Rev. Rul. 79-389

ISSUE

What is the proper method of computing the portion of a pension payment that is income from sources without the United States for purposes of determining the limitation on the credit for foreign taxes pursuant to section 904 of the Internal Revenue Code?

FACTS

The taxpayer, a citizen of the United States, was employed in the United States for a period of years by a United States employer and was employed abroad on behalf of this employer continuously from January 1, 1965, through December 31, 1977, when the taxpayer retired and became eligible for a pension. During the taxpayer's employment the employer, on behalf of the taxpayer, contributed to a qualified pension trust described in section 401(a) that is exempt from tax under 501(a). The pension plan is a noncontributory arrangement with respect to employees. The pension plan invested the contributions and received income from the investments.

The taxpayer files a federal income tax return on a calendar year basis. Since January 1, 1978, the taxpayer's first day of retirement, the taxpayer has resided abroad in foreign country X. Country X imposed an income tax on the pension income that the taxpayer received in 1978.

LAW AND ANALYSIS

Section 901(b)(1) of the Code provides that, subject to the limitation of section 904, a citizen of the United States shall be allowed as a credit under section 901(a) the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States.

Section 904(a) of the Code provides that the total amount of the credit taken under section 901(a) shall not exceed the same proportion of the tax against which such credit is taken that the taxpayer's taxable income from sources without the United States (but not in excess of the taxpayer's entire taxable income) bears to the taxpayer's entire taxable income for the same taxable year.

Sections 861 through 864 of the Code contain rules for sourcing income for services performed within and without the United States, but those sections contain no specific provision regarding the source of income from pensions.

Section 861(a)(3) of the Code provides that compensation for labor or personal services performed in the United States shall be treated as income from sources within the United States and section 862(a)(3) provides that compensation for labor or personal services performed without the United States shall be treated as income from sources without the United States.

Section 1.861-4(b)(1)(i) of the Income Tax Regulations provides, with respect to taxable years beginning after December 31, 1975, that when labor or service is performed partly within and partly without the United States, the amount to be included in the gross income shall be determined on the basis that most correctly reflects the proper source of income under the facts and circumstances of the particular case.

Employer contributions to an annuity or pension plan represent compensation for personal services. See Rev. Rul. 56-82, 1956-1 C.B. 59. An employer's contributions to a pension plan with respect to wages earned abroad by a taxpayer are compensation for labor or personal services performed without the United States and are treated as derived from sources without the United States. See Rev. Rul. 72-149, 1972-1 C.B. 218.

Rev. Rul. 56-125, 1956-1 C.B. 627, indicates that distributions to a citizen of the United States from a qualified pension trust are income from sources within the United States, to the extent such distribution represent earnings and accretions to contributions of either the employer or the employee.

HOLDING

In determining the proper allocation between United States and foreign sources of the distributions from the United States plan for purposes of computing the limitation on the credit for foreign taxes under section 904(a) of the Code, that part of the distribution that represents the earnings of a United States pension plan is income from sources within the United States and the taxpayer's taxable income from sources without the United States includes only the amount of the pension distribution attributable to the employer's contributions to the pension plan with respect to wages earned abroad by the taxpayer. Therefore, that portion of the pension payment that is income from sources without the United States for purposes of determining the limitation on the credit for foreign taxes pursuant to section 904(a) is determined by multiplying the portion of the pension payment received by the taxpayer that is attributable to the employer contributions with respect to wages by the ratio that the employer's contributions made to the pension plan with respect to wages earned by the taxpayer while the taxpayer was employed outside of the United States bears to the total of the employer's contributions to the pension plan with respect to all the wages earned by the taxpayer.

The principles of this Revenue Ruling are illustrated by the following example:

A, a citizen of the United States residing abroad, received payments from a United States pension plan totaling 15x dollars for the taxable year. The portion of the 15x dollars attributable to earnings of the pension plan is 5x dollars, and the portion attributable to employer contributions is 10x dollars. A's employer contributed a total of 100x dollars to the pension plan with respect to wages earned by A. Twentyx dollars of this amount was contributed to the plan by the employer while A was employed outside of the United States. The portion of the pension received during the taxable year that was income from sources without the United States for purposes of determining the limitation on the credit for foreign taxes paid by A pursuant to section 904(a) is 2x dollars (10x X 20x). --- 100x

For a related issue involving pension payments to a nonresident alien, see Rev. Rul. 79-388, page 270, this Bulletin.