Residence and Source Rules Involving U.S. Possessions and Other Conforming Changes, 18920-18948 [05-7087]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 70, Number 68 (Monday, April 11, 2005)]
[Rules and Regulations]
[Pages 18920-18948]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-7087]



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Part III





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1, 301, and 602



Residence and Source Rules Involving U.S. Possessions and Other 
Conforming Changes; Final and Temporary Regulations; Notice of Proposed 
Rulemaking

Federal Register / Vol. 70, No. 68 / Monday, April 11, 2005 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 9194]
RIN 1545-BE22


Residence and Source Rules Involving U.S. Possessions and Other 
Conforming Changes

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that provide 
rules under section 937(a) of the Internal Revenue Code (Code) for 
determining whether an individual is a bona fide resident of the 
following U.S. possessions: American Samoa, Guam, the Northern Mariana 
Islands, Puerto Rico, and the United States Virgin Islands. The 
temporary regulations also provide rules under section 937(b) for 
determining whether income is derived from sources within a U.S. 
possession and whether income is effectively connected with the conduct 
of a trade or business within a U.S. possession. Section 937 was added 
to the Code by section 908 of the American Jobs Creation Act (2004 
Act).
    The temporary regulations also provide updated guidance under 
sections 876, 881, 884, 931, 932, 933, 934, 935, 957, and 6688 of the 
Code to reflect amendments made by the Tax Reform Act of 1986 (1986 
Act) and the 2004 Act. Conforming changes are also made to regulations 
under sections 170A, 243, 702, 861, 863, 871, 901, 1402, 6038, 6046, 
and 7701 of the Code. The text of the temporary regulations also serves 
as the text of the proposed regulations set forth in the cross-
referenced notice of proposed rulemaking on this subject in the 
Proposed Rules section in this issue of the Federal Register.

DATES: Effective Date: These regulations are effective April 11, 2005.

FOR FURTHER INFORMATION CONTACT: J. David Varley (202) 435-5165 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collection of information contained 
in these regulations has been reviewed and pending receipt and 
evaluation of public comments, approved by the Office of Management and 
Budget under control number 1545-1930. Responses to this collection of 
information are mandatory.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    For further information concerning this collection of information, 
and where to submit comments on the collection of information and the 
accuracy of the estimated burden, and suggestions for reducing this 
burden, please refer to the preamble to the cross-referencing notice of 
proposed rulemaking published in the Proposed Rules section of this 
issue of the Federal Register.
    Books and records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    The income tax laws of the United States have always contained 
special provisions concerning the income taxation of individuals 
residing in U.S. possessions and corporations created or organized in 
U.S. possessions. See e.g., sections 260 and 261 of Public Law 65-254 
(40 Stat. 1057). The current rules for residents of the Commonwealth of 
Puerto Rico (Puerto Rico) were first enacted in 1950. See sections 220 
and 221 of Public Law 81-814 (64 Stat. 906) (enacting the predecessors 
to sections 876 and 933 of the Code). Special rules for residents of 
the United States Virgin Islands (USVI) were added in 1960. See section 
4 of Public Law 86-779 (74 Stat. 998) (enacting section 934 of the 
Code). Special rules for residents of Guam were added in 1972. See 
Public Law 92-606 (86 Stat. 1494) (1972 Act) (enacting sections 935 and 
7654 of the Code). These special rules for residents of Guam were made 
applicable to residents of the Commonwealth of the Northern Mariana 
Islands (NMI) for tax years beginning after December 31, 1978. See 
section 601 of Public Law 94-241 (90 Stat. 263) and Presidential 
Proclamation 4534.
    The 1986 Act substantially revised the provisions governing the 
income taxation of individuals residing in U.S. possessions. See 
sections 1271 through 1277 of Public Law 99-514 (amending sections 876, 
931 through 935, 957(c), and 7654 of the Code). The 2004 Act restated 
and supplemented certain aspects of these provisions. See section 908 
of Public Law 108-357 (enacting section 937 of the Code). These 
regulations conform the existing regulations to the amended statutes 
and provide additional guidance on the proper application of the 
statutory provisions.
    This document contains amendments to 26 CFR parts 1, 301, and 602. 
The cross-referenced notice of proposed rulemaking is published 
elsewhere in this issue of the Federal Register.

Explanation of Provisions

I. Operative Provisions

    Many of the substantive and procedural provisions of the Code 
specifically relating to the possessions were amended by the 1986 Act. 
The 2004 Act further amended certain of these provisions. These 
regulations implement the statutory changes by modifying or replacing 
existing regulations as discussed below.

A. Puerto Rico

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

[[Page 18921]]

credits. These regulations amend the existing regulations under section 
933 to reflect this statutory change.

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

    Section 931, as enacted in the 1986 Act, operates in a similar 
fashion to section 933. For U.S. citizens and alien individuals who are 
bona fide residents of possessions to which it applies (section 931 
possessions), income from sources within such possessions or 
effectively connected with the conduct of a trade or business in such 
possessions is excluded from gross income for U.S. Federal income tax 
purposes. Consequently, such individuals have a U.S. Federal income tax 
return filing obligation only if their income from sources outside 
section 931 possessions and not effectively connected with the conduct 
of a trade or business in such possessions exceeds their deductions 
under section 151 relating to personal exemptions. To the extent such 
income constitutes income from sources outside the United States, U.S. 
citizens who are bona fide residents of section 931 possessions 
generally may claim a foreign tax credit under section 901(b) for 
income taxes paid to foreign countries and U.S. possessions (including 
section 931 possessions) to offset their U.S. Federal income tax 
liability, subject to certain limitations. As under section 933, any 
deductions (other than the deduction under section 151, relating to 
personal exemptions) and credits properly allocable or chargeable 
against amounts excluded from gross income under section 931 are 
disallowed.
    Although section 931 by its terms applies to bona fide residents of 
American Samoa, Guam, and the NMI (collectively, the Pacific 
possessions), the statute takes effect with respect to any such 
possession only when the possession enters into an implementing 
agreement with the Internal Revenue Service as required under the 
relevant effective date provisions of the 1986 Act. See sections 
1271(b) and 1277(b) of Public Law 99-514. To date, only American Samoa 
has entered into such an agreement. Consequently, section 931 currently 
applies only to bona fide residents of American Samoa.
    Although section 935 was repealed by the 1986 Act, the effective 
date of its repeal is contingent on the entry into force of 
implementing agreements, as described above, by the possessions to 
which section 935 historically has applied (section 935 possessions), 
namely, Guam and the NMI. Given that neither has agreed to the entry 
into force of such agreements, section 935 remains in force with 
respect to bona fide residents of Guam and the NMI.
    Section 935, as in effect prior to its repeal, refers only to Guam. 
Pursuant to section 601 of the Covenant to Establish a Commonwealth of 
the Northern Mariana Islands in Political Union with the United States, 
Public Law 94-241, however, the income tax laws of the United States 
entered into force in the NMI in the same manner as those laws are in 
force in Guam, and references in the Code to Guam generally are deemed 
also to refer to the NMI. Consequently, section 935 currently applies 
to bona fide residents of Guam and of the NMI.
    These regulations amend the existing regulations under section 935 
to reflect the fact that the section currently applies not only to bona 
fide residents of Guam but also to bona fide residents of the NMI, and 
may in the future apply only to bona fide residents of one or the other 
and will not apply to bona fide residents of either possession if both 
enter into the implementing agreements contemplated in the 1986 Act. 
Similarly, these regulations set forth the post-1986 Act statutory 
framework for residents of section 931 possessions in a manner that 
reflects the potential for bona fide residents of Guam and the NMI to 
be covered by its provisions upon entry into force of such implementing 
agreements.

C. United States Virgin Islands

    Section 932, as enacted in the 1986 Act, provides two sets of 
operative rules: one for bona fide residents of the USVI, and one for 
U.S. citizens and resident alien individuals who are not bona fide 
residents of the USVI but have income from sources within the USVI or 
income effectively connected with the conduct of a trade or business in 
the USVI.
    With respect to individuals who are bona fide residents of the USVI 
(whether U.S. citizens or alien individuals), section 932(c) generally 
provides that an income tax return must be filed with the USVI tax 
authorities. If the individual properly reports on this return his or 
her income from all sources and identifies the source of each item of 
income, and pays all of the tax properly due with respect to such 
income, then such income is excluded from gross income for U.S. Federal 
income tax purposes. Consequently, such individuals have a U.S. Federal 
income tax return filing obligation only if they fail to report or 
properly identify the source of some of their income on their USVI 
income tax return, or if they fail to pay all of the tax properly due 
with respect to their income (for example, by improperly claiming the 
benefit of a tax credit or exemption provided under USVI law but 
subject to the limitations of section 934(b)).
    With respect to U.S. citizens and resident alien individuals who 
are not bona fide residents of the USVI but have income from sources 
within the USVI or income effectively connected with the conduct of a 
trade or business in the USVI, section 932(a) generally provides that 
each such individual must file his or her income tax return with both 
the IRS and with the USVI Bureau of Internal Revenue. In addition, 
under section 932(b), such an individual must pay to the USVI the 
``applicable percentage'' of the taxes imposed under Chapter 1 of the 
Code. For this purpose, the term applicable percentage means the 
percentage which the individual's Virgin Islands adjusted gross income 
bears to the individual's adjusted gross income; the term Virgin 
Islands adjusted gross income means the individual's adjusted gross 
income determined by taking into account only income derived from 
sources within the Virgin Islands and deductions properly apportioned 
or allocable thereto. On the individual's U.S. Federal income tax 
return, he or she may claim a credit for the tax required to be paid to 
the USVI, so that only the remainder is due to the United States.
    In general, the USVI administers income tax laws that are identical 
(except for the substitution of the name of the USVI for the term 
United States where appropriate) to those in force in the United States 
(commonly referred to as the mirror code). However, subject to the 
limitations of section 934(b), as amended by the 1986 Act, the USVI has 
the authority to reduce or remit tax liabilities under the mirror code 
in certain situations.
    First, under section 934(b)(1), the USVI may reduce or remit the 
tax otherwise imposed on the income of any person (other than a U.S. 
citizen or resident alien individual who is not a bona fide resident of 
the USVI) from sources within the USVI or effectively connected with 
the conduct of a trade or business in the USVI.
    Second, under section 934(b)(3), the USVI may reduce or remit the 
tax otherwise imposed on the income (other than income from sources 
within the United States or effectively connected with the conduct of a 
trade or business in the United States) of a foreign corporation, 
provided that less than ten percent of its stock (by vote and value) is 
owned by United States persons. Given that a corporation created or 
organized outside of the USVI can only have a mirror code tax liability 
with respect to income from sources within

[[Page 18922]]

the USVI or effectively connected with the conduct of a trade or 
business within the USVI (all of which is within the scope of section 
934(b)(1)), the additional waiver of the limitations of section 934(a) 
provided by section 934(b)(3) generally will have no practical effect 
for such corporations. Instead, section 934(b)(3) generally is relevant 
only to corporations created or organized in the USVI (which are 
treated as ``foreign'' corporations for U.S. Federal income tax 
purposes).
    These regulations amend the existing regulations under section 934 
and provide new regulations under section 932 to reflect this post-1986 
Act statutory framework.

D. U.S. Tax Liabilities of Certain Possessions Corporations

    Section 881(a) generally imposes a 30 percent tax on U.S.-source 
fixed or determinable annual or periodical income of foreign 
corporations. Section 884 imposes certain branch-level taxes on foreign 
corporations that are engaged in a trade or business in the United 
States. Section 881(b) provides for the reduction or elimination of the 
taxes otherwise imposed under sections 881(a) and 884 on corporations 
created or organized in U.S. possessions (possessions corporations) 
under certain circumstances.
    Section 881(b), as enacted by the 1972 Act, provides the rules 
currently in effect for corporations created or organized in section 
935 possessions. Under these rules, such corporations effectively are 
exempt from tax under section 881(a), provided that the following 
conditions are satisfied--
    (1) At all times during the taxable year, less than 25 percent in 
value of the stock of such corporation is owned (directly or 
indirectly) by foreign persons; and
    (2) At least 20 percent of the gross income of such corporation is 
shown to the satisfaction of the Secretary to have been derived from 
sources within such possession for the 3-year period ending with the 
close of the preceding taxable year of such corporation (or for such 
part of such period as the corporation has been in existence).
    Section 881(b), as enacted by the 1972 Act, also provides the rules 
currently in effect for corporations created or organized in the United 
States that otherwise might incur a tax liability to a section 935 
possession under a mirrored version of section 881(a). Under these 
rules, such corporations effectively are exempt from tax in the section 
935 possession in all cases.
    Section 881(b), as amended by the 1986 Act, provides the rules 
currently in effect for corporations created or organized in section 
931 possessions and in the USVI. Under these rules, such corporations 
effectively are exempt from tax under section 881(a) and section 884, 
provided that the following conditions (1986 conditions) are 
satisfied--
    (1) At all times during the taxable year, less than 25 percent in 
value of the stock of such corporation is beneficially owned (directly 
or indirectly) by foreign persons;
    (2) At least 65 percent of the gross income of such corporation is 
shown to the satisfaction of the Secretary to be effectively connected 
with the conduct of a trade or business in such a possession or the 
United States for the 3-year period ending with the close of the 
taxable year of such corporation (or for such part of such period as 
the corporation or any predecessor has been in existence); and
    (3) No substantial part of the income of such corporation is used 
(directly or indirectly) to satisfy obligations to persons who are not 
bona fide residents of such a possession or the United States.
    Corporations that are created or organized in section 935 
possessions and satisfy the 1986 conditions also are exempt from the 
U.S. tax imposed under section 884. Similarly, corporations that are 
created or organized in the United States and satisfy the 1986 
conditions are exempt from the tax imposed under mirrored versions of 
section 884 in section 935 possessions.
    Section 881(b), as amended by the 2004 Act, provides a special rule 
for corporations created or organized in Puerto Rico. Under this rule, 
such corporations are subject to tax under section 881(a) at a rate of 
10 percent (rather than the generally applicable rate of 30 percent) on 
their U.S.-source dividend income, provided that the 1986 conditions 
are satisfied. However, if, on or after October 22, 2004, there is an 
increase in the rate of Puerto Rico's withholding tax which is 
generally applicable to dividends paid to United States corporations 
not engaged in a trade or business in Puerto Rico to a rate greater 
than 10 percent, this special rule shall not apply to dividends 
received on or after the effective date of the increase.
    These regulations amend the existing regulations under sections 881 
and 884 to reflect this post-1986 Act and post-2004 Act statutory 
framework. These regulations also provide rules similar to the 1972 Act 
rules applicable to section 935 possessions for purposes of determining 
tax liability incurred to the USVI by corporations created or organized 
in the United States, pursuant to section 1274(c) of the 1986 Act.

E. Application of Subpart F to Bona Fide Residents of a Possession

    With respect to bona fide residents of section 935 possessions and 
the USVI (mirror code possessions), corporations created or organized 
in the possession in which they reside are treated as domestic 
corporations for mirror code tax purposes. Thus, provisions such as 
subpart F of part III of subchapter N of chapter 1 of the Code 
(relating to controlled foreign corporations) as mirrored do not apply 
with respect to their ownership of such corporations.
    With respect to bona fide residents of section 931 possessions and 
Puerto Rico, corporations created or organized in the possession in 
which they reside are treated as foreign corporations for U.S. Federal 
income tax purposes. Thus, in cases where, after the application of 
section 931 or 933 as the case may be, such individuals are required to 
file U.S. Federal income tax returns, they generally must treat such 
corporations as foreign corporations for purposes of applying 
provisions, such as subpart F, to determine their U.S. Federal income 
tax liability.
    Section 957(c), however, provides a significant exception for bona 
fide residents of section 931 possessions and Puerto Rico. In cases 
where it applies, the individual is not treated as a United States 
person for purposes of subpart F. Consequently, such individual is not 
treated as a United States shareholder under section 951(b), and 
possession corporations described in section 957(c) that are controlled 
by such individuals are not treated as controlled foreign corporations 
under section 957(a).
    In the case of a bona fide resident of Puerto Rico, section 
957(c)(1) applies with respect to a corporation organized under the 
laws of the Commonwealth of Puerto Rico if a dividend received by such 
individual during the taxable year from such corporation would, for 
purposes of section 933(1), be treated as income derived from sources 
within Puerto Rico. (As discussed in more detail below in section II.B. 
of this explanation, such would be the case if, during a three-year 
testing period ending with the taxable year, the corporation's gross 
income was derived entirely from sources within Puerto Rico or the 
corporation met certain gross income and trade or business 
requirements.)
    In the case of a bona fide resident of a section 931 possession, 
section 957(c)(2) applies with respect to a corporation organized under 
the laws of

[[Page 18923]]

such a possession if the following conditions are satisfied--
    (1) 80 percent or more of the gross income of the corporation for 
the 3-year period ending at the close of the taxable year (or for such 
part of such period as such corporation or any predecessor has been in 
existence) was derived from sources within such a possession or was 
effectively connected with the conduct of a trade or business in such a 
possession; and
    (2) 50 percent or more of the gross income of the corporation for 
such period (or part) was derived from the active conduct of a trade or 
business within such a possession.
    These regulations amend the existing regulations under section 957 
to reflect this post-1986 Act statutory framework. These regulations 
also make corresponding changes to the regulations under sections 6038 
and 6046 (relating to information reporting requirements with respect 
to certain foreign corporations owned by United States persons).

F. Taxation of Aliens Residing in a Possession

    Under section 876, individuals who are nonresident aliens with 
respect to the United States and are bona fide residents of certain 
possessions are subject to U.S. Federal income tax on their worldwide 
income under section 1 (rather than solely on their income from sources 
within the United States or effectively connected with the conduct of a 
trade or business in the United States under section 871). Prior to the 
1986 Act, section 876 applied only to alien individuals who were bona 
fide residents of Puerto Rico. As amended by the 1986 Act, section 876 
applies also to alien individuals who are bona fide residents of 
section 931 possessions.
    These regulations amend the existing regulations under section 876 
to reflect this post-1986 Act statutory framework.

G. Entity Status

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

H. Effective Date

    To the extent they provide rules under the operative provisions of 
the Code relating to the possessions, as amended by 1986 Act and the 
2004 Act, these regulations generally apply to taxable years ending 
after October 22, 2004. The underlying statutory rules, however, 
generally apply to taxable years beginning after December 31, 1986. 
Accordingly, taxpayers may rely upon the guidance provided in these 
regulations with respect to prior years for which the underlying 
statutory rules are in effect, provided that they do so consistently.

II. Definitional Provisions

    As indicated above in section I of this explanation, when applying 
the operative provisions of the Code relating to the possessions, 
determinations must be made regarding whether an individual is a bona 
fide resident of a particular possession, or whether income is derived 
from sources within a particular possession or is effectively connected 
with the conduct of a trade or business in a particular possession. 
Section 937 and these regulations provide guidance on these issues, as 
discussed below.

A. Bona Fide Residency in a Possession

    The term bona fide resident has been an integral part of the 
special provisions of the Code relating to U.S. possessions since 1950. 
See sections 220 and 221 of Public Law 81-814. From the beginning, this 
term has been used to identify the class of persons entitled to Federal 
tax exemptions or other special treatment under these provisions, and 
its meaning has remained essentially unchanged through all of the 
expansions and revisions of these provisions.
    Historically, the determination of whether an individual is a bona 
fide resident of a possession has turned on the facts and circumstances 
and, specifically, on an individual's intentions with respect to the 
length and nature of his or her stay in the possession. See, e.g., 
Sec. Sec.  1.933-1(a), 1.934-1(c)(2), and 1.935-1(a)(3) (generally 
applying the principles of Sec. Sec.  1.871-2 through 1.871-5). But see 
Sec.  301.7701(b)-1(d) (applying the rules of section 7701(b) for 
determining whether alien individuals qualified as residents of mirror 
code possessions for taxable years beginning after December 31, 1984). 
The qualifier ``bona fide'' indicates that a claim of residence in a 
possession is respected for Federal tax purposes when it is made in 
good faith.
    As enacted by the 2004 Act, section 937(a) provides that an 
individual generally will be considered a bona fide resident of a 
possession only if he or she satisfies all three of the following 
conditions--
    (1) He or she is physically present in the possession for 183 days 
during the taxable year (physical presence test);
    (2) He or she does not have a tax home (determined under the 
principles of section 911(d)(3) without regard to the second sentence 
thereof) outside the possession during the taxable year (tax home 
test); and
    (3) He or she does not have a closer connection (determined under 
the principles of section 7701(b)(3)(B)(ii)) to the United States or a 
foreign country than to the possession (closer connection test).
    Section 937(a) further provides that, for purposes of the physical 
presence test, the determination as to whether a

[[Page 18924]]

person is present for any day shall be made under the principles of 
section 7701(b). The legislative history explains that, under this 
rule, an individual is to be considered present in a possession for a 
particular day if he is physically present in such possession during 
any time during such day, and in certain circumstances (e.g., certain 
medical emergencies), an individual's presence outside a possession is 
ignored. See H.R. Rep. No. 108-755, at 780 (2004).
    The tax home and closer connection tests are similar to the 
conditions that individuals historically have needed to meet to be 
considered residents of a possession.
    Congress also provided regulatory authority for the IRS and 
Treasury to create exceptions to this general definition, for cases in 
which an individual's absence from the possession is motivated by 
reasons other than tax avoidance. In particular, the legislative 
history indicates that Congress anticipated that exceptions would be 
provided for military personnel, workers in the fisheries trade, and 
retirees who may travel outside of a possession for personal reasons. 
At the same time, the legislative history makes clear that Congress 
wished to ensure that individuals who live and work stateside cannot 
avail themselves of the tax benefits that Congress intended to provide 
only to individuals who actually reside in the possessions. See H.R. 
Rep. No. 108-755, at 780 (2004).
    Consistent with this legislative history, these regulations include 
several exceptions to the general statutory rules of section 937(a).
    First, these regulations provide several alternatives to the 183-
day rule for purposes of satisfying the physical presence test. One 
alternative is that the individual spend no more than 90 days in the 
United States during the taxable year. Thus, for example, workers in 
the fisheries trade who spend considerable periods at sea, and 
individuals who travel extensively to neighboring islands to provide 
goods and services, may satisfy the physical presence requirement under 
this alternative.
    Another alternative is that the individual spend more days in the 
possession than in the United States and have no earned income (as 
defined in Sec.  1.911-3(b)) in the United States during the taxable 
year. Thus, for example, retirees who spend several months each year 
stateside for vacation, for medical treatment, or to visit relatives, 
and some time traveling in foreign countries, may satisfy the physical 
presence requirement under this alternative.
    A final alternative is that the individual have no permanent 
connection to the United States. For this purpose, the term permanent 
connection to the United States includes a permanent residence and a 
spouse or dependent with a principal place of abode in the United 
States. In other words, the absence of a permanent connection will 
enable an individual to satisfy the physical presence test. Thus, for 
example, an individual who lives in a possession but travels 
extensively in the United States for business reasons or to receive 
medical treatment may satisfy the physical presence requirement under 
this alternative.
    For purposes of determining whether the above-mentioned 
alternatives are satisfied, certain days spent in the United States are 
disregarded. In particular, days spent as a full-time student, as a 
full-time government official or employee of a possession, or as a 
professional athlete participating in a charitable event generally are 
disregarded. In addition, days spent in transit and days that an 
individual is prevented from leaving the United States because of a 
medical condition that arose while the individual was present in the 
United States generally will also be disregarded.
    The above-mentioned alternatives apply with respect to individuals 
who are U.S. citizens or resident aliens (as defined in section 
7701(b)). A different approach is appropriate in the case of 
individuals who are nonresident aliens with respect to the United 
States. For such individuals, in lieu of the above-mentioned 
alternatives, a mirrored version of the section 7701(b) substantial 
presence test applies.
    For purposes of the tax home test, these regulations provide a 
special rule for seafarers. Under this special rule, an individual will 
not be considered to have a tax home outside the relevant possession 
solely by reason of employment on a ship or other seafaring vessel that 
is predominantly used in local and international waters.
    For purposes of the closer connection test, these regulations 
provide a special rule under which another possession is not considered 
a foreign country. Thus, for example, an individual who has a tax home 
in the USVI and a closer connection to Puerto Rico, and who satisfies 
the presence test with respect to both possessions, generally will be 
considered a bona fide resident of the USVI, and not of Puerto Rico.
    Special rules apply under Federal law for determining the residence 
of military personnel for tax purposes. See 50 App. U.S.C. 571(a). 
Consistent with these special rules, these regulations provide that an 
individual's absence from or presence in a possession in compliance 
with military orders generally does not affect whether the individual 
qualifies as a bona fide resident of such possession.
    Finally, consistent with existing law (see Notice 2000-61 (2000-2 
C.B. 569)), these regulations provide that only natural persons may be 
considered bona fide residents of a possession for U.S. Federal income 
tax purposes. Thus, juridical persons such as corporations, 
partnerships, trusts, and estates cannot be considered bona fide 
residents of a possession for U.S. Federal income tax purposes.
    It should be noted that the 2004 Act modified sections 932 and 935, 
to conform the treatment of individuals who acquire or relinquish 
residency in mirror code possessions with the historical treatment of 
individuals who acquire or relinquish residency in Puerto Rico and 
section 931 possessions. Thus, for example, in order to be subject to 
the special rules of section 932(c), an individual must qualify as a 
bona fide resident of the USVI during the entire year. Accordingly, an 
individual generally is not subject to such special rules for any year 
during which he or she moves to or from the USVI.
    The 2004 Act provisions and these regulations as they relate to the 
determination of bona fide residency in a possession generally apply to 
taxable years ending after October 22, 2004, except that the physical 
presence requirement applies only to taxable years beginning after 
October 22, 2004. In addition, taxpayers may choose to apply the rules 
set forth in these regulations in their entirety (including the 
physical presence test) to any open taxable years by notifying the IRS 
upon examination of their intent to do so. Alternatively, for such 
years, U.S. citizens and resident alien individuals (as well as 
nonresident aliens in possessions other than mirror code possessions) 
may continue to apply the principles of Sec. Sec.  1.871-2 through 
1.871-5, and nonresident alien individuals in mirror code possessions 
may continue to apply the rules of Sec.  301.7701(b)-1(d) (as in effect 
for such years).

B. Income From Sources in a Possession

    In general, the rules for determining whether income is derived 
from sources within the United States have applied for purposes of 
determining whether income is derived from sources within a possession. 
See Sec.  1.863-6. The 2004 Act codified this rule in section 937(b), 
with two exceptions.

[[Page 18925]]

    First, section 937(b)(2) (U.S. income rule) provides that an item 
of income shall not be considered to be derived from sources within a 
possession (or effectively connected with the conduct of a trade or 
business within a possession) if such item of income constitutes income 
from sources within the United States or income effectively connected 
with the conduct of a trade or business in the United States under the 
general rules of sections 861 through 865.
    Second, section 937(b) provides an express grant of authority, 
consistent with the authority contained in sections 931, 934, and 957 
as amended by the 1986 Act, for Treasury and the IRS to provide 
appropriate exceptions to the general source rules.
    The legislative history to the 2004 Act indicates that Congress 
intended for Treasury and the IRS to use this authority to continue the 
existing treatment of income from the sale of goods manufactured in a 
possession. The 2004 Act legislative history further indicates that 
Congress intended for this authority to be used to prevent abuse, for 
example, to prevent U.S. persons from avoiding U.S. tax on appreciated 
property by acquiring residency in a possession prior to its 
disposition. See H.R. Rep. No. 108-755, at 781 (2004).
    The legislative history to the 1986 Act reflects similar concerns. 
For example, Congress did not believe that a mainland resident who 
moves to a possession while owning appreciated personal property such 
as corporate stock or precious metals and who sells that property in 
the possession should escape all tax, both in the United States and the 
possession, on that appreciation. Similarly, Congress did not believe 
that a resident of a possession who owns financial assets such as 
stocks or debt of companies organized in, but the underlying value of 
which is primarily attributable to activities performed outside, the 
possession should escape tax on the income from those assets.
    Accordingly, Congress anticipated that regulations would treat such 
income as sourced outside the possession where the taxpayer resides. 
See H.R. Rep. No. 99-426, at 487 and 489 (1985); S. Rep. No. 99-313, at 
481 and 484 (1986).
    These regulations include several exceptions to the general 
statutory rules of section 937(b).
    First, the regulations provide that the U.S. income rule only 
applies for income earned after December 31, 2004.
    Second, the regulations contain a special conduit rule to prevent 
the avoidance of the U.S. income rule. Under this special conduit rule, 
income is considered to be from sources within the United States for 
purposes of the U.S. income rule if, pursuant to a plan or arrangement, 
(i) the income is received in exchange for consideration provided to 
another person, and (ii) such person (or another person) 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. This rule supplements, and does not 
supersede, other potentially applicable conduit rules. See, for 
example, Aiken Indus., Inc. v. Commissioner, 56 T.C. 925 (1971). Unlike 
more generally applicable conduit rules, however, the special conduit 
rule in these regulations applies only for purposes of section 937 (and 
provisions for which the rules of section 937 apply); it does not cause 
the income to be treated as income from sources within the United 
States for other purposes of the Code.
    Third, the regulations preserve the existing treatment of income 
from the sale of goods manufactured in a possession under Sec.  1.863-
3(f). These existing rules reflect a careful consideration of the 
relevant policy considerations arising with respect to the transactions 
to which they apply, and Congress did not intend for this result to be 
changed through a mechanical application of the general source rules of 
section 937(b). For the same reason, these regulations contain rules to 
preserve the results with respect to the allocation of income between 
the United States and its possessions under sections 863(c), 863(e), 
865(g)(3), and 865(h)(2)(B).
    Fourth, the regulations provide special rules for gains from 
dispositions of certain property held by a U.S. person prior to 
becoming a resident of a possession. Under these rules, such gains 
generally are treated as income from sources outside of the possession. 
These rules supplement, and do not supersede, the special source rule 
of section 1277(e) of the 1986 Act, which applies to individuals who 
become residents of Pacific possessions. Under this 1986 Act special 
source rule, gains from dispositions of certain property held by a U.S. 
person prior to becoming a resident in a Pacific possession is treated 
as income from sources within the United States for all purposes of the 
Code (including section 7654 of the 1954 Code as applicable to Guam and 
the NMI). The regulations also contain rules that are designed to 
prevent the avoidance of these special gain rules.
    Fifth, the regulations provide special rules for dividends from 
corporations created or organized in a possession (possessions 
corporations). In general, such dividends constitute income from 
sources within a possession under the principles of section 
861(a)(2)(A). A special look-through rule applies, however, when the 
shareholder owns, directly or indirectly, at least 10 percent of the 
voting stock of the corporation. Under this special rule, only a 
ratable portion of any dividend paid or accrued by a possessions 
corporation to such a shareholder is treated as income from sources 
within the possession. The ratable portion is determined by applying to 
the dividend the ratio of the corporation's income from sources within 
the possession over its total income over a three-year testing period 
ending with the year in which the dividend is paid. (See also sections 
881(b) and 957(c) for which a similar three-year testing period 
applies.) This look-through rule does not apply, however, if the 
corporation meets the following conditions (the 80/50 conditions)--
    (1) 80 percent or more of the gross income of the corporation for 
the three-year testing period was derived from sources within the 
possession or was effectively connected with the conduct of a trade or 
business in the possession; and
    (2) 50 percent or more of the gross income of the corporation for 
such period was derived from the active conduct of a trade or business 
within the possession.
    Sixth, the regulations provide rules for determining the extent to 
which income inclusions (for example, under section 951(a)) may be 
considered to be derived from sources within a possession. 
Specifically, for shareholders owning at least 10 percent of the voting 
stock of the corporation, the regulations generally apply the 
principles of section 904(h)(2), under which the source of income 
inclusions ordinarily is determined for foreign tax credit purposes. 
For all other shareholders, income inclusions are considered to be 
derived from sources within the jurisdiction in which the corporation 
is created or organized.
    Seventh, the regulations provide rules for determining the extent 
to which interest payments may be considered to be derived from sources 
within a possession. In general, interest paid by possessions 
corporations and noncorporate residents of a possession constitutes 
income from sources within the possession under the principles of 
section 861(a)(1). A special look-through rule applies, however, when 
the interest is paid by a possessions corporation to a shareholder who 
owns, directly or

[[Page 18926]]

indirectly, at least 10 percent of the voting stock of the corporation. 
Under this special rule, which is applied in accordance with the 
principles of Sec. Sec.  1.861-9 through 1.861-12, the interest is 
treated as income from sources within the possession only to the extent 
that such interest is allocable to assets giving rise to income from 
sources within the possession or income effectively connected with the 
conduct of a trade or business within the possession. This look-through 
rule does not apply, however, if the corporation meets the 80/50 
conditions described above. The regulations further provide that 
interest paid by a partnership is treated as income from sources within 
a possession only to the extent that such interest is allocable (under 
the principles of Sec.  1.882-5) to income effectively connected with 
the conduct of a trade or business in the possession.
    Special rules apply under Federal law for determining, for tax 
purposes, the source of income from the performance of services by 
military personnel. See 50 App. U.S.C. 571(b). Consistent with these 
special rules, these regulations provide that income from military 
services performed stateside (or in another possession) by a bona fide 
resident of a possession is considered to be income from sources within 
such possession, and income from military services performed in a 
possession by an individual who is not a bona fide resident of such 
possession is not considered to be income from sources within such 
possession.
    Lastly, the regulations continue the existing treatment of income 
from services performed within a possession and from dividends paid by 
corporations created or organized outside of a possession. Thus, 
compensation received for services performed in a possession 
constitutes income from sources within the possession without regard to 
the de minimis exception in section 861(a)(3), and dividends paid by 
corporations created or organized outside of a possession constitute 
income from sources outside of the possession in all cases.
    The rules of section 937(b) and these regulations generally apply 
for purposes of all provisions of the Code for which a determination 
must be made regarding whether income is derived from sources within a 
possession. They generally do not apply, however, for purposes of 
applying mirrored provisions of the Code in mirror code possessions. 
Thus, for example, gain that is treated as income from sources outside 
the USVI for purposes of section 934(b) under the special gain rules 
described above (in the paragraph regarding dispositions of certain 
property held by a U.S. person prior to becoming a resident of a 
possession), nonetheless may constitute income from sources within the 
USVI for purposes of mirrored section 904. In addition, in order to 
avoid unintended reduction of the tax base of mirror code possessions, 
certain of the special rules described above do not apply for 
determining whether individuals who are not bona fide residents of such 
possessions have income from sources within such possessions for 
purposes of sections 932 and 935.
    The 2004 Act provisions concerning the determination of whether 
income is derived from sources within a possession generally apply to 
taxable years ending after October 22, 2004, except that the U.S. 
income rule applies only to income earned after October 22, 2004. The 
regulations generally adopt these effective dates, except that the 
regulations provide that the U.S. income rule only applies for income 
earned after December 31, 2004. Also, the special rules provided for 
gains from dispositions of certain personal property apply to 
dispositions after April 11, 2005, and the conduit rule and the look-
through rules for dividends and interest from possessions corporations 
apply to amounts paid or accrued after April 11, 2005. For taxable 
years beginning after December 31, 1986, and ending before October 23, 
2004, the rules of Sec.  1.863-6 (as in effect for such years) remain 
applicable.

C. Income Effectively Connected With the Conduct of Trade or Business 
in a Possession

    In 1960, in response to concerns about the reach of a local, tax-
related subsidy program, section 934 was enacted to provide explicit 
limits on the ability of the USVI to reduce income tax liabilities. The 
legislative history explains that, ``while recognizing the desirability 
of economic development'' in the USVI, Congress believed that ``in no 
case should this be attained by granting windfall gains to taxpayers 
with respect to income derived from investments in corporations in the 
continental United States, or with respect to income in any other 
manner derived from sources outside of the Virgin Islands.'' S. Rep. 
No. 1767, 86th Cong., 2nd Sess. 4 (1960).
    In 1986, in response to certain identified abuses and other 
problems related to tax administration in the possessions, section 934 
was modified and current section 931 was enacted (among other changes 
to the rules relating to the possessions). In so doing, Congress 
expressed concerns similar to those expressed in 1960:
    ``While the committee believes it is appropriate to provide more 
local autonomy to these possessions, the committee does not intend to 
allow them to be used as tax havens. The committee believes that it may 
be appropriate for these possessions to reduce tax on local income in 
some cases, but the committee has included antiabuse rules to prevent 
use of these possessions to avoid U.S. tax. The complexity and 
ambiguity of the present law rules have provoked taxpayers to take 
return positions that, while plausible under a literal reading, would 
result in tax avoidance beyond what taxpayers would ask from this 
committee or from Congress. The committee is seeking to prevent this in 
the future.'' H.R. Rep. No. 99-426, at 485-486 (1985). See also S. Rep. 
No. 99-313, at 479 (1986).
    This concern was also expressed in the legislative history 
regarding how the IRS and Treasury might exercise their authority under 
sections 931 and 934 as enacted and modified, respectively, by the 1986 
Act, to define the scope of income that would be considered derived 
from sources within a possession or effectively connected with the 
conduct of a trade or business in a possession (possession ECI). The 
discussion in the legislative history was devoted exclusively to ways 
in which the IRS and Treasury might narrow the scope of these concepts 
(as compared to the scope they otherwise would have under a mirrored 
application of the existing principles for determining whether income 
is considered to be derived from sources within the United States or 
effectively connected with the conduct of a trade or business in the 
United States). H.R. Rep. No. 99-426, at 487 and 489 (1985); S. Rep. 
No. 99-313, at 481 and 484 (1986).
    In 2004, in response to certain abusive cases that had been 
identified, the rules relating to the possessions were again modified. 
In so doing, Congress once again expressed its concern about how such 
rules might be used as an inappropriate means to reduce U.S. taxes: 
``The conferees are further concerned that the general rules for 
determining whether income is effectively connected with the conduct of 
a trade or business in a possession present numerous opportunities for 
erosion of the U.S. tax base.'' H.R. Rep. No. 108-755, at 780 (2004). 
The U.S. income rule discussed above (see section II.B. of this 
explanation) was enacted in order to prevent such U.S. tax avoidance.

[[Page 18927]]

    Reflecting the concern that tax benefits intended to foster 
economic development in the possessions should not be permitted to be 
used as a means to reduce U.S. taxes on income derived from U.S. 
economic activity, these regulations incorporate the U.S. income rule 
of section 937(b)(2), as well as a conduit rule (as described above in 
section II.B. of this explanation) that is intended to prevent the 
avoidance of the U.S. income rule. Accordingly, income from U.S. 
sources generally will not be considered possession ECI.
    Section 937(b) also includes regulatory authority for the IRS and 
Treasury to provide exceptions to this rule. As noted above in section 
II.B. of this explanation, the legislative history to the 2004 Act 
indicates that Congress intended for Treasury and the IRS to use this 
authority to continue the existing treatment of income from the sale of 
goods manufactured in a possession. Accordingly, these regulations 
provide an exception from the U.S. income rule for such income. In 
addition, the regulations provide that the U.S. income rule only 
applies for income earned after December 31, 2004.
    Apart from the U.S. income rule, these regulations apply the same 
principles for determining whether income is possession ECI as have 
applied since the 1986 Act. See Francisco v. Commissioner, 119 T.C. 317 
(2002) aff'd, 370 F.3d 1228 (DC Cir. 2004) (principles of section 
864(c)(4) apply for determining whether U.S. source income is 
possession ECI for U.S. Federal income tax purposes).
    The rules of section 937(b) and these regulations generally apply 
for purposes of all provisions of the Code for which a determination 
must be made regarding whether income is possession ECI. They generally 
do not apply, however, for purposes of applying mirrored provisions of 
the Code in mirror code possessions. Thus, for example, U.S. source 
income that is treated as income not effectively connected with the 
conduct of a trade or business within the USVI for purposes of section 
934(b) under the U.S. income rule described above nonetheless may 
constitute income effectively connected with the conduct of a trade or 
business within the USVI for purposes of mirrored section 871 or 882.
    The 2004 Act provisions concerning the determination of whether 
income is possession ECI generally apply to taxable years ending after 
October 22, 2004, except that the U.S. income rule applies only to 
income earned after October 22, 2004. The regulations generally adopt 
these effective dates, except that the regulations provide that the 
U.S. income rule only applies for income earned after December 31, 
2004. In addition, the conduit rule applies only to amounts paid or 
accrued after April 11, 2005. For taxable years beginning after 
December 31, 1986, and ending before October 23, 2004, the principles 
of section 864(c) (including section 864(c)(4)) remain applicable.

III. Information Reporting by Residents of a Possession

    Section 7654(e), as enacted by the 1972 Act and still applicable 
with respect to section 935 possessions, provides an express grant of 
authority for the IRS and Treasury to issue regulations prescribing 
information reporting requirements for individuals to whom section 935 
applies, as necessary to carry out the provisions of sections 935 and 
7654. Section 7654(e), as amended by the 1986 Act, provides a similar 
express grant of authority for the IRS and Treasury to issue 
regulations prescribing information reporting requirements for 
individuals to whom sections 931 and 932 apply, as necessary to carry 
out the provisions of those sections and section 7654. The penalty 
provided under section 6688, as amended by the 2004 Act, for failure to 
satisfy such reporting requirements is $1,000.
    The 2004 Act supplemented this general grant of authority with a 
specific requirement under section 937(c) for information reporting by 
individuals who take the position for U.S. income tax reporting 
purposes that they became, or ceased to be, bona fide residents of 
Guam, American Samoa, the NMI, Puerto Rico, or the USVI. For taxable 
years ending after October 22, 2004, as well as for any of an 
individual's preceding three taxable years, section 937(c) requires 
that such individuals provide notice of their change in residency. 
Thus, for calendar year taxpayers, such information reporting generally 
is required if they changed their residency to or from a possession 
during 2001, 2002, 2003, or 2004 (or if they do so in any future year).
    Section 937(c) authorizes the IRS and Treasury to prescribe the 
time and manner by which taxpayers are to provide such notice. In early 
2005, the IRS will provide a form on which the notice required by 
section 937(c) is to be made, as well as instructions specifying the 
time and manner for filing the form. The IRS and Treasury anticipate 
issuing guidance that will provide appropriate exceptions to the 
general statutory rules in order to minimize the reporting burden on 
taxpayers. Reporting will not be required until the form and 
instructions are made available. The same $1,000 penalty under section 
6688 will apply in cases of failure to file this form when required.

IV. Removal of Obsolete Regulations

    This document also removes certain regulations, and cross-
references to such regulations, which became obsolete with the 
enactment of the 1986 Act. The 1986 Act amendments that rendered them 
obsolete were effective for tax years beginning after December 31, 
1986. For example, the regulations promulgated by TD 6500, 25 FR 11910; 
TD 7283, 38 FR 20825; and TD 7385, 40 FR 50260, relating to former 
section 931, were rendered obsolete with the enactment of the 1986 Act. 
Thus, such regulations have no legal effect for taxable years beginning 
after December 31, 1986. See, e.g., Specking v. Commissioner, 117 T.C. 
95 (2001), aff'd sub nom. Umbach v. Commissioner, 357 F. 3d 1108 (10th 
Cir. 2004).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
refer to the Special Analyses section of the preamble to the cross-
referencing notice of proposed rulemaking published in the Proposed 
Rules section in this issue of the Federal Register. Pursuant to 
section 7805(f) of the Code, these temporary regulations will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal authors of these regulations are W. Edward Williams 
and J. David Varley, Office of the Associate Chief Counsel 
(International), IRS. However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

[[Page 18928]]

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR parts 1, 301, and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.931-1T also issued under 26 U.S.C. 7654(e).
    Section 1.932-1T also issued under 26 U.S.C. 7654(e).
    Section 1.935-1T also issued under 26 U.S.C. 7654(e). * * *
    Section 1.937-1T also issued under 26 U.S.C. 937(a).
    Section 1.937-2T also issued under 26 U.S.C. 937(b).
    Section 1.937-3T also issued under 26 U.S.C. 937(b). * * *
    Section 1.957-3T also issued under 26 U.S.C. 957(c). * * *


0
Par. 2. In Sec.  1.170A-1, paragraph (j)(9) is revised to read as 
follows:


Sec.  1.170A-1  Charitable, etc., contributions and gifts; allowance of 
deduction.

* * * * *
    (j)(9) [Reserved]. For further guidance see Sec.  1.170A-1T(j)(9).
* * * * *

0
Par. 3. Section 1.170A-1T is added to read as follows:


Sec.  1.170A-1T  Charitable, etc., contributions and gifts; allowance 
of deduction (temporary).

    (a) through (j)(8) [Reserved]. For further guidance, see Sec.  
1.170A-1(a) through (j)(8).
    (j)(9) Charitable contributions paid by bona fide residents of a 
section 931 possession as defined in Sec.  1.931-1T(c)(1) or Puerto 
Rico are deductible only to the extent allocable to income that is not 
excluded under section 931 or 933. For the rules for allocating 
deductions for charitable contributions, see the regulations under 
section 861.
    (j)(10) and (11) [Reserved]. For further guidance, see Sec.  1.170-
1(j)(10) and (11).
    (k) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 4. In Sec.  1.243-3, paragraph (a)(2)(iii) is revised to read as 
follows:


Sec.  1.243-3  Certain dividends from foreign corporations.

* * * * *
    (a)(2) * * *
    (iii) by a domestic corporation during any period to which section 
931 (relating to income from sources within possessions of the 
UnitedStates), as in effect for taxable years beginning before January 
1, 1976, applied.

0
Par. 5. In Sec.  1.702-1, paragraph (c)(1)(iii) is revised to read as 
follows:


Sec.  1.702-1  Income and credits of partner.

* * * * *
    (c)(1) * * *
    (iii) In computing the amount of gross income received from sources 
within possessions of the United States (section 937).
* * * * *

0
Par. 6. In Sec.  1.861-3, paragraph (a)(2) is revised to read as 
follows:


Sec.  1.861-3  Dividends.

* * * * *
    (a)(2) [Reserved]. For further guidance, see Sec.  1.861-3T(a)(2).

0
Par. 7. Section 1.861-3T is added to read as follows:


Sec.  1.861-3T  Dividends (temporary).

    (a)(1) [Reserved]. For further guidance, see Sec.  1.861-3(a)(1).
    (2) Dividend from a domestic corporation. A dividend described in 
this paragraph (a)(2) is a dividend from a domestic corporation other 
than a corporation which has an election in effect under section 936. 
See paragraph (a)(5) of this section for the treatment of certain 
dividends from a DISC or former DISC.
    (a)(3) through (c) [Reserved]. For further guidance, see Sec.  
1.861-3(a)(3) through (c).
    (d) Effective date. This section shall apply for taxable years 
ending after October 22, 2004.

0
Par. 8. In Sec.  1.861-8, paragraphs (f)(1)(vi)(E), (F), and (H) are 
revised to read as follows:


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

* * * * *
    (f) * * *
    (1) * * *
    (vi) * * *
    (E) [Reserved].
    (F) [Reserved].
* * * * *
    (H) [Reserved].
* * * * *

0
Par. 9. Section 1.863-6 is revised to read as follows:


Sec.  1.863-6  Income from sources within a foreign country.

    The principles applied in sections 861 through 863 and section 865 
and the regulations thereunder for determining the gross and the 
taxable income from sources within and without the United States shall 
generally be applied in determining the gross and the taxable income 
from sources within and without