Source Rules Involving U.S. Possessions and Other Conforming Changes, 19350-19377 [08-1105]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 69 (Wednesday, April 9, 2008)]
[Rules and Regulations]
[Pages 19350-19377]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 08-1105]



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Part IV





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 301



Source Rules Involving U.S. Possessions and Other Conforming Changes; 
Final Rule

Federal Register / Vol. 73, No. 69 / Wednesday, April 9, 2008 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[TD 9391]
RIN 1545-BF85


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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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 Sec. Sec.  1.1-
1(d), 1.170A-1(k), 1.861-3(d), 1.861-8(h), 1.871-1(d), 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), 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 (TD 9194, 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, 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 (TD 9248, 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 (TD 9297, 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, 
Sec. Sec.  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.

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 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

[[Page 19351]]

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 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 Sec.  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 section 861 through 865, the only permissible 
modifications to the U.S. source rules were the substitutions described 
in Sec.  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 Sec.  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, 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 sections 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 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 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 
932 and 934(b)

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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, Sec.  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 Sec.  1.863-6 for determining 
income within and without a territory. See Sec.  1.863-6 (2004).
    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 $3000 (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 Sec.  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 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 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).

[[Page 19353]]

    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 for 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 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 
territories. 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 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 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 Sec.  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.
    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.

[[Page 19354]]

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 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 final 
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 coverage 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 Sec. Sec.  
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 (2006-38 IRB 459) (see Sec.  
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 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

[[Page 19355]]

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 CB 323) (see Sec.  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 Sec.  1.931-1(c)(1). Rather, section 935 remains in 
effect with respect to bona fide residents of Guam and the NMI. The 
final regulations under section 935 generally retain the provisions of 
the temporary and revised 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, 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 regulations 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 CB 900) (see Sec.  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 IRB 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

[[Page 19356]]

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 IRB 689) continue to 
apply. See Sec.  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 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 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 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 Sec.  1.937-2T, including the special rules 
for determining whether dividends to individuals who own more than 10 
percent of the total voting 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 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 sections 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 
Sec.  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

[[Page 19357]]

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 Sec.  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), Sec.  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 code 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 apply 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 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 IRB 368) (IRS pre-filing agreement procedures) and Rev. Proc. 
2006-23 (2006-1 CB 900) (U.S. competent authority assistance procedures 
with respect to the territories). See Sec.  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 CB 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 and Treasury

[[Page 19358]]

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.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 301 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 1.931-1 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). * * *


0
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:


Sec.  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 
Sec.  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.

0
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:


Sec.  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 Sec.  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.


Sec.  1.170A-1T  [Removed]

0
Par. 4. Section 1.170A-1T is removed.
0
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:


Sec.  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.


Sec.  1.861-3T  [Removed]

0
Par. 6. Section 1.861-3T is removed.
0
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:


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

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