Part III

Administrative, Procedural, and Miscellaneous

26 CFR 1.861-4: Compensation for labor or personal services

(Also: Part I, Sections 861, 862, 871, 1441)

Rev. Proc. 2004-37

# SECTION 1. PURPOSE

This revenue procedure provides a method for determining the source of a
pension payment to a nonresident alien individual from a defined benefit
plan where the trust forming part of the plan is a trust created or
organized in the United States that constitutes a qualified trust under
§ 401(a) of the Internal Revenue Code.

# SECTION 2. BACKGROUND

Section 871(a) imposes a tax of 30 percent on amounts received by
nonresident alien individuals as interest (other than original issue
discount as defined in § 1273), dividends, rents, salaries, wages,
premiums, annuities, compensations, remunerations, emoluments, and other
fixed or determinable annual or periodical gains, profits, and income to
the extent the amount so received is from sources within the United
States and is not effectively connected with the conduct of a trade or
business within the United States.

Section 1441(a) provides for the withholding of tax, generally at a 30
percent rate, on certain income from sources within the United States
paid to a nonresident alien individual. Section 1441(b) lists salaries,
wages, annuities, compensations, remunerations, or other fixed or
determinable annual or periodical gains, among other things, as items of
income subject to the withholding of tax under § 1441(a).

Section 1.1441-4(b)(1)(ii) of the Income Tax Regulations provides
generally that U.S.-source payments to a nonresident alien individual
from a trust described in § 401(a) are subject to withholding under §
1441. But see § 871(f) (excluding from income certain amounts received
from certain qualified plans); § 1.1441-4(d) (excluding such amounts
from withholding).

Section 861(a)(3) provides generally that compensation for labor or
personal services performed in the United States is treated as income
from sources within the United States. Section 862(a)(3) provides that
compensation for labor or personal services performed outside the United
States is treated as income from sources without the United States.

Employer contributions to an annuity or pension plan constitute
compensation for labor or personal services. See, e.g., Rev. Rul. 56-82,
1956-1 C.B. 59. For purposes of determining the source of pension
payments from a qualified trust under § 401(a), the portion of each
payment that is attributable to employer contributions with respect to
services rendered within the United States is treated as income from
sources within the United States, the portion that is attributable to
employer contributions with respect to services rendered outside the
United States is treated as income from sources without the United
States, and the portion that represents earnings and accretions to
contributions of either the employer or the employee is treated as
income from sources within the United States. Rev. Rul. 79-388, 1979-2
C.B. 270. [See also]{.underline}, [Clayton v. United
States]{.underline}, 33 Fed. Cl. 628 (1995), [aff'd without published
opinion]{.underline}, 91 F.3d 170 (Fed. Cir. 1996), [cert.
denied]{.underline}, 519 U.S. 1040 (1996).

Employer contributions to a defined benefit plan qualified under §
401(a) covering more than one individual participant are not made for
the benefit of specific participants, but are made based on aggregate
liabilities to all participants. All funds held under the plan are
available to provide benefits to any participant. Accordingly, it is not
possible in such a case to allocate actual contributions to specific
participants.

SECTION 3. SCOPE

.01 [General application]{.underline}. If a trust under a qualified
defined benefit plan makes a payment with respect to a participant who
is a nonresident alien individual and the actual amounts of employer
contributions made to the plan for the benefit of such participant are
not known, the method set forth in section 4 of this revenue procedure
may be used to allocate the payment to sources within and without the
United States. The method set forth in section 4 is based on methods
similar to those used for purposes of §§ 1.403(b)-1(d)(4),
1.402(b)-1(a)(2), and 1.402(b)-1(b)(2)(ii) of the Income Tax Regulations
when contributions for the benefit of a particular participant are not
known.

.02 [Application to a possession of the United States]{.underline}. The
method set forth in section 4 of this revenue procedure also may be used
for purposes of allocating a payment from a trust under a qualified
defined benefit plan to sources within and without a possession of the
United States. See § 1.863-6 (providing that the principles applied for
determining income from sources within and without the United States are
generally applied for purposes of determining income from sources within
and without a possession). Thus, for example, in the case of a payment
from a trust under a qualified defined benefit plan to a bona fide
resident of Puerto Rico, the method set forth in section 4 may be used
for purposes of determining what portion of the payment is derived from
sources within Puerto Rico and therefore excludible from the recipient's
gross income under § 933(1).

# SECTION 4. METHOD

.01 [Determination of total contributions]{.underline}. The amount of
total contributions to a defined benefit plan for the benefit of a
particular individual is deemed to be the product of the following three
quantities multiplied by one another, each such quantity determined as
of the annuity starting date---

\(i\) the present value of the individual=s pension payable at the
annuity starting date, determined under section 4.02;

\(ii\) the amount from Table I below based on the number of years from
the first date the individual became a participant in the plan to the
annuity starting date (representing the amount that, when contributed on
an annual level basis, will accumulate to \$1.00 at the annuity starting
date); and

\(iii\) the number of years from the first date the individual became a
participant in the plan to the annuity starting date.

.02 [Present value of pension]{.underline}. (a) If payment is made in
the form of a straight life annuity commencing at the annuity starting
date, then the present value of the individual=s pension is the product
of (i) the amount payable annually, multiplied by (ii) the value from
Table II below, based on the individual's age at the annuity starting
date, of an annuity of \$1.00 per annum payable in equal monthly
installments during the life of the individual.

\(b\) If payment is made in the form of a single-sum payment of the
total benefit due to the individual under the plan at the annuity
starting date, then the present value of the individual=s pension is
equal to the amount of the single-sum payment.

\(c\) If payment is made in a form not identified in either of the two
preceding paragraphs, then the present value of the individual=s pension
is the actuarial present value of the individual=s pension, determined
on the annuity starting date based on a 7% rate of interest and the
mortality table in Rev. Rul. 2001-62, 2001-2 C.B. 632.

.03 [Tables]{.underline}.

> Table I.---Amount that, when contributed on an annual level basis,
> will accumulate to \$1.00 at the annuity starting date, based on the
> total number of years from the first date the individual became a
> participant in the plan to the annuity starting date

  ----------------------------------- -----------------------------------
  Number of Years                     Amount

  1                                   \$1.0000

  2                                   0.4831

  3                                   0.3111

  4                                   0.2252

  5                                   0.1739

  6                                   0.1398

  7                                   0.1156

  8                                   0.0975

  9                                   0.0835

  10                                  0.0724

  11                                  0.0634

  12                                  0.0559

  13                                  0.0497

  14                                  0.0443

  15                                  0.0398

  16                                  0.0359

  17                                  0.0324

  18                                  0.0294

  19                                  0.0268

  20                                  0.0244

  21                                  0.0223

  22                                  0.0204

  23                                  0.0187

  24                                  0.0172

  25                                  0.0158

  26                                  0.0146

  27                                  0.0134

  28                                  0.0124

  29                                  0.0115

  30                                  0.0106

  31                                  0.0098

  32                                  0.0091

  33                                  0.0084

  34                                  0.0078

  35                                  0.0072

  36                                  0.0067

  37                                  0.0062

  38                                  0.0058

  39                                  0.0054

  40                                  0.0050

  41                                  0.0047

  42                                  0.0043

  43                                  0.0040

  44                                  0.0038

  45                                  0.0035

  46                                  0.0033

  47                                  0.0030

  48                                  0.0028

  49                                  0.0026

  50                                  0.0025
  ----------------------------------- -----------------------------------

Table II.--- The value of an annuity of \$1.00 per annum payable in
equal monthly installments during the life of the individual, based on
the individual's age at the annuity starting date.

  ----------------------------------- -----------------------------------
  Age at Annuity Starting Date        Value

  40                                  13.61

  41                                  13.54

  42                                  13.46

  43                                  13.38

  44                                  13.29

  45                                  13.20

  46                                  13.11

  47                                  13.00

  48                                  12.89

  49                                  12.78

  50                                  12.66

  51                                  12.53

  52                                  12.40

  53                                  12.25

  54                                  12.11

  55                                  11.95

  56                                  11.79

  57                                  11.62

  58                                  11.45

  59                                  11.26

  60                                  11.08

  61                                  10.88

  62                                  10.68

  63                                  10.48

  64                                  10.27

  65                                  10.06

  66                                  9.84

  67                                  9.62

  68                                  9.40

  69                                  9.17

  70                                  8.93

  71                                  8.69

  72                                  8.44

  73                                  8.18

  74                                  7.92

  75                                  7.65

  76                                  7.38

  77                                  7.10

  78                                  6.83

  79                                  6.55

  80                                  6.28
  ----------------------------------- -----------------------------------

.04 [Allocation of payments to sources within and without the United
States]{.underline}. (a) [General rule]{.underline}. The portion of each
payment that is deemed to be attributable to contributions for services
rendered outside the United States, and thus treated as income from
sources without the United States, is equal to the quotient of (i) the
product of (A) the total deemed contributions (as determined under
section 4.01 of this revenue procedure), multiplied by (B) a fraction,
the numerator of which is the months of service credited under the plan
that were rendered outside the United States and the denominator of
which is the total months of service credited under the plan as of the
annuity starting date (i.e., prorated based on months of service
rendered within and without the United States), divided by (ii) the
present value of the pension at the annuity starting date (as determined
under section 4.02 of this revenue procedure). The remainder of the
payment, which represents the sum of deemed contributions for services
rendered within the United States plus earnings on all contributions, is
treated as income from sources within the United States.

\(b\) [Special rule for employee after-tax contributions]{.underline}.
If the participant has made any employee after-tax contributions to the
plan, then each payment is first reduced by the employee after-tax
contributions allocable to such payment under § 72. The portion of the
remainder of each payment that is treated as income from sources without
the United States is equal to the quotient of (i) the product of (A) the
excess of the total contributions (as determined under section 4.01 of
this revenue procedure) over the total employee after-tax contributions
to the plan, multiplied by (B) a fraction, the numerator of which is the
number of months of service credited under the plan that were rendered
outside the United States and the denominator of which is the total
months of service credited under the plan at the annuity starting date,
divided by (ii) the excess of the present value of the pension at the
annuity starting date (as determined under section 4.02 of this revenue
procedure) over the total employee after-tax contributions to the
plan**.** The portion of each payment that is allocable neither to
employee after-tax contributions nor to income from sources without the
United States is treated as income from sources within the United
States.

SECTION 5. EXAMPLES

.01 [Retirement at age 65]{.underline}. (a) [Facts]{.underline}. P, a
nonresident alien individual, is a citizen and resident of Country B. P
will be age 65 on December 31, 2004. There is no income tax treaty in
force between the United States and Country B.

P has been an employee of Company X, a domestic corporation, since 1975
and is retiring on December 31, 2004. P worked in Company X's branch
office in Country B from January 1, 1975 through December 31, 1984. On
January 1, 1985, P was transferred to the United States to work at
Company X's headquarters. While P worked in the United States, P was
classified as a resident alien under § 7701(b)(1)(A)(ii). On January 1,
1995, P was transferred back to Company X's branch office in Country B,
where P will have worked until retiring on December 31, 2004. In total,
P will have worked 360 months for Company X, including 240 months worked
in Country B and 120 months worked in the United States.

Throughout P's employment by Company X, P has been a participant in a
defined benefit plan ("Plan A") maintained by Company X. The trust
forming part of Plan A is a trust created or organized in the United
States that constitutes a qualified trust under § 401(a). The normal
form of retirement benefit under Plan A is a straight life annuity. The
amount payable under the straight life annuity form is an annual benefit
of 1 percent of highest-five years' pay multiplied by years of service
credited under the plan, payable monthly for life commencing at normal
retirement age (age 65) or at actual retirement age, if later. Plan A
provides for an actuarially reduced amount to be payable if the
participant has a severance from employment before normal retirement
age, but the reduction is smaller if the participant retires after age
55 with at least 20 years of service (for example, only a 16.67%
reduction applies at age 55). Contributions under Plan A are not made on
behalf of specific individual participants.

P is entitled to a monthly pension from Plan A beginning at age 65, the
annual amount of which will be \$30,000 payable as a straight life
annuity. P elects to receive payment of that pension in the form of a
straight life annuity commencing immediately. P has never made any
after-tax contributions to Plan A, and § 871(f), relating to an
exclusion from gross income for certain amounts received from certain
qualified pension plans, does not apply to any amounts received by P
from Plan A.

\(b\) [Application]{.underline}. The total deemed contributions for the
benefit of P under the method set forth in section 4.01 of this revenue
procedure equal \$95,972, which is the product of \$301,800 (the present
value of P's pension benefit from Plan A under section 4.02(a), computed
as the product of \$30,000 multiplied by 10.06, which is the applicable
adjustment factor under Table II of section 4.03), multiplied by 0.0106
(the number from Table I that corresponds to the total number of years
of accumulation for P before the annuity starting date), multiplied by
30 (P's total years of service credited under the plan). Under section
4.04 of this revenue procedure, the portion of each payment that is
treated as income from sources without the United States is equal to the
quotient of (i) the product of 240/360 multiplied by \$95,972, divided
by (ii) \$301,800, or 21 percent. The remaining 79 percent is treated as
income from sources within the United States that is subject to
withholding under § 1441(a).

.02 [Early Retirement]{.underline}. (a) [Facts]{.underline}. The facts
with respect to Plan A and Company X are the same as in [Example
5.01]{.underline}. Q, a nonresident alien individual, is a citizen and
resident of Country B. Q will be age 55 on December 31, 2004. There is
no income tax treaty in force between the United States and Country B.

Q has been an employee of Company X since 1985 and is retiring on
December 31, 2004. Q worked in Company X's branch office in Country B
from January 1, 1985 through December 31, 1994. On January 1, 1995, Q
was transferred to the United States to work at Company X's
headquarters. While Q worked in the United States, Q was classified as a
resident alien under § 7701(b)(1)(A)(ii). On September 1, 2001, Q was
transferred back to Company X's branch office in Country B, where Q will
have worked until retiring on December 31, 2004. In total, Q will have
worked 240 months for Company X, including 160 months worked in Country
B and 80 months worked in the United States.

Throughout Q's employment by Company X, Q has been a participant in Plan
A. Q is entitled to a monthly pension from Plan A beginning at age 55,
the annual amount of which will be \$25,000 payable as a straight life
annuity. Q elects to receive an actuarially equivalent joint and
contingent annuity option of \$23,000 annually with a 50 percent
continuation percentage (and Q's designated contingent annuitant is age
55) and the actuarial present value of that benefit under section
4.02(c) is \$288,019. Q has never made any after-tax contributions to
Plan A, and § 871(f), relating to an exclusion from gross income for
amounts received from certain qualified pension plans, does not apply to
any amounts received by Q from Plan A.

\(b\) [Application]{.underline}. The total deemed contributions for the
benefit of Q under the method set forth in section 4.01 of this revenue
procedure equal \$140,553, which is the product of \$288,019 (the
present value of Q's \$23,000 annual pension benefit from Plan A with a
50-percent continuation percentage, as determined under the assumptions
in section 4.02(c)), multiplied by 0.0244 (the number from Table I that
corresponds to the total number of years of accumulation for Q before
the annuity starting date), multiplied by 20 (Q's total years of service
credited under the plan). Under section 4.04 of this revenue procedure,
the portion of each payment that is treated as income from sources
without the United States is equal to the quotient of (i) 160/240
multiplied by \$140,553, divided by (ii) \$288,019, or 33 percent. The
remaining 67 percent is treated as income from sources within the United
States that is subject to withholding under § 1441(a).

SECTION 6. LIMITATION ON ISSUANCE OF PRIVATE LETTER RULINGS

.01 The Service will not issue a private letter ruling regarding a
method for determining the source of a pension payment to a nonresident
alien individual from a trust under a defined benefit plan that is
qualified under § 401(a) if the proposed method (including the related
assumptions) is inconsistent with sections 4.01, 4.02, and 4.03 of this
revenue procedure.

.02 Revenue Procedure 2004-7, 2004-1 I.R.B. 237, is amplified by adding
the following to section 3.01:

> Section 861. Income from Sources Within the United States. A method
> for determining the source of a pension payment to a nonresident alien
> individual from a trust under a defined benefit plan that is qualified
> under § 401(a) if the proposed method is inconsistent with sections
> 4.01, 4.02, and 4.03 of Revenue Procedure 2004-37, 2004-26 I.R.B.
> \_\_.

# Section 862. Income from Sources Without the United States. A method for determining the source of a pension payment to a nonresident alien individual from a trust under a defined benefit plan that is qualified under § 401(a) if the proposed method is inconsistent with sections 4.01, 4.02, and 4.03 of Revenue Procedure 2004-37, 2004-26 I.R.B. \_\_.

# 

# SECTION 7. DRAFTING INFORMATION

# 

# The principal author of this revenue procedure is Michelle S. Lyon of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in its development. For further information regarding this revenue procedure generally, contact Ms. Lyon on (202) 622-3880 (not a toll-free call). For information regarding computations under the method set forth in section 4 of this revenue procedure, contact Diane S. Bloom at (202) 283-9888 (not a toll-free call).