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  • Writer's pictureLewis Grunfeld, CPA

Guide to US Source Income and Foreign Source Income

Updated: Feb 29


Introduction

It's important to identify US source income from foreign source income since this generally determines who has the first right of taxation and eligibility for the foreign tax credit (FTC). Essentially, if your income is considered foreign source, the country where it's earned has the primary right to tax it. The US then allows you to claim the FTC for taxes paid to that foreign country. Getting this distinction right is crucial; misidentifying your income's source can lead to claiming too much FTC and potential issues with the IRS.

Interest Income

Interest income is typically determined based on the residence of the payor. Interest income includes earnings from bank accounts, bonds, and notes. If the interest arises from sources within the 50 states and the District of Columbia, it is considered income from within the U.S.

Example:

John, who is a U.S. citizen, receives interest income from a personal loan given to Alex, who is also a U.S. citizen but resides in a foreign country. Since taxpayer B is a resident of the foreign country, even though they are a U.S. citizen, the income is considered foreign sourced income.


Dividend Income

Dividend income is generally determined by the country where the paying company is incorporated. Dividends from domestic corporations are considered U.S. sourced income, while dividends from foreign corporations are considered foreign sourced income.


Wages and Personal Services Income

When it comes to sourcing wages and personal services income, the general rule is based on where the services are performed, disregarding factors like the recipient's residence, contracting location, or payment details.


If services are performed both within and outside the U.S., the compensation is allocated in a way that accurately reflects the proper source of income, often using a time-based apportionment.


However, when a non-resident alien (NRA) performs services in the U.S., the compensation is considered foreign source income if the following conditions are met:

  • The NRA is temporarily in the U.S.

  • The presence in the U.S. during the taxable year doesn't exceed 90 days

  • The compensation for services doesn't exceed $3,000.

Example: Taxpayer A, a citizen and resident of Germany, was hired by a U.S. company to develop a new product for global sales. During the project, taxpayer A spent 56 days (8 weeks) in the U.S. to address production issues. The entire project lasted twenty weeks, and taxpayer A was compensated $60,000.

Since taxpayer A worked as a non-resident alien in the U.S. for 56 days and received payment exceeding $3,000, the income cannot be categorized solely as foreign sourced. Instead, it needs to be allocated as follows: 8 weeks in the U.S. out of a total of 20 weeks for the project multiplied by the $60,000 payment, resulting in $24,000 sourced to the U.S.


Rent and Royalty Income

Income from renting or using property, whether tangible or intangible, within the U.S. is considered U.S sourced income.


Capital Gains

Income sourcing for property depends on the nature of the property being sold. Real property is sourced based on its physical location, while the sale of personal property is sourced to the tax residence of the seller, known as the seller's tax home.


Pension and Retirement Plans

When it comes to sourcing pension income, there are two components to consider: contributions to the pension plan and the earnings generated from those contributions. The contribution portion is sourced based on where the services were performed that earned the pension. On the other hand, the investment earnings portion is sourced according to the location of the pension trust. U.S. social security benefits are generally considered to be from U.S. sources.


For instance, if a U.S. citizen worked in Puerto Rico for a U.S. company and received a pension from the U.S. pension trust after retirement while staying in Puerto Rico, the distributions from the pension trust would need to be allocated between contributions (considered Puerto Rico source income) and investment earnings (considered U.S. source income).


Need Help With Filing Your U.S. Taxes From Abroad?

At CPAs for Expats, we specialize in helping US expats stay compliant with their US taxes. Our low fees and 4.9/5 rating on independent review platforms attests to our commitment to excellence and client satisfaction. Contact us today, and let our tax experts simplify your life and taxes.





Article by Lewis Grunfeld, CPA

Lewis Grunfeld, CPA, is a renowned expert in international and U.S. expat taxation, with expertise spanning over ten years. He has successfully helped thousands of expats around the world navigate complex international U.S. tax regulations, and achieve significant tax savings. His work is driven by a strongly rooted passion for assisting the expat community through a wide range of tax situations, ensuring tailored solutions for each unique situation.




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