514 (100 Stat.
2085), an individual described in paragraph (f)(1)(iii) of this section may elect
to treat as gain from sources within the
relevant possession the portion of the gain
attributable to the individual’s possession holding period. The election under
this paragraph (f)(1)(vi) will be considered made if the individual’s income tax
return for the year of disposition of the
property reports the portion of gain attributable to the taxpayer’s possession holding period as determined in accordance
with paragraph (f)(1)(vi)(A) or paragraph
(f)(1)(vi)(B) of this section, as the case
may be.
(A) In the case of marketable securities,
the portion of gain attributable to the possession holding period will be determined
by reference to the fair market value of the
marketable security at the close of the market on the first day of the individual’s possession holding period. In the event that
the individual is a bona fide resident of the
relevant possession for more than a single
continuous period, the portion of gain described in this paragraph (f)(1)(vi)(A) will
be the aggregate of the portions of gain (or
offsetting loss) attributable to each possession holding period.
(B) In the case of property other than
marketable securities, the portion of gain
attributable to the possession holding pe-

2008–20 I.R.B.

riod in the relevant possession will be determined by multiplying the total gain on
disposition of the property by a fraction,
the numerator of which is the number of
days in the possession holding period and
the denominator of which is the total number of days in the individual’s holding period for the property. For purposes of the
preceding sentence, in the event that the
individual is a bona fide resident of the
relevant possession for more than a single
continuous period, the number of days in
the numerator will be the aggregate of the
number of days in each possession holding period. For purposes of this paragraph
(f)(1)(vi)(B), the denominator will include
days that are required to be included in an
individual’s holding period under section
735(b), section 1223, and any other applicable holding period rule in the Internal
Revenue Code.
(vii) For purposes of paragraph
(f)(1)(vi) of this section—
(A) The term marketable securities
means property described in paragraph
(f)(1)(ii) of this section that is, throughout the individual’s holding period, actively traded within the meaning of
§1.1092(d)–1(a); and
(B) The term possession holding period
means the part of the individual’s holding
period for the property during which the
individual is a bona fide resident of the relevant possession. However, for this purpose, the possession holding period will
be considered to commence in all cases on
the first day during such period that the
individual does not have a tax home outside the relevant possession. In the event
that the individual is a bona fide resident
of the relevant possession for more than a
single continuous period, each possession
holding period prior to the one ending on
the date of sale or other disposition will be
considered to end on the first day that the
individual has a tax home outside the relevant possession. With respect to the determination of tax home, see §1.937–1(d).
(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) will be considered income from sources within Puerto
Rico; and
(B) Gain that is considered to be derived
from sources outside of the United States

969

under section 865(h)(2)(B) will 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 under that section
pursuant to paragraph (b) of this section,
the rules of section 865(g) will not apply,
but the special rule of section 865(h)(2)(B)
will 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 possessions source ratio of any dividend paid
or accrued by a corporation created or organized in a possession (possessions corporation) will be treated as income from
sources within such possession. For purposes of this paragraph (g)—
(A) The possessions source ratio will be
a fraction, the numerator of which is 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 is 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 will
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 §1.937–3);
and
(B) 50 percent or more of the gross income of the corporation for the testing pe-

May 19, 2008

riod 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 will be treated as if
it—
(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 under that section
pursuant to paragraph (b) of this section,
the special rules relating to dividends for
which deductions are allowable under section 243 or 245 will 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) will 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 will 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 will
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 will 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 §1.937–3). For purposes of the preceding sentence, the principles of §§1.861–9 through 1.861–12 will
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 will 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 will
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 will 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)
will apply except that the language “5 percent” will 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:
Example 1. (i) X, a U.S. citizen, resides in State
N and acquires stock of Corporation C, a domestic
corporation, in 2008 for $10x. X moves to the Northern Mariana Islands (NMI) on March 1, 2009 and
changes his principal place of business to NMI on that
same date. Assume for purposes of this example that,

under §1.937–1(b) and (f)(1) (year-of-move exception), X is considered a bona fide resident of NMI for
2009 through 2012. On March 1, 2009, the closing
value of X’s stock in Corporation C, a marketable security (within the meaning of paragraph (f)(1)(vii)(A)
of this section), is $20x. On January 3, 2012, X sells
all his Corporation C stock for $70x.
(ii) Pursuant to section 1277(e) of the Tax Reform
Act of 1986, and absent an election under paragraph
(f)(1)(vi) of this section, all of X’s gain ($60x) will
be 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 (under paragraph (f)(1)(i) of this section) not as income from sources in the NMI. However, pursuant to paragraph (f)(1)(vi) of this section,
X may elect on his 2012 income tax return filed with
NMI to treat the portion of this gain attributable to
X’s possession holding period with respect to NMI as
gain from sources within NMI. X’s possession holding period with respect to NMI begins on March 1,
2009, the date his tax home changes to the NMI. Under paragraph (f)(1)(vi)(A) of this section, the portion
of X’s gain attributable to this possession holding period is $50x, the excess of the sale price of the stock
($70x) over its closing value ($20x) on the first day of
the possession holding period. By reporting $50x of
gain on his 2012 NMI return, X will elect under paragraph (f)(1)(vi) of this section to treat that amount as
NMI source income.
Example 2. (i) R, a U.S. citizen, resides in State F
and acquires a 5 percent interest in Partnership P on
January 1, 2009. R moves to Puerto Rico on June 1,
2010 and changes her principal place of business to
Puerto Rico on that same date. Assume for purposes
of this example that under §1.937–1(b) and (f)(1)
(year-of-move exception), R is considered a bona fide
resident of Puerto Rico for 2010 through 2012. On
June 1, 2010, R’s interest in Partnership P is not a
marketable security within the meaning of paragraph
(f)(1)(vii)(A) of this section. On December 31, 2012,
having owned the interest in Partnership P for a period of 4 years (1461 days), R sells it, recognizing
gain of $100x.
(ii) Pursuant to paragraph (f)(1) of this section,
and absent an election under paragraph (f)(1)(vi) of
this section, the gain will not be treated as income
from sources within Puerto Rico for purposes of the
Internal Revenue Code (including section 933(1)).
However, pursuant to paragraph (f)(1)(vi) of this section, R may elect on her 2012 return filed with the
IRS to treat the portion of this gain attributable to R’s
possession holding period with respect to Puerto Rico
as gain from sources within Puerto Rico. R’s possession holding period with respect to Puerto Rico is the
945-day period from June 1, 2010, the date her tax
home changes to Puerto Rico, through December 31,
2012, the date of sale. Under paragraph (f)(1)(vi)(B)
of this section, the portion of R’s gain attributable to
this possession holding period is $64.68x, computed
as follows:

$100x gain × 945 days in possession holding period
1461 days in total holding period

May 19, 2008

970

2008–20 I.R.B.

(iii) By reporting $64.68x of gain on her 2012
Federal return, R will elect under paragraph (f)(1)(vi)
of this section to treat that amount as Puerto Rico
source income.
Example 3. X, a bona fide resident of Possession S, a section 931 possession (as defined in
§1.931–1(c)(1)), is engaged in a trade or business
in the United States through an office in State H.
In 2008, this office materially participates in the

2008
2009
2010
(ii) A Corp owns 50 percent of the outstanding
shares of B Corp, a corporation organized under the

2008
2009
2010
(iii) A Corp is treated as having received 50 percent of the gross income of B Corp. Therefore, for

2008
2009
2010
Totals
(iv) Pursuant to paragraph (g) of this section, the
portion of the dividend of $70x that X receives from
Corp A in 2010 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 2008, 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. 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. Under the principles of section
863(d)(1)(A) as applied pursuant to paragraph (b)
of this section, the compensation that X receives for
services performed in international waters is treated
as income from sources within the NMI for purposes
of the Internal Revenue Code (including section
7654, as in effect with respect to the NMI). Thus,
all of X’s compensation for services during 2008 is
treated as income from sources within the NMI.
Example 6. X, a U.S. citizen, resides in State L
and receives $2,500 of compensation for services performed in Possession J during 2008 for Y, X’s employer. X is temporarily present in Possession J in
2008 for a period (or periods) not exceeding a total
of 90 days. Y, a U.S. citizen, is not a bona fide resident of Possession J and is not engaged in a trade or
business within Possession J. Under the principles of

2008–20 I.R.B.

sale of inventory property in Possession S, 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 will not be treated as income from sources
within Possession S for purposes of section 931(a)(1)
pursuant to paragraph (c)(1)(ii) of this section, but
nonetheless will continue to be treated as income

Possession I Sources
$10x
20x
25x

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 2010, X receives a dividend of $70x
from A Corp. During 2008 through 2010, A Corp has
gross income from the following sources:

Sources Outside Possession I
$20x
10x
15x

laws of Country FC. During 2008 through 2010, B
Corp has gross income from the following sources:

Possession I Sources
$10x
14x
10x

Sources Outside Possession I
$6x
8x
4x

2008 through 2010, the gross income of A Corp is
from the following sources:

Possession I Sources
$15x
27x
30x
$72x
section 861(a)(3) as applied pursuant to paragraph (b)
of this section, the compensation that X receives for
services performed in Possession J during 2008 is not
treated as income from sources within Possession J.
Example 7. (i) Company Y, a corporation organized in State C, produces, markets, and distributes
music products. Y enters into a recording contract
with Z, a recording artist who is a bona fide resident
of the U.S. Virgin Islands (USVI). Pursuant to the
contract between Y and Z, Z agrees to perform services as writer, musician, and vocalist on the recording of a new musical composition and related music
video. Under the contract, all songs, recordings and
related artwork, packaging copy, and liner notes, together with copyrights and other intellectual property
in those works, are the sole property of Y, and Z obtains no proprietary rights in that property. As compensation for Z’s services, all of which are performed
at a recording studio or other locations in the USVI,
Y agrees to pay amounts designated as the “writer’s
share” to Z based on a percentage of the music products sold. Y also agrees to make an upfront payment to Z as an advance against future portions of
Z’s writer’s share.
(ii) To the extent that Z performs personal services within the USVI, the compensation that Z receives for his services is sourced to the USVI under
the principles of section 861(a)(3) and §1.861–4 as
applied pursuant to §1.937–2(b). If all of Z’s services
are performed in the USVI, none of the writer’s share
is derived from sources within the United States under section 861(a)(3) and §1.861–4, nor is it effec-

971

Sources Outside Possession I
$23x
14x
17x
$54x
tively connected with the conduct of a trade or business in the United States under section 864(c)(3). Accordingly, the U.S. income rule of section 937(b)(2)
and paragraph (c)(1) of this section would not operate to prevent Z’s services income from being USVI
source or USVI effectively connected income within
the meaning of section 937(b)(1). If Z also performs
services in the United States, however, then the U.S.
income rule would apply to the part of Z’s compensation that is sourced to the United States under section 861(a)(3) and §1.861–4. In the event that Y
and Z are controlled taxpayers within the meaning of
§1.482–1(i)(5), section 482 and the regulations under
that section, including §1.482–9T(i), would apply to
evaluate the arm’s length amount charged for Z’s controlled services.

(l) Effective/applicability dates. Except
as otherwise provided in this paragraph (l),
this section applies to income earned in
taxable years ending after April 9, 2008.
Taxpayers may choose to apply paragraph
(b) of this section to income earned in
open taxable years ending after October
22, 2004. Taxpayers may choose to apply
paragraph (f)(1) of this section to dispositions made after April 11, 2005.
§1.937–2T [Removed]
Par. 29. Section 1.937–2T is removed.

May 19, 2008

Par. 30. Section 1.937–3 is added to
read as follows:
§1.937–3 Income effectively connected
with the conduct of a trade or business in
a possession.
(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
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 under that section (relating to the determination of income, gain or loss that is
effectively connected with the conduct of a
trade or business within the United States)
generally will be applied in determining
whether income is effectively connected
with the conduct of a trade or business
within the relevant possession, without regard to whether the taxpayer qualifies as
a nonresident alien individual or a foreign
corporation with respect to such possession. Subject to the rules of this section,
the principles of section 864(c)(4) will apply for purposes of determining whether
income from sources without the relevant
possession is effectively connected with
the conduct of a trade or business in the
relevant possession. For purposes of the
preceding sentence, all income other than
income from sources within the relevant
possession (as determined under the rules
of §1.937–2) will be considered income
from sources without the relevant possession in the application of the principles of
section 864(c) under this paragraph (b), it
generally will be sufficient to substitute
the name of the relevant possession for the
term “United States” where appropriate,
but additional substitutions may be nec-

May 19, 2008

essary to accomplish the intent of section
937(b) and this section. In no case, however, will a bona fide resident or other person have, as a result of the application of
these principles, more income effectively
connected with the conduct of a trade or
business in the relevant possession than the
amount of U.S. effectively connected income that a similarly situated U.S. person
who is not a bona fide resident would have
under section 864(c).
(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 will not include any item of income
determined under the rules of sections
861 through 865 and the regulations under
those provisions 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 will
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
will 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
§1.931–1(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

972

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 §1.937–2(b), interest payments
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 will 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 will 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

2008–20 I.R.B.

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.
Example 4. (i) Corporation A, a corporation organized in Possession X, is engaged in a business consisting of the development of computer software and
the sale of that software. Corporation A has its sole
place of business in Possession X and is not engaged
in the conduct of a trade or business in the United
States. Corporation A receives orders for its software from customers in the United States and around
the world. After orders are accepted, Corporation
A’s software is either loaded onto compact discs at
Corporation A’s Possession X facility and shipped
via common carrier, or downloaded from Corporation
A’s server in Possession X. The sales contract provides that the rights, title, and interest in the product
will pass from Corporation A to the customer either
at Corporation A’s place of business in Possession X
(if shipped in compact disc form) or at Corporation
A’s server in Possession X (if electronically downloaded). Assume for purposes of this example that
each transaction is classified as a sale of a copyrighted
article under §1.861–18(c)(1)(ii) and (f)(2).
(ii) Under the principles of section 863(a), as applied pursuant to §1.937–2(b), because Corporation
A passes the rights, title, and interest to the copyrighted articles in Possession X, Corporation A’s sales
income is sourced to Possession X. Corporation A’s
sales income is also effectively connected with the
conduct of a trade or business in Possession X, under
the principles of section 864(c)(3) as applied pursuant
to §1.937–3(b). Corporation A’s income is not from
sources within the United States, nor is it effectively
connected with the conduct of a trade or business in
the United States. Accordingly, the U.S. income rule
of section 937(b)(2), §1.937–2(c)(1), and paragraph
(c)(1) of this section does not operate to prevent Corporation A’s sales income from being Possession X
source and Possession X effectively connected income under section 937(b)(1).
Example 5. (i) Corporation B, a corporation organized in Possession X, has its sole place of business
in Possession X and is not engaged in the conduct of a
trade or business in the United States. Corporation B
employs a software business model generally referred
to as an application service provider. Employees of
Corporation B in Possession X develop software and
maintain it on Corporation B’s server in Possession X.
Corporation B’s customers in the United States and
around the world transmit detailed data about their
own customers to Corporation B’s server and electronic storage facility in Possession X. The customers
pay a monthly fee to Corporation B under a Subscription Agreement, and they can use the software to generate reports analyzing the data at any time but do not
receive a copy of the software. Corporation B’s soft-

2008–20 I.R.B.

ware allows its customers to generate the reports from
their location and to keep track of their relationships
with their own customers. Assume for purposes of
this example that Corporation B’s income from these
transactions is derived from the provision of services.
(ii) Under the principles of section 861(a)(3) and
§1.861–4(a), as applied pursuant to §1.937–2(b),
because Corporation B performs personal services
wholly within Possession X, the compensation
Corporation B receives for services is sourced to
Possession X. Corporation B’s services income is
also effectively connected with the conduct of a trade
or business in Possession X, under the principles of
section 864(c)(3) as applied pursuant to §1.937–3(b).
Corporation B’s income is not from sources within
the United States, nor is it effectively connected
with the conduct of a trade or business in the United
States. Accordingly, the U.S. income rule of section
937(b)(2), §1.937–2(c)(1), and paragraph (c)(1) of
this section does not operate to prevent Corporation
B’s services income from being Possession X source
or Possession X effectively connected income within
the meaning of section 937(b)(1).

(f) Effective/applicability date. Except
as otherwise provided in this paragraph (f),
this section applies to income earned in
taxable years ending after April 9, 2008.
Taxpayers may choose to apply paragraph
(b) of this section to income earned in
open taxable years ending after October
22, 2004.
§1.937–3T [Removed]
Par. 31. Section 1.937–3T is removed.
Par. 32. Section 1.957–3 is revised to
read as follows:
§1.957–3 United States person defined.
(a) Basic rule—(1) In general. The
term United States person has the same
meaning for purposes of sections 951
through 965 that it has under section
7701(a)(30) and the regulations under that
section, 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.”

973

(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 Puerto Rico or any section 931 possession;
(ii) The term section 931 possession
has the same meaning that it has under
§1.931–1(c)(1);
(iii) The rules of §1.937–1 will apply
for determining whether an individual is a
bona fide resident of a possession of the
United States;
(iv) Except as provided in paragraph
(b)(2) of this section, the rules of §1.937–2
will apply for determining whether income
is from sources within a possession of the
United States; and
(v) The rules of §1.937–3 will 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) will 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 that 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. For purposes of this paragraph (b)(2), the rules of §1.937–2(g)(1)
will not apply.
(c) Section 931 possession corporation
and resident. An individual (who, without regard to this paragraph (c), is a United
States person) will 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 that 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

May 19, 2008

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.
(d) Effective/applicability date. This
section applies to taxable years ending after April 9, 2008.
§1.957–3T [Removed]
Par. 33. Section 1.957–3T is removed.
Par. 34. Section 1.1402(a)–12 is revised to read as follows:
§1.1402(a)–12 Continental shelf and
certain possessions of the United States.
(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)
will 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/applicability date. This
section applies to taxable years ending after April 9, 2008.
§1.1402(a)–12T [Removed]
Par. 35. Section 1.1402(a)–12T is removed.
Par. 36. Section 1.6012–1 is amended
by revising paragraph (a)(1)(iii) to read as
follows:

May 19, 2008

§1.6012–1 Individuals required to make
returns of information.
(a) * * * (1) * * *
(iii) An alien bona fide resident of
Puerto Rico or any section 931 possession,
as defined in §1.931–1(c)(1), during the
entire taxable year.
*****
Par. 37. Section 1.6038–2 is amended
by revising paragraph (d) and adding a new
sentence at the end of paragraph (m) to
read as follows:
§1.6038–2 Information returns required
of United States persons with respect to
annual accounting periods of certain
foreign corporations.
*****
(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.—(i) With respect to
an individual who is a bona fide resident of
Puerto Rico, the term United States person
has the meaning assigned to it by §1.957–3
except that the rules of §1.937–2(g)(1) will
apply.
(ii) With respect to an individual who is
a bona fide resident of any section 931 possession, as defined in §1.931–1(c)(1), the
term United States person has the meaning
assigned to it by §1.957–3.
(3) Special rule for certain nonresident
aliens. An individual for whom an election under section 6013(g) or (h) is in effect
will, 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.
*****
(m) * * * Paragraph (d) of this section
applies to taxable years ending after April
9, 2008.

§1.6046–1 Returns as to organization or
reorganization of foreign corporations
and as to acquisitions of their stock.
*****
(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.—(A) With respect to an individual who is a bona fide
resident of Puerto Rico, the term United
States person has the meaning assigned
to it by §1.957–3 except that the rules of
§1.937–2(g)(1) will apply.
(B) With respect to individuals who are
bona fide residents of any section 931 possession, as defined in §1.931–1(c)(1), the
term United States person has the meaning
assigned to it by §1.957–3.
(iii) Special rule for certain nonresident
aliens. An individual for whom an election under section 6013(g) or (h) is in effect
will, 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.
*****
(l) Effective/applicability date. Paragraph (f)(3) of this section applies to taxable years ending after April 9, 2008.
§1.6046–1T [Removed]
Par. 40. Section 1.6046–1T is removed.
PART 301—PROCEDURE AND
ADMINISTRATION
Par. 41. The authority citation for part
301 continues to read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 42. 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.

§1.6038–2T [Removed]
Par. 38. Section 1.6038–2T is removed.
Par. 39. Section 1.6046–1 is amended
by revising paragraph (f)(3) and adding a
new paragraph (l) to read as follows:

974

(a) In general. Each individual described in section 7654(a) who is subject
to an information reporting requirement
promulgated under the authority of section 937(c) or 7654 and who fails to fully

2008–20 I.R.B.

satisfy such requirement within the time
prescribed for reporting such information
must, in addition to any criminal penalty
provided by law, pay a penalty of $1,000
for each such failure. Information reporting requirements promulgated under the
authority of sections 937(c) and 7654(e)
include the requirement for an individual
to file Form 8898, “Statement for Individuals who Begin or End Bona Fide Residence
in a U.S. Possession,” under §1.937–1(h)
of this chapter, to report that he or she became or ceased to be a bona fide resident
of a possession.
(b) Manner of payment. The penalty set
forth in paragraph (a) of this section must
be paid in the same manner as tax upon
the issuance of a notice and demand for the
penalty.
(c) Reasonable cause. The penalty set
forth in paragraph (a) of this section will
not apply if it is established to the satisfaction of the Commissioner 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. This
statement must be filed with the Internal
Revenue Service Center where Form 8898
must be filed. 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.
(d) Effective/applicability date. This
section applies to taxable years ending after April 9, 2008.

2008–20 I.R.B.

Linda E. Stiff,
Deputy Commissioner for
Services and Enforcement.

§301.6688–1T [Removed]
Par. 43. Section 301.6688–1T is removed.
Par. 44. Section 301.7701(b)–1 is
amended by revising paragraph (d) to read
as follows:

Approved April 1, 2008.
Eric Solomon,
Assistant Secretary of
the Treasury (Tax Policy).

§301.7701(b)–1 Resident alien.
*****
(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 Federal income tax purposes. For the
applicable rules for making this determination, see section 937(a) and §1.937–1 of
this chapter.
*****

(Filed by the Office of the Federal Register on April 4, 2008,
8:45 a.m., and published in the issue of the Federal Register
for April 9, 2008, 73 F.R. 19349)

Section 4980G.—Failure
of Employer to Make
Comparable Health Savings
Account Contributions
26 CFR 54.4980G–4: Calculating comparable contributions.

T.D. 9393
Department of the Treasury
Internal Revenue Service
26 CFR Part 54
Employer Comparable
Contributions to Health
Savings Accounts Under
Section 4980G
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.

§301.7701(b)–1T [Removed]
Par. 45. Section 301.7701(b)–1T is
removed.
Par. 46. Section 301.7701(b)–9 is
amended by revising the section heading
and adding new paragraph (b)(5) to read
as follows:
§301.7701(b)–9 Effective/applicability
dates of §§301.7701(b)–1 through
301.7701(b)–7.
*****
(b) * * *
(5) Possessions and territories. For
purposes of applying section 7701(b)
and the regulations under that section,
§301.7701(b)–1(d) applies to taxable years
ending after April 9, 2008.

975

SUMMARY: This document contains final regulations providing guidance on employer comparable contributions to Health
Savings Accounts (HSAs) under section
4980G in instances where an employee has
not established an HSA by December 31st
and in instances where an employer accelerates contributions for the calendar year
for employees who have incurred qualified medical expenses. These final regulations affect employers that contribute to
employees’ HSAs and their employees.
DATES: Effective Date: These regulations
are effective on April 17, 2008.
Applicability Date: These regulations
apply to employer contributions made for
calendar years beginning on or after January 1, 2009.

May 19, 2008