IRS warns against frivolous filing positions that rely on foreign-based-income argument.

• Author: Fiore, Nicholas J.

Certain persons are promoting the view that U.S. citizens and residents are not subject to tax on their wages and other income earned or derived within the U.S., based on the claim that the Code imposes taxes only on income derived from certain foreign-based activities. The Service is issuing this notice to inform taxpayers that this reporting position has no basis in law.

The proponents of this position misread the Code and regulations. Although the proponents acknowledge that Sec. 1 imposes income tax on "taxable income," taxable income consists of "gross income" minus deductions (Sec. 63) and gross income is income "from whatever source derived" (Sec. 61), they assert that Secs. 861-865 and the regulations thereunder (in particular, Regs. Sec. 1.861-8) limit taxable "sources" of income to certain foreign-based activities.

That assertion is refuted by the express and unambiguous terms of the Code. Sec. 61 includes in gross income "all income from whatever source derived." As the Supreme Court stated in Glenshaw Glass Co., 348 US 426 (1955), "Congress applied no limitations as to the source of taxable receipts ..." Nothing in Secs. 861-865 limits the gross income subject to U. S. taxation to foreign-source income. Secs. 861-865 have significance in determining whether income is considered from sources within or outside the U.S., which is relevant, for example, in determining whether a U.S. citizen or resident may claim a credit for foreign taxes paid. The source rules do not operate to exclude from U.S. taxation income earned by U.S. persons from sources within the U.S.

The courts have categorically rejected contentions that U.S. citizens are not lawfully subject to Federal income tax on their income from all sources, and have upheld criminal convictions of individuals who based their refusal to pay...