New Opportunities to Exclude Foreign Income.

• Author: Bakale, Anthony

While many of the benefits of the extraterritorial income exclusion (EIE) also existed under the foreign sales corporation (FSC) regime, certain taxpayers may derive additional benefits after passage of the Extraterritorial Income Exclusion Act of 2000 that were previously unavailable.

Small Business

Small exporters can benefit from the EIE without significant incremental efforts or expenses. Unlike the FSC regime, there is no need to set up a foreign entity with its own accounting, foreign management and U.S. and foreign taxes. EIE benefits are extended to passthrough entities, including S corporations, partnerships and sole proprietorships. As long as exports do not exceed $5 million per year, such exporters are not required to perform foreign economic processes. Thus, a small business can enjoy FSC benefits even if it sells to a U.S. distributor, as long as it can document that its products are sold for ultimate use outside the U.S. (although it cannot use the foreign trading gross receipts method in computing EIE if the distributor is related). The greatest cost to a small business in taking advantage of the EIE may be the training involved in maintaining documentation and completing Form 8873, Extraterritorial Income Exclusion.

Foreign Manufacturing

Under the old FSC rules, to qualify as "export property" an article had to be manufactured, produced, grown or extracted in the U.S.; moreover, not more than 50% of the fair market value (FMV) of such property could be attributed to articles imported into the U.S. (import content).

For purposes of the 50%-import content test, the FMV of exported property, if sold to an unrelated party, is the sale price for such property. The FMV of imported articles is generally their appraised value as determined under Section 403 of the Tariff Act of 1930 and evidenced by the customs invoice issued in connection with their importation.

Under the EIE rules, qualifying foreign trade property can be manufactured, produced, grown or extracted either within or without the U.S., provided that not more than 50% of the FMV of such property is attributed to articles manufactured, produced, grown or extracted outside the U.S., and direct costs for labor performed outside the U.S. (the 50%-foreign-content rule). However, if the property is not manufactured in the U.S., it must be manufactured by a person taxable in the U.S. (i.e., a domestic corporation, an individual subject to U.S. taxation, a foreign company...