There are 14 U.S. territories, or possessions, five of which are inhabited: Puerto Rico (PR), Guam, U.S. Virgin Islands (USVI), American Samoa (AS), and the Commonwealth of the Northern Mariana Islands (CNMI). Each inhabited territory's local tax system has features that help determine the structure of its public finances. Additionally, U.S. law, including the Internal Revenue Code (IRC), provides the territories with certain authorities relating to each territory's tax system, while also placing limits on the taxing authority of local lawmakers. The IRC also establishes interdependencies between federal and territorial tax systems, such that changes to the IRC can have economic and revenue effects in the territories and vice versa. These dynamics between federal and territorial tax policy could interest Congress for a number of reasons. First, the inhabited territories elect representatives to Congress. The U.S. insular areas of Guam, AS, CNMI, and USVI are each represented in Congress by a Delegate to the House of Representatives. PR is represented by a Resident Commissioner, whose position is treated the same as a Delegate. Although these representatives have limited voting powers relative to other Members of the House, Delegates and the Resident Commissioner can speak and introduce bills and resolutions on the floor of the House, offer amendments and most motions on the House floor, and speak and vote in House committees. Second, Congress could be interested in using tax policies intended to improve the economic conditions of the territories. The expansion of several individual federal tax benefits that are currently used to assist lower-income households and increase participation in the labor market, or the introduction of new ones, could potentially improve the quality of living among the territories. Additionally, Congress could use business-related tax incentives to encourage capital investment and employment in the territories. Third, U.S. tax policies could have revenue implications for the territories, and vice versa. For the United States, territorial policies meant to encourage the relocation of certain industries, high-income, or high-net-worth residents to the territories could compound concerns about the erosion of the U.S. tax base and profit shifting. For the territories, their fiscal balances could be positively or negatively affected by the mix of federal and local tax policies. Territorial fiscal imbalances could raise concerns in Congress, such as recent legislation to create a fiscal control board for the purposes of restructuring public finances in PR. These policies could be considered by the bipartisan Congressional Task Force on Economic Growth in PR, created by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA; P.L. 114-187 ). The Task Force has been directed to issue a report, by the end of 2016, providing recommended changes to federal law that would serve to "spur sustainable long-term economic growth, job creation, reduce child poverty, and attract investment" in PR. Although many of these issues are currently being considered within the context of PR, some of these issues have also been part of longer policy debates over U.S. tax policy toward the territories. This report summarizes U.S. tax policy related to the territories, including what federal tax policies apply to residents in each of the territories and how federal law affects the different territorial tax systems. Multiple current tax policy issues related to the territories are then analyzed. This report is intended to provide Congress with an overview of tax issues related to the territories. It is not intended to be a comprehensive guide to territorial or federal tax policy or tax law. For more tax policy and tax law background on the U.S. territories, please see the list of related readings listed in the Appendix . U.S. law restricts the territories' authority to impose territorial (local) taxes. Most importantly is the distinction between the mirror code and non-mirror code tax systems. Three territories—Guam, CNMI, and the USVI—are currently required by U.S. law to have a mirror code (see Figure 1 ). This means these territories must use the IRC as their territorial income tax law, substituting terms where appropriate (e.g., the territory's name for "United States"). The mirror code requirements relate only to the IRC's income tax provisions (individual, corporate, and noncorporate business income), and not the IRC's other provisions such as excise taxes. Also, while these territories use the IRC as their income tax system, the tax imposed is a local tax (see Table A-1 for a discussion of how this could also affect tax filing requirements). In contrast, territories that are not bound by the mirror code (PR and AS) may establish their own local forms of income taxation and promulgate their own income tax regulations. Regardless of whether territories use the mirror code, they are still allowed to enact additional forms of taxation within certain boundaries enacted by U.S. Constitution and applicable federal statutes. A number of territories have used this authority to enact additional types of revenue-raising measures, or provide rebates on territorial-source income taxes. Although Guam and CNMI are mirror-code jurisdictions, they are authorized under Section 1271 of the Tax Reform Act of 1986 (TRA86) to delink from the IRC if certain conditions are met. In order to delink, Guam or CNMI would need to (1) enact a new, non-discriminatory local income tax system to replace the IRC that raised revenue during each of its first five years that is at least equal to the revenue raised during the final year under the old system; and (2) enter into an implementing agreement with the United States to address issues relating to tax administration. While Guam signed an implementing agreement with the United States in 1989, it has never gone into effect. CNMI, meanwhile, has not entered into an implementing agreement with the United States. USVI is required to mirror the IRC for its local tax code but has additional authority to levy taxes compared to Guam and CNMI. Unlike Guam or CNMI, TRA86 did not provide USVI with the authority to delink from the mirror code, reportedly by mutual agreement with the United States. TRA86 did grant USVI, though, with the authority to enact nondiscriminatory local income taxes in addition to those taxes mirrored in the IRC. However, USVI has not enacted any additional forms of income taxes to date. Under IRC Section 934, USVI is also allowed to provide tax benefits to its residents on their USVI-source income only. There is no requirement in U.S. law that PR and AS use a mirror code. Thus, these two territories may enact their own income tax laws, subject to any requirements in U.S. law (e.g., any such tax laws must comply with the U.S. Constitution). Congress recognized PR's authority over matters of internal governance, including territorial tax law and policy, in the 1950 Federal Relations Act (P.L. 81-600) and its approval of the territory's constitution in 1952. Since then, PR has enacted its own income tax laws. AS, meanwhile, has chosen to adopt a modified version of the IRC as its territorial income tax laws. The current version of AS's local tax code is the version of the IRC that was in effect on December 31, 2000, with some modifications. In other words, provisions in the IRC that were enacted after December 31, 2000 are not automatically incorporated into AS' mirror-code system, unless the AS' government passed legislation amending their local tax code. In addition to the imposition of local taxes in each territory, there are instances when federal taxes may apply as well. Two general principles are helpful in understanding when federal taxes apply in the territories. First, while the United States taxes its citizens, residents, and corporations based on their worldwide income regardless of whether the income is earned within the United States or abroad, for federal tax purposes the residents of the U.S. territories are generally treated more similar to foreign citizens (even though they are U.S. citizens or nationals) and corporations organized or created in the territories are treated like foreign companies. This means that federal taxes will generally only be levied when a territory resident or corporation has income that can be sourced (or connected) to the United States. Second, the territories are generally considered to be beyond the physical borders of the United States for federal tax purposes. Thus, any IRC provision whose applicability is limited to the geographic United States does not apply in the territories unless the provision specifically provides otherwise (such as the provisions listed in the " U.S. Tax Incentives Targeted to the Territories " section of this report). As a general rule, individuals who are bona fide residents of a territory are eligible for a possession-source income exclusion, and therefore not subject to U.S. income tax on work or business income sourced from within the territories (except for compensation of federal government employees). Bona fide residents of a territory with income only from that territory need to only file one tax return with their local tax authorities. Table A-1 summarizes the general tax filing and income reporting procedures for individuals with territorial-source income. The possession-source income exclusion currently applies to each of the territories through several sections of the IRC: American Samoa (IRC Section 931) U.S. Virgin Islands (IRC Section 932) Puerto Rico (IRC Section 933) Guam and CNMI (former IRC Section 935) The possession-source income exclusion and IRC tax coordination requirements between each territory and the United States will determine the filing situation of bona fide residents with income earned outside of their jurisdiction, and individuals who are not bona fide residents and earned territorial-source income. Bona fide residents with income from another jurisdiction (such as the United States) might have to file returns with the IRS or their local tax authorities (or both).