Tuesday, June 25, 2013

Tax Breaks for Americans in Naughty Countries Like North Korea

One lesser-known aspect of the Internal Revenue Code is its use in furthering America's foreign policy by denying certain tax benefits to US persons operating in the Axis of Evil and other bad countries.  For vague reasons, the Internal Revenue Code has two separate lists of disapproved countries, and some countries are allowed certain tax benefits but not other benefits. 

For example, the first list penalizes US companies who do business in North Korea by denying them foreign tax credits, but the second list fortunately allows American citizens living and working in North Korea to exclude up to ~$100,000 of their North Korean wages from being taxed by the United States. 

List #1
Albania was on the first list until 1991.
US taxpayers are normally allowed to claim foreign tax credits for paying taxes to foreign countries, except for any countries on a list prescribed by Internal Revenue Code section 901(j).  As a result, American individuals and businesses cannot offset their US tax liability dollar-for-dollar by taxes paid to these countries, though they can still deduct the taxes as a business expense. 

The naughty countries are:
North Korea

Iraq and Libya were most recently removed from the list in 2004.  The list also once included Afghanistan, Albania, Angola, Cambodia, South Africa, Vietnam, and the former South Yemen.

(Though the list began in 1987, poor Albania was the only Warsaw Pact country to ever be on the list.)

The US tax on income earned in the first list's countries cannot be offset by foreign taxes paid to that country, nor by other foreign taxes paid to other countries not on the list.  Furthermore, US persons are subject to US tax on their income from corporate subsidiaries operating in those countries, even though the income might be deferred under normal tax rules.  The result is that the income from those countries is generally subject to US tax no matter what.  Apple's tax-sheltering Irish subsidiary would not have worked as a North Korean subsidiary. 

List #2
An entirely separate list of naughty countries is prescribed by Internal Revenue Code section 911(d)(8).  US citizens and resident aliens who work in foreign countries are normally allowed to receive tax-free up to ~$100,000 of foreign wages and other earned income.  But this "foreign earned income exclusion" is denied if the US person works in a country on the second list.

The second list of naughty countries is:

That is all.

Libya and Iraq were the only other countries on the second list, and they were removed from the second list in 2004.

Section 901(j)   Denial of foreign tax credit, etc., with respect to certain foreign countries.  
(1)  In general.  Notwithstanding any other provision of this part—
(A) no credit shall be allowed under subsection (a) for any income, war profits, or excess profits taxes paid or accrued (or deemed paid under section 902 or 960) to any country if such taxes are with respect to income attributable to a period during which this subsection applies to such country, and
(B) subsections (a), (b), and (c) of section 904 and sections 902 and 960 shall be applied separately with respect to income attributable to such a period from sources within such country.
(2)  Countries to which subsection applies. (A) In general. This subsection shall apply to any foreign country—
(i) the government of which the United States does not recognize, unless such government is otherwise eligible to purchase defense articles or services under the Arms Export Control Act,
(ii) with respect to which the United States has severed diplomatic relations,
(iii) with respect to which the United States has not severed diplomatic relations but does not conduct such relations, or
(iv) which the Secretary of State has, pursuant to section 6(j) of the Export Administration Act of 1979, as amended, designated as a foreign country which repeatedly provides support for acts of international terrorisms.
(B) Period for which subsection applies. This subsection shall apply to any foreign country described in subparagraph (A) during the period—   (i) beginning on the later of— (I) January 1, 1987, or (II) 6 months after such country becomes a country described in subparagraph (A) , and (ii) ending on the date the Secretary of State certifies to the Secretary of the Treasury that such country is no longer described in subparagraph (A).
(3)  Taxes allowed as a deduction, etc. Sections 275 and 78 shall not apply to any tax which is not allowable as a credit under subsection (a) by reason of this subsection.
(4)  Regulations. The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection , including regulations which treat income paid through 1 or more entities as derived from a foreign country to which this subsection applies if such income was, without regard to such entities, derived from such country.
(5)  Waiver of denial. (A) In general. Paragraph (1) shall not apply with respect to taxes paid or accrued to a country if the President — (i) determines that a waiver of the application of such paragraph is in the national interest of the United States and will expand trade and investment opportunities for United States companies in such country; and (ii) reports such waiver under subparagraph (B).
(B) Report. Not less than 30 days before the date on which a waiver is granted under this paragraph, the President shall report to Congress— (i) the intention to grant such waiver; and (ii) the reason for the determination under subparagraph (A)(i).

Section 911(d)(8)  Limitation on income earned in restricted country.
(A) In general. If travel (or any transaction in connection with such travel) with respect to any foreign country is subject to the regulations described in subparagraph (B) during any period—
(i) the term “foreign earned income” shall not include any income from sources within such country attributable to services performed during such period,
(ii) the term “housing expenses” shall not include any expenses allocable to such period for housing in such country or for housing of the spouse or dependents of the taxpayer in another country while the taxpayer is present in such country, and
(iii) an individual shall not be treated as a bona fide resident of, or as present in, a foreign country for any day during which such individual was present in such country during such period.
(B) Regulations. For purposes of this paragraph , regulations are described in this subparagraph if such regulations—
(i) have been adopted pursuant to the Trading With the Enemy Act (50 U.S.C. App. 1 et seq.), or the International Emergency Economic Powers Act (50 U.S.C. 1701 et seq.), and
(ii) include provisions generally prohibiting citizens and residents of the United States from engaging in transactions related to travel to, from, or within a foreign country.
(C) Exception. Subparagraph (A) shall not apply to any individual during any period in which such individual's activities are not in violation of the regulations described in subparagraph (B).

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