Rev. Rul. 77-167

Advice has been requested as to the proper method of allocating compensation for personal services between services performed within the United States and without the United States for purposes of section 911 of the Internal Revenue Code of 1954, under the circumstances described below.

The taxpayer, a United States citizen and bona fide resident (within the meaning of section 911(a)(1) of the Code) of foreign country S, performed personal services during 1975 under an exclusive employment contract in cities within both country S and the United States. The services performed by taxpayer, an airline pilot, consisted of actual flight time services and preflight services that the taxpayer was required to perform. The preflight services consist of the review and approval of flight plans, checking weather data prior to the actual flight, checking the physical structure of the aircraft, running through an operational checklist of the onboard systems with the co-pilot and navigator and other related flight preclearances involving passenger lists and safety precautions. These preflight services were expressly and impliedly required to be performed by the taxpayer by the terms of the contract and general industry practice. None of the services (actual flight time or preflight) were performed in the context of a customary workday or workweek.

Under the contract, the taxpayer received a monthly compensation for the services performed. The monthly compensation was computed based on the actual flight time and not preflight services. The taxpayer's contract did not provide for an allocation of compensation based on services performed either within or without the United States.

From August 1, 1975, to August 31, 1975, the taxpayer spent 60 hours performing flight services and 40 hours performing preflight services. The compensation paid to the taxpayer, computed only on the time spent performing flight services, was 1,000x dollars. Of the time spent performing flight services, 30 hours were spent in the United States and 30 hours were spent outside the United States. Of the time spent performing preflight services, 30 hours were spent in the United States and 10 hours were spent outside the United States. The 100 hours worked by the taxpayer were spread over a period of 20 days and varied in the number of hours worked on any given day.

Section 911(a)(1) of the Code provides, in part, that an individual citizen of the United States who is a bona fide resident of a foreign country for an uninterrupted period that includes an entire taxable year shall exclude from gross income amounts received from sources without the United States that constitute earned income attributable to services performed during the period of foreign residence. The amount excluded is limited under section 911(c).

Section 911(b) of the Code provides, in part, that "earned income" means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered.

Section 861(a)(3) of the Code provides, in part, that compensation for labor or personal services performed in the United States shall be treated as income from sources within the United States.

Section 1.911-2(c)(4) of the Income Tax Regulations provides, in part, that no amounts received for services performed within the United States shall be excluded from gross income under section 911 of the Code. For the allocation or segregation as between sources within and sources without the United States in the case of compensation for labor or personal services, see sections 861, 862, 863, and 864 and the regulations thereunder.

Section 1.861-4(b)(2) of the regulations provides, in part, that for taxable years beginning before January 1, 1976, a specific amount paid for labor or personal services performed in the United States shall be included in gross income if it constitutes income from sources within the United States. If no accurate allocation or segregation of compensation for labor or personal services performed in the United States can be made, or when such labor or service is performed partly within and partly without the United States, the amount to be included in gross income shall be determined by an apportionment on the time basis; that is, there shall be included in gross income an amount which bears the same relation to the total compensation as the number of days of performance of the labor or services within the United States bears to the total number of days of performance of labor or services for which payment is made.

In Tennessee Coal, Iron & Railroad Co. v. Muscoda Local No. 123, 321 U.S. 590, 598 (1944), rehearing denied, 322 U.S. 771 (1945), the Supreme Court of the United States stated that, as commonly used, work or employment means physical or mental exertion (whether burdensome or not) controlled or required by the employer and pursued necessarily and primarily for the benefit of the employer and the employer's business.

Compensation, regardless of how measured, is an expressed amount intended to compensate an employee for the employee's regular workday labor or for services including such other obligations that may be required or incidental thereto. See Rapp v. United States, 340 F.2d 635 (Ct. Cl. 1964).

Rev. Rul. 69-238, 1969-1 C.B. 195, involves a situation in which a cost of living allowance received by a taxpayer eligible for the benefits of section 911 of the Code was allocated between United States and foreign source income based solely on the number of regular workdays, spent in the United States and spent abroad, for which the taxpayer received compensation.

Rev. Rul. 76-66, 1976-1 C.B. 189, states that the salary paid to the taxpayer, a nonresident alien professional hockey player, employed by a U.S. professional hockey club that trains and plays part of its games in Canada, and part in the United States, is earned from sources partly within and partly without the U.S. and may be allocated on the basis of services performed during the regular season under section 1.861-4(b) of the regulations. Prior to the regular season the taxpayer reported to and participated in a 30-day training period at a camp of the club located in Canada, during which period the taxpayer received a per diem allowance in addition to a per diem allowance and other amounts for playing in exhibition games played during this period. The per diem allowances and amounts received for the training camp period and for the exhibition games played in this period were not included in the taxpayer's salary for purposes of allocating the taxpayer's salary to sources within and without the U.S. under section 1.861-4(b). Such allowances and amounts were considered to be from a source at the location of the training camp and at the location of the exhibition games. These amounts were considered separately from the salary paid to the taxpayer for regular season play.

In the subject case, the taxpayer's compensation is based solely on the number of hours spent performing flight services. However, an allocation of compensation between United States and foreign sources based solely on these hours would be inaccurate since it would not take into account all of the preflight services performed by the taxpayer. These services must be taken into account since the taxpayer was required to perform them as a condition for receiving the compensation. Moreover, but for the performance of those preflight services, the particular flight to which they relate could not be performed. In essence, preflight time and flight time for a particular flight are inextricably connected, even though the employer has chosen to compute compensation with reference only to the latter. Therefore, all the required services (flight and preflight) must be taken into account in making the allocation required by section 1.861-4(b)(2) of the regulations. Since an accurate record of all of the hours of service performed by the taxpayer is available, an accurate allocation can be made.

Unlike the preflight services performed by the taxpayer in the subject case, the taxpayer in Rev. Rul. 76-66 was separately compensated for preseason training and exhibition games. The taxpayer's regular season salary was completely separate and apart from preseason activities, although a fine of $500 could be imposed for the taxpayer's failure to report and participate in the preseason training and exhibition activities.

Accordingly, where taxpayer's services are performed and an accurate record of all of the hours of service is available, an allocation of compensation for labor or personal services performed by the taxpayer between United States and foreign sources shall be made by comparing the hours of service performed in the United States and the total hours of service.

In the instant case, the taxpayer spent 60 hours performing services in the United States out of 100 total hours performing services both within and without the United States. Therefore, the United States source income of the taxpayer was 600x dollars (60 hours performing services within the United States divided by 100 total hours performing services times 1,000x dollars compensation).

Thus, 400x dollars of the taxpayer's income will be treated as income from sources without the United States and is eligible to be excluded from gross income under section 911 of the Code.

Rev. Rul. 76-66 is distinguished.