United States

Sourcing guaranteed payments to partners working abroad as foreign may offer benefits

INSIGHT ARTICLE  | 

When a partner works outside the U.S. for a U.S. partnership with predominantly domestic source income, there may be a benefit to receiving partner compensation as a guaranteed payment rather than as part of the partner's distributive share. Guaranteed payments for work performed outside the U.S. are generally sourced as foreign, while a distributive share is foreign sourced only to the extent of the partnership's foreign source income. Such sourcing could be beneficial when considering such things as the foreign earned income exclusion under Internal Revenue Code section 911, and certain treaty provisions. Foreign sourcing also could help with the utilization of foreign tax credits and could reduce U.S. source income to a foreign partner.

Discussion

A guaranteed payment to a partner from a partnership is an amount to which the partner is entitled to without regard to the income of the partnership. Generally, a guaranteed payment is regarded as a distributive share of ordinary income. As such, a guaranteed payment from a service partnership operating predominantly in the U.S. would generally be characterized as mostly U.S. source income. In several cases, however, where the guaranteed payment was for work performed by the partner outside the U.S., the sourcing rules of section 862 were applied to source the payment to the foreign location where the services were performed.

The Tax Court in Miller v. Comr., (52 T.C. 752 (1969), acq., 1972-2 C.B. 2), and the Court of Claims in Carey v. U.S., (427 F.2d 763 (Ct. Cl. 1970)), held that a guaranteed payment to a partner working outside the U.S. qualified as foreign-source compensation for purposes of the exclusion under section 911. In addition, in TAM 7939005, the IRS followed Miller and Carey, and allowed that a guaranteed payment to the managing partner of a foreign office qualified for section 911. Although the cases specifically dealt with section 911, the same rationale might be held applicable to other sections of the Code.

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