TAM 201014051: IRS analyzes employment taxes for nonresident alien flight attendants

Plain-English summary

The IRS technical advice memorandum analyzes U.S. income-tax withholding, FICA, and FUTA treatment for nonresident alien flight attendants employed by a certified U.S. air carrier. It concludes that remuneration for services performed in the United States is subject to income-tax withholding unless the business-visitor exception applies, and that services on or connected with an American aircraft touching a U.S. port are generally employment for FICA and FUTA purposes. It also addresses the included-excluded rules, a totalization agreement, sourcing and apportionment, and reporting obligations. The memorandum concludes that section 530 relief is irrelevant because the case concerns whether compensation is excluded from wages, not worker classification.

Ruling snapshot

• Question: How should a U.S. air carrier treat compensation paid to nonresident alien flight attendants for income-tax withholding, FICA, and FUTA purposes?
• Outcome: Advice given
• Key authorities: IRC §§ 3101, 3111, 3121, 3306, 3401, 3402, 861, 864, 1441, 1461, and 6110; Revenue Act of 1978 § 530; Rev. Rul. 79-318

Full text (IRS public release)

INTERNAL REVENUE SERVICE
NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

Number: 201014051
Release Date: 4/9/2010
December 18, 2009

Third Party Communication: None
Date of Communication: Not Applicable

Index (UIL) No.: 3101.02-00, 3111.01-00, 3121.01-00, 3121.02-00, 3121.03-00, 3306.02-00, 3306.03-00, 3306.04-00, 3401.01-00, 3401.01-05, 3402.04-00, 1441.02-02, 1441.03-00, 1461.02-00, 861.04-00, 864.02-00
CASE-MIS No.: TAM-115068-09

Director
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Taxpayer's Name: ------------------------------
Taxpayer's Address: -------------------------------------
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Taxpayer's Identification No
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Year(s) Involved: ---------------
Date of Conference: ----------------------

LEGEND: Taxpayer = ------------------------------
Headquarters Office = ---------------------------------
State A = --------
Foreign Countries = --------------------------------------------------
Country X = -------
B Airport = ------------------------------------------------------------
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ISSUES1:

1) Gross Income and Income Tax Withholding

Whether wage withholding under Internal Revenue Code (Code) section2 3402 or 30 percent withholding under section 1441 applies to remuneration paid by a certified 1 The TAM initially raised issues with respect to the U.S. taxation of severance which was paid to the NRA flight attendants. However, this issue was subsequently withdrawn.

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United States air carrier to nonresident alien (NRA) employees with D-1 visas (or other types of visas) for services the employees perform within the United States.3

(a) Whether any remuneration paid to the NRA flight attendants should be apportioned to sources within the United States?

(b) What impact, if any, does the 90-day/$3,000 business visitor exception under sections 861(a)(3) and 864(b)(1) have in determining the U.S. taxation of gross income and wages of the NRA flight attendants?

(c) What impact, if any, does the included-excluded rule provided in section 3402(e) have on the determination of wages of the NRA flight attendants for income tax withholding purposes?

(2) Federal Insurance Contributions Act (FICA)

(a) Whether services by a NRA flight attendant under a contract of service entered into outside the United States are included in the definition of “employment” under section 3121(b) if the services are performed on or in connection with the flight of an American aircraft and if the flight touches a port in the United States?

(b) Whether the included-excluded rule provided by section 3121(c) applies if only a portion of the NRA flight attendant’s services are included in the basic definition of employment in section 3121(b) (i.e., the definition contained in the flush language at the beginning of section 3121(b))? Whether Rev. Rul. 79-318, 1979-2 C.B. 352, still represents the IRS position on the issue?

(c) If the services are employment under section 3121(b), (i) With respect to remuneration for service that is includible in the gross income of the NRA flight attendant, whether such remuneration is includible in “wages” under section 3121(a) and subject to FICA taxes?
(ii) With respect to remuneration for the service that is not includible in the gross income of the NRA flight attendant, whether such remuneration is includible in wages under section 3121(a) and subject to FICA taxes?

(3) Federal Unemployment Tax Act (FUTA)

(a) Whether services by a NRA flight attendant under a contract of service entered into outside the United States are included in the definition of “employment” under section 3306(c) if the services are performed on or in connection with the flight of an American aircraft and if the flight touches a port in the United States? 2 Unless otherwise indicated, all section references are to the Internal Revenue Code or the regulations promulgated thereunder. 3 The United States includes airspace over the United States.

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(b) Whether the included-excluded rule provided by section 3306(d) applies if only a portion of the NRA flight attendant’s services are included in the basic definition of employment in the flush language at the beginning of section 3306(c)? Does Rev. Rul. 79-318 also apply for purposes of the FUTA?

(c) If the services are employment under section 3306(c), (i) With respect to remuneration for the service that is includible in the gross income of the NRA flight attendant, whether such remuneration is includible in “wages” under section 3306(b) and subject to FUTA?
(ii) With respect to remuneration for the service that is not includible in the gross income of the NRA flight attendant, whether such remuneration is includible in wages under section 3306(b) and subject to FUTA?

(4) Section 530 of the Revenue Act of 1978

Whether section 530 of the Revenue Act of 1978 applies to Taxpayer with respect to its treatment of the remuneration at issue?

CONCLUSIONS:

(1) Gross Income and Income Tax Withholding – Wage withholding under section 3402 applies to remuneration paid by Taxpayer, a certified United States air carrier, to a NRA flight attendant for services performed by the NRA flight attendant within the United States, provided the three prongs of the business visitor exception under sections 861(a)(3) and 864(b)(1) are not met.

(a) U.S. source gross income and wages for services performed in the United States by NRA flight attendants should be determined on a time basis by multiplying the total compensation paid to the NRA flight attendant by the percentage of time the individual worked in the United States during the period to which the compensation relates. The calculation of time worked within and without the United States should take into account all time that the NRA flight attendant is required to report for duty, including pre-flight, post-flight, and training time.

(b) Because the NRA flight attendants are performing services for a foreign office of a domestic corporation, if a NRA flight attendant is present in the United States less than 90 days and has earned less than $3,000 of income from services performed in the United States for the taxable year (the “business visitor exception”), then all of the income earned by the NRA flight attendant in the taxable year is treated as from sources without the United States under section 861(a)(3), and as income not effectively connected with the conduct of a U.S. trade or business under section 864(b)(1), and is not subject to any U.S. income tax withholding. In all other cases, the

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portion of the NRA flight attendant’s salary apportioned to income from sources within the United States is subject to income tax withholding under section 3402.

(c) The portion of the NRA flight attendant’s salary apportioned to sources within the United States is subject to withholding under section 3402 even if it is less than the amount apportioned to foreign sources because the included-excluded rule provided in section 3402(e) does not apply. However, withholding under section 3402 is not required on the NRA flight attendant’s salary if all three prongs of the business visitor exception are met during that calendar year.

(2) FICA

(a) Services performed by a NRA flight attendant under a contract of service entered into outside the United States are included in the definition of “employment” under section 3121(b) if the services are performed on or in connection with an American aircraft and if the flight touches a port in the United States.

(b) The included-excluded rule provided in section 3121(c) does not apply when only a portion of the NRA flight attendant’s services are included in the basic definition of employment provided in section 3121(b) (i.e., services performed on or in connection with an American aircraft on a flight that touches a port in the United States). Rev. Rul. 79-318 represents the IRS position on the issue.

(c) Remuneration received by a NRA flight attendant for services that are determined to be included in the definition of “employment” under section 3121(b) is wages under section 3121(a) subject to FICA tax whether or not the remuneration is gross income of the NRA flight attendant from sources within the United States. However, remuneration paid to a NRA flight attendant who is a resident of Country X and based in Country X is not subject to FICA tax provided Taxpayer has obtained a certificate of coverage from Country X stating that the services of the NRA flight attendant are covered under the Country X social security system.

(3) FUTA

(a) Services performed by a NRA flight attendant under a contract of service entered into outside the United States are included in the definition of “employment” under section 3306(c) if the services are performed on or in connection with an American aircraft and if the flight touches a port in the United States.

(b)The included-excluded rule provided in section 3306(d) does not apply when only a portion of the NRA flight attendant’s services are included in the basic definition of employment in section 3306(c) (i.e., services performed on or in connection with an American aircraft on a flight that touches a port in the United States). Rev. Rul. 79-318 also applies for purposes of the FUTA.

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(c) Remuneration received by a NRA flight attendant for services that are determined to be included in the definition of “employment” under section 3306(c) is wages under section 3306(b) subject to FUTA tax whether or not the remuneration is gross income of the NRA flight attendant from sources within the United States.

(4) Section 530 is irrelevant because this case does not involve the issue of worker classification.

FACTS:

Taxpayer is incorporated in the United States and has its corporate headquarters in State A. It engages in the business of providing air transportation on aircraft registered under the laws of the United States. Taxpayer operates through branches or divisions (not subsidiaries) in foreign countries, including certain branches (the “foreign branch offices”) in the foreign countries at issue here (“Foreign Countries”). NRA individuals are employed as flight attendants by Taxpayer on its U.S. registered aircraft. The only flights to and from the United States on which the NRA flight attendants are permitted to perform services for Taxpayer are flights that arrive at or depart from the B Airport located in the United States. According to data provided by Taxpayer, substantially all of the flights on which the NRA flight attendants perform services for Taxpayer originate from or terminate at B airport.

The NRA flight attendants perform services as employees within and without the United States in connection with such flights. Thus, it appears that a portion (but less than 50 percent in each payroll period for each employee) of the NRA flight attendants’ services is performed within the United States. Also, it appears that less than 50 percent of the remuneration received by the NRA flight attendants in each payroll period is attributable to services performed within the United States. Taxpayer has not withheld or paid United States employment taxes with respect to any of the remuneration paid the NRA flight attendants.

The United States has not entered into income tax treaties with any of the Foreign Countries. The United States has entered into a totalization agreement with Country X which was in effect for the years at issue. The totalization agreement with Country X provides that traveling employees of air transportation companies who perform services in the territories of both contracting states and would otherwise be covered under the laws of both contracting states are, with respect to that work, subject to the laws of only the contracting state in the territory in which the firm has its home office. However, if such employees reside in the territory of the other contracting state, they shall be subject to the law of only that state.

Taxpayer has stated that the labor laws of each of the Foreign Countries specifically prohibit unilaterally withholding taxes other than those imposed by that country.

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Some of the Foreign Countries permit agreements between the employer and the employee to have additional amounts withheld from the employee’s wages, beyond what is required under the specific country’s law.

Taxpayer was audited on the issue of the employment taxation of compensation paid to NRA flight attendants for years prior to the years at issue in this technical advice request. The issue was settled in Appeals, with no employment tax assessment attributable to the compensation for the services performed by the NRA flight attendants.

Hiring, scheduling, training, payroll and benefits for the NRA flight attendants are handled by a combination of Taxpayer’s system operations control center located in the United States and branch offices located in the Foreign Countries. Taxpayer’s system operations control center located near the Headquarters Office manages the availability of aircraft, the number of crew members assigned to flights, ground employees, and the airspace and facilities. The monitoring systems of the control center account for flight crews’ scheduling, time reporting, and paycheck computations. The scheduling of flight crews’ work must be coordinated to ensure certain requirements are met for rest periods and maximum flying times. The foreign branch offices do not have independent

stand alone scheduling and flight tracking systems. All flight data is fed into one automated system located in the United States to ensure consistency and uniformity. The flight system is based on contractual months set by Taxpayer. During the first half of the month, the system publishes the flight selections for allocations made to the foreign branch office. During the second half of the month, flight attendants may bid for routes through the automated system. Preliminary results of these selections are published and the crew members may resolve any flight sequence conflicts. The foreign branch office will resolve any conflicts not resolved by crew members.

The Local Crew Planner and Local Flight Manager are the individuals responsible for the final schedule, using the data in the global system based in the United States to ensure that Taxpayer’s operating needs are met, union guidelines are followed, and Federal Aviation Administration (FAA) regulations are observed. The control center system has to be used to make assignments so employee hours can be monitored for pay purposes as well as for FAA required rest periods and maximum flying times. Taxpayer claims that all decisions about daily business operations, including (relative to the NRA flight attendants at issue) all decisions with respect to which individual employees will be assigned to specific flights, are controlled by the foreign branch offices.

Taxpayer’s control center near the Headquarters Office tracks flights and flight crews. Upon arrival at the airport for duty, the NRA flight attendants log into one of the control center’s monitoring systems, which records they have reported for their flight. One of the monitoring systems generates flight crew paycheck computations. Since the flight crews are paid based on actual flight time, the actual departure and arrival times are fed

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to one of the monitoring systems from the onboard aircraft system. Actual departure and arrival time is based on when the aircraft brakes are released and set. The data from the monitoring system is used for Taxpayer’s flight crew payroll for United States nationals and additionally the data is transmitted to the foreign branch office in the Foreign Countries. These offices use this data in their payroll systems to calculate the NRA flight attendants’ pay and to process payroll.

Each Foreign Country branch office has local receipts and expenses. Local receipts are from ticket and cargo sales originating from the office’s location, and are attributable to transportation on the Taxpayer’s U.S. registered aircraft. Taxpayer represents that the cash source for NRA flight attendants’ pay is from local ticket and cargo sales. Local receipts are sufficient to cover local expenses in each foreign branch office except for one of the Foreign Countries. Due to high processing costs in that country, credit card sales are processed in the U.S. Taxpayer funds local expenses in that Foreign Country on an as-needed basis from the credit card receipts for that country processed in the United States. Since the foreign branch offices are divisions (foreign branches) of a U.S. corporation, all profits and losses are ultimately borne by the U.S. Corporation.

Payroll checks are issued by and through local payroll systems that are managed by the local controller responsible for the payroll of the branch office. Taxpayer represents that these payroll systems are separate from the U.S. payroll system located in the United States and the foreign payrolls are not funded from the United States. Only local income and social security taxes are withheld. U.S. employment taxes are not withheld. Additionally, NRA flight attendants’ health and other benefits, as well as other employment issues are handled by personnel in the foreign branch office; Taxpayer ultimately is responsible for the administration of the health and benefit plans. Taxpayer represents that these plans are not subject to U.S. labor laws and are not subject to any information reporting on Form 5500, Annual Return/Report of Employee Benefit Plan. Each foreign branch office has a full accounting office and the payroll for the NRA flight attendants based in the Foreign Countries is calculated by the local controller from information transmitted from the monitoring system in the United States. The monitoring system reports hours and the controller in the foreign branch office calculates the salary in the local currency. The foreign branch offices print the payroll checks and payroll summaries in three of the countries; in one of the countries, the printing is outsourced to a local contractor.

NRA flight attendants are paid in local currency, and their base pay is computed as a minimum number of hours flight time per month and varies based on the flight time.4 NRA flight attendants are required to arrive for their flights 90 minutes prior to a flight departing from a Foreign Country and 60 minutes prior to a flight departing from the United States. They are released from their duty 30 minutes after the flight has landed. Taxpayer considers pre-flight and post-flight time as “off the clock” even though the

4
The NRA flight attendants may be compensated for additional items as provided in the union contracts.

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union agreements refer to this time as work or service time. Under the union contract, the NRA flight attendants’ base pay is based on flight hours and not on these additional work time hours. Pre-flight and post-flight ground time for all flight attendants is tracked to calculate on-duty maximum hour limitations, which are limited by the FAA. The on- duty period begins at sign in and ends after debriefing.

Taxpayer’s NRA flight attendants in the Foreign Countries are represented by local unions. Taxpayer indicates collective bargaining agreements are negotiated with Taxpayer’s foreign branch offices in those countries and signed by the branch managers in those countries. Employment contracts are entered into between the foreign branch and the employees in some countries; however, no individual employment contracts are signed in other countries.

Hiring decisions for the NRA flight attendants are made by the branch manager, located in the foreign country, and the regional flight manager and a recruitment specialist, both located in the United States. During the years at issue Taxpayer did not hire any new NRA flight attendants. Taxpayer is required to follow FAA regulations for flight attendant training. Upon recruiting foreign nationals/residents to become flight attendants, Taxpayer provides initial training for them in the United States. If an individual successfully completes the initial training, Taxpayer may offer the individual a position. If an offer of employment is made, a contract of employment between Taxpayer and the foreign national is signed in the foreign national’s base country, except in certain of the Foreign Countries where employment contracts are not used. Taxpayer states that during the years at issue, there was no initial training because no flight attendants were hired. As to the number to be hired, Taxpayer has indicated that each year, the Capacity Planning Department determines the number of flights and routes that will be flown. Based on the plan, Crew Resources determines how many flight attendants are needed to work the flight schedule. The Capacity Planning Department and Crew Resources are based in the United States.

Once hired, all of Taxpayer’s flight attendants are required to attend annual training in the United States on emergency procedures for FAA certification. Taxpayer’s office near the Headquarters Office in the United States is responsible for updating operating procedures for all of its flight attendants in accordance with FAA regulations. Crew Resources in the United States is responsible for deciding when the annual training will occur.

Employee reviews are conducted by the local foreign branch manager. Termination of NRA flight attendants is done by the Foreign Country Flight Service Manager and the Regional Flight Manager in the United States. Neither party has the unilateral authority to terminate a NRA flight attendant without the participation of the other.

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LAW AND ANALYSIS:

1) Gross Income and Income Tax Withholding

Section 1441 provides that any person making a payment of compensation or wages constituting gross income from sources within the United States to a NRA individual is required to deduct and withhold from the payment a tax equal to 30 percent thereof (even if effectively connected with a U.S. trade or business).

Section 861(a)(3) provides that generally, compensation received by a NRA individual for personal services performed in the United States is from sources within the United States. Section 862(a)(3) provides that compensation for personal services performed without the United States is income from sources without the United States. These general sourcing rules are subject to the business visitor exception provided in section 861(a)(3) as discussed below.

Section 1.861-4(b)(1) states that if income is derived from personal services performed partly within the United States and partly without the United States, the amount to be included in gross income is determined on the basis that reflects the most proper source of income under the facts and circumstances of the particular case. In many cases the facts and circumstances will support an apportionment on the time basis. In that case, the amount to be included in gross income will be that 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 the payment is made.

Section 1461 states that every person required to deduct and withhold any tax under section 1441 is liable for such tax.

Section 1441(c)(4) provides that compensation for personal services performed by a NRA individual may be exempted from withholding under regulations prescribed by the Secretary. Section 1.1441-4(b)(1) provides that no withholding is required under section 1441 for a payment of compensation that is subject to withholding under section 3402.

Section 3402(a) provides that every employer making payment of wages is required to deduct and withhold Federal income tax withholding according to tables or computational procedures prescribed by the Secretary.

Section 3403 provides that every employer required to deduct and withhold the tax under section 3402 from the wages of an employee is liable for the payment of the tax whether or not it is collected from the employee. See section 31.3403-1.

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Section 31.3402(d)-1 relieves the employer of liability under section 3403 to the extent the income tax against which the tax under section 3402 may be credited is paid. Such payment does not, however, operate to relieve the employer from liability for penalties or additions to the tax applicable in respect of such failure to deduct and withhold. The employer will not be relieved of his liability for payment of the tax required to be withheld under section 3402 unless he can show that the income tax against which the tax under section 3402 may be credited has been paid.

Section 3401(a) defines wages for the purposes of income tax withholding under section 3402 as all remuneration for services performed by an employee for his employer, with certain specific exceptions.

Section 3401(a)(6) provides an exception from the definition of “wages” for remuneration paid for such services, performed by a NRA, as may be designated by regulations prescribed by the Secretary. The implementing regulations provide detailed rules.

Section 31.3401(a)(6)-1(a) provides that all remuneration paid for services performed by a NRA individual, if such remuneration otherwise constitutes wages within the meaning of section 31.3401(a)-1 and if such remuneration is effectively connected with the conduct of a trade or business within the United States, is subject to withholding under section 3402 unless excepted from wages under this section of the regulations.

Section 31.3401(a)(6)-1(b) provides that remuneration paid to a NRA individual for services performed outside the United States is excepted from wages and hence is not subject to withholding.

Section 31.3401(a)(6)-1(f) provides that remuneration paid for services performed within the United States by a NRA individual after December 31, 2000, is excepted from wages and hence is not subject to withholding if such remuneration is, or will be, exempt from the income tax imposed by chapter 1 of the Code by reason of a provision of the Code or an income tax convention to which the United States is a party.

Section 864(b) provides that the performance of personal services within the United States constitutes being engaged in a trade or business in the United States. See also section 1.864-2(a). Such performance of personal services does not constitute being engaged in a trade or business in the United States if the business visitor exception applies.

Section 1.864-4(c)(6)(ii) provides that compensation received by a NRA individual for performing personal services that constitute being engaged in a trade or business within the United States is income that is effectively connected to a trade or business if the individual is engaged in a trade or business in the United States at some time during the year in which such income is received.

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Section 871(b) provides that a NRA individual engaged in a trade or business in the United States during the taxable year shall be subject to graduated rates of tax as provided in sections 1 or 55 on taxable income which is effectively connected with the conduct of a trade or business within the United States.

Pursuant to section 31.3401(a)(6)-1(a), withholding under section 3402 applies to remuneration paid for services performed by the NRA flight attendants in the United States (unless excluded by the business visitor exception) because the income is from sources within the United States and is effectively connected with the NRA flight attendant’s conduct of a U.S. trade or business. See sections 861(a)(3) and 864(b)(1) and (c). Because withholding under section 3402 applies, this income is not subject to NRA withholding under section 1441. See section 1.1441-4(b)(1). Income which is excluded from section 3402 withholding due to the business visitor exception would similarly be excluded from section 1441 withholding because that income would also be treated as from sources without the United States under the business visitor exception.

The remuneration received by the NRA flight attendant for services performed outside of the United States is excepted from income tax withholding by section 31.3401(a)(6)- 1(b). Such income is also excepted from NRA withholding under section 1441 because remuneration for services performed outside of the United States is income from sources without the United States.

1)(a) Whether any remuneration paid to the NRA flight attendants should be apportioned to sources within the United States?

It must first be determined what portion of the NRA flight attendant’s wages is remuneration from services performed within the United States and what portion is from services performed without the United States. During the years at issue, section 1.861- 4(b)(1) provided that when compensation is paid for services which are performed partly within and partly without the United States, the amount to be included in the gross income shall be determined on the basis that most correctly reflects the proper source of income under the facts and circumstances of the particular case. In many cases, apportionment on the time basis is acceptable. Apportioning on a time basis means that the amount to be included in gross income will be that 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 the payment is made.

Rev. Rul. 77-167, 1977-1 C.B. 239, contemplates the appropriate method for allocating compensation for personal services performed by a pilot between sources within and without the United States for purposes of section 911, as in effect in 1977. Citing section 1.861-4(b) the ruling states that the appropriate method for determining the

pilot’s compensation from sources within the United States is done on a time basis

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measured in hourly units. The revenue ruling clarified that the sourcing apportionment under section 1.861-4(b) should take into account all service time required of the pilot, including pre-flight time during which a pilot is required to be present, though such time is not expressly compensated for under the employment contract, since the provision of pre-flight services is necessary, and is thus inextricably connected, to the flight itself.

The Tax Court in Rogers v. Commissioner, T.C. Memo 2009-111, in determining the amount of foreign earned income of a flight attendant, for purposes of section 911, took into account pre- and post-flight time required by the airlines, even though the flight attendant was compensated only for actual flight time.

In Stemkowski v. Commissioner, 690 F.2d 40 (2nd Cir. 1982), the court determined that training time required by a hockey player’s contract is work time that should be taken into account when allocating the player’s compensation between sources within and without the United States.

The NRA flight attendants in this case perform services while traveling within and without the United States. Compensation is determined based on actual flight time. In addition to the services performed during the flight, the NRA flight attendants are also required to check in prior to the flight, remain for 30 minutes after the flight has landed, and attend annual training conducted in the United States.

Because the remuneration paid to the NRA flight attendants compensates them for services performed both within and without the United States, it is appropriate to apportion between sources within and without the United States on a time basis as provided by section 1.861-4(b)(1). Furthermore, since the NRA flight attendants usually provide services both within and without the United States during a single day, apportioning time on an hourly basis in accordance with Rev. Rul. 77-167 is a method that more accurately reflects source than using a daily basis method.

We note that an alternate basis for apportioning income may be used if that basis is shown to be an equally reliable means of reflecting the source of income under the facts and circumstances. However, Taxpayer has not provided an alternate means of apportioning income that reflects source as accurately as the use of the hourly time basis. Therefore, we conclude that the apportioning on an hourly time basis is the most appropriate method in this case.

With respect to the inclusion of pre-flight, post-flight, and training time, Taxpayer takes the position that the controlling authority for the taxable years at issue is Zimmerman v. Commissioner, 36 T.C. 235 (1961), under which pre-flight and post-flight time was disregarded when determining the amount of income from services performed within Guam. Accordingly, Taxpayer asserts that the position adopted in Rev. Rul. 77-167 and Rogers with respect to pre-flight and post-flight time should be disregarded.

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In Zimmerman the Tax Court considered whether a United States citizen who worked as an air navigator based in Guam for flights over international waters was permitted to exclude from gross income a portion of his compensation that he claimed related to services provided while within Guam under section 931, as in effect in 1961. In fact, the Zimmerman court never concluded that time upon which the taxpayer’s salary was calculated was the only time to be considered in determining the income from sources within Guam. Instead, the court determined that there was insufficient evidence provided to show that the taxpayer derived 80 percent of his income from within Guam, as required by section 931, as in effect in 1961, and, due to this lack of evidence, could not determine that certain income should be excluded from gross income. Although the court noted that the taxpayer’s compensation was based solely on his flying time, not groundwork, and, based on flying time alone, the taxpayer’s time in Guam appeared inconsequential, there was no indication that any pre-flight or post-flight time was required by the employer in that case. The court also pointed out that the taxpayer had failed to demonstrate how much time he spent in Guam or what other activities he performed in Guam to earn his salary.

The court’s determination that the income from sources within Guam was inconsequential was merely further evidence that the taxpayer had failed to demonstrate that he had met the 80 percent threshold. No such minimal threshold is applicable for purposes of sourcing under section 861, except as provided by the
$3,000 prong of the business visitor exception. Consequently, Zimmerman is neither controlling nor relevant in this case.

Rev. Rul. 77-167, on the other hand, does provide clear and relevant guidance that, when allocating between time spent performing services within and without the United States, time which is required of an employee though not separately compensated for, should be taken into account. The Tax Court’s subsequent decision in Rogers is further indication that the apportionment method adopted in Rev. Rul. 77-167, rather than the method suggested by the Taxpayer, is the more appropriate one. Similarly, the Second Circuit decision in Stemkowski illustrates that required training or preparation time is work time that is relevant to the determination of services performed within the United States.

Accordingly, pre-flight, post-flight, and training time should be taken into account when determining the amount of U.S. source income from services performed within the United States and the amount of foreign source income from services performed without the United States.

1)(b) What impact, if any, does the 90-day/$3,000 business visitor exception under sections 861(a)(3) and 864(b)(1) have in determining the gross income and wages of the NRA flight attendants?

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In general, wages received for performing services in the United States constitutes income from sources within the United States. However, section 861(a)(3)5 provides an exception to the general sourcing rules for the performance of services by a NRA individual. This exception, known as the “business visitor exception” provides that compensation received by a NRA individual for personal services performed in the United States shall not be deemed to be income from sources within the United States if (A) the services are performed by a NRA individual temporarily present in the United States 90 days or less during the taxable year, (B) such compensation does not exceed
$3,000 in the aggregate, and (C) the compensation is for services performed as an employee of a domestic corporation if such services are performed for an office or place of business maintained in a foreign country by such corporation.

Taxpayer argues that none of the NRA flight attendants had U.S. source income that is effectively connected with a U.S. trade or business in the years at issue because every NRA flight attendant satisfied the three-prong test set forth in sections 861(a)(3) and 864(b)(1). Because under Taxpayer’s analysis no NRA flight attendant had U.S. source or U.S. effectively-connected income, Taxpayer argues it was under no obligation to withhold U.S. income tax.

As an initial matter, we agree that if a NRA flight attendant meets each prong of the business visitor exception, the remuneration paid to the NRA flight attendant will be treated as foreign source income and, thus, is exempted from U.S. income tax withholding.

To be income from sources without the United States under section 861(a)(3), however, a NRA flight attendant must satisfy each of the three conditions set forth under that section. Whether the NRA flight attendant is providing services for an office or place of business maintained by Taxpayer in a foreign country, as required by section 861(a)(3)(C), is a factual determination. Based on the facts presented, the NRA flight attendants are performing services for offices maintained by Taxpayer in the Foreign Countries. Because we conclude that, for purposes of section 861(a)(3)(C), the NRA flight attendants are performing services for the foreign branch office in which they are based one prong of the business visitor test is met. Therefore, if a NRA flight attendant employed by Taxpayer meets the other two conditions because that individual is present in the United States for 90 days or less, and earns compensation of $3,000 or less, satisfying sections 861(a)(3)(A) and (B), respectively, the compensation of that individual will be considered to be income from sources without the United States and not subject to U.S. income tax withholding. The 90-day and $3,000 prongs of the business visitor test are determined on a case-by-case basis. Following is the relevant law with respect to all three prongs.

5
Section 864(b)(1) provides an identical rule for purposes of determining whether a NRA is engaged in a trade or business within the United States. Because the effect of the application of each rule has the same impact on whether amounts in this case will be subject to withholding, we limit our discussion to application of section 861(a)(3), unless otherwise noted.

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1)(b)(i) Calculation of days for purposes of section 861(a)(3)(A).

For purposes of the 90-day test under section 861(a)(3)(A) and section 1.861-4(a)(1)(i), section 1.861-4(a)(2) defines “day” as follows:

(i) As a general rule, the term “day,” as used in subparagraph (1)(i) of this paragraph, means a calendar day during any portion of which the NRA individual is physically present in the United States.

Section 1.864-2(b)(2)(i) contains an identical definition of “day” for purposes of the 90- day test of section 864(b)(1) and section 1.864-2(b)(1). Taxpayer argues that the use of the term “as a general rule” must mean that there are exceptions to this definition, such as not counting the day of arrival or aggregating multiple time increments of less than a full calendar day to count as a single day. Although Taxpayer is correct that there can be exceptions to the general definition of a day, those exceptions are extremely narrow. For example, in Rev. Rul. 57-330, 1957-2 C.B. 1013, it was determined that, under the United States-Canada Income Tax Convention, individuals engaged in transportation services that required them to cross the U.S.-Canada border at frequent intervals fell outside the scope of the general definition of “day” and could instead aggregate fractional parts of a day.6 Accordingly, while there are exceptions to the general rule that physical presence in the United States for any portion of a day constitutes an entire day for purposes of the 90-day test, Taxpayer has not shown that it qualifies for such an exception in this case.

Taxpayer has taken the position that the day of arrival into the United States should not count towards the 90-day threshold test of section 861(a)(3)(A) and section 1.861- 4(a)(1)(i), based on Martin Tow v. Commissioner, 36 T.C. 861 (1961). The Tax Court in that decision held that for purposes of section 871(a)(2)(A), the predecessor to section 871(a)(2), the day of arrival should not count but that the day of departure should count. The tax year involved in that case was 1954. That decision has been rendered irrelevant by the promulgation of section 1.871-7(d)(3)(ii), in 1974, and section 1.864- 2(b)(2)(i), in 1968, which do not include such a rule. Accordingly, both the day of arrival and the day of departure must count as a day for purposes of the 90-day test in this case.

1)(b)(ii) Apportionment of flight time between sources within and without the United States for purposes of section 861(a)(3)(B).

To determine whether compensation earned by a NRA flight attendant for services performed in the United States is in excess of $3,000, the remuneration paid to the NRA

6
We note that this exception applies in other contexts to transportation service workers making multiple trips between the United States and Mexico, as well. See section 1.871-7(d)(3)(ii).

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flight attendant should be apportioned between sources within and without the United States in the manner described in Issue 1(a), above.

1)(b)(iii) Whether the NRA flight attendants are providing services for a foreign branch of Taxpayer for purposes of section 861(a)(3)(C).

As stated previously, whether the NRA flight attendants are providing services for an office or place of business maintained by Taxpayer in a foreign country is a factual determination. The relevant inquiry is whether the foreign branch office has sufficient control over the NRA flight attendants to render the flight attendants to be performing services for the foreign branch office for purposes of section 861(a)(3)(C).

This determination involves many of the same factors used to determine whether an individual is an employee for employment tax purposes. Therefore, it is appropriate to utilize, to the extent relevant, the guides for determining the existence of an employer- employee relationship which are found in three substantially similar sections of the Employment Tax Regulations, namely sections 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1, relating to the FICA, the FUTA, and federal income tax withholding, respectively. These regulations provide that the relationship of employer and employee generally exists under the common law when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. Accordingly, evidence of both control and lack of control or autonomy must be considered. Relevant facts generally fall into three categories: behavioral controls, financial controls, and the relationship of the parties. It should be noted that the inquiry whether the attendants are performing services for a U.S. office or the foreign branch offices of Taxpayer has no effect on the status of Taxpayer as the employer of the NRA flight attendants for federal employment tax purposes, because the U.S. offices and foreign branch offices are considered parts of the same taxpayer, rather than separate entities. See 1)(d)(iv) of this memorandum.

In the present context, the factors which are particularly significant to the determination, under section 861(a)(3)(C), of whether the NRA flight attendants are performing services for the foreign branch offices rather than directly for a U.S. office of Taxpayer, include the location in which the work is performed, the intent of the parties within the relationship, the office that provides instruction and control over the NRA flight attendants, the office responsible for determining the working hours of the NRA flight attendants, and the office responsible for the hiring, supervision, and discharge of the NRA flight attendants.7

7
Because the test under section 861(a)(3)(C) in this case is whether the NRA flight attendants are working for an unincorporated branch of a U.S. corporation, certain factors that are significant to determining the existence of a common law employment relationship will be less relevant as they are likely to be present in any relationship between a branch and its parent. These factors include requirements regarding the training of the flight attendants in the United States, the provision of tools and

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Unlike most employees, flight attendants do not provide services in a fixed location, but rather perform services aboard an airplane which travels through multiple locations. For this reason, the location in which the services are performed is not determinative as to the office for which the NRA flight attendants are considered performing services.

The intent of the Taxpayer to treat the NRA flight attendants as performing services for the foreign branch offices can be evidenced by the union contracts and employment contracts which are entered into by the foreign branch manager, are subject to local law, and often reference the foreign branch office as the party to the contract. Similarly, the fact that payroll for the NRA flight attendants is handled by the accounting offices in the Foreign Countries (or in one case is contracted out to a local payroll service) also evidences the intent that the NRA flight attendants are performing services for the foreign branch offices.8

The most significant factors focus on determining which office exerts the most control over the NRA flight attendants. This is evidenced by the active participation of the foreign branch in performance reviews, work hours, hiring, and discharge of the NRA flight attendants. The facts indicate that the foreign branch managers are responsible for reviewing the performance of the NRA flight attendants.

For the most part, work hours are determined through a bidding system which is done on the airline’s central control system maintained in the United States. The control system provides an automated process that resolves most conflicts without the involvement of either a U.S. office or the foreign branch offices. However, the foreign branch office has the ultimate responsibility for scheduling the NRA flight attendants from its base and is the party that will resolve conflicts that cannot be resolved via the central control system.

materials necessary for the flight attendants’ services by a U.S. office, and the integration of the employees’ services into the business operations of the Taxpayer. Another factor that is less relevant to the present context is responsibility for paying the salaries and expenses of the NRA flight attendants. Although the foreign branch offices have sufficient local receipts to cover the salaries and expenses of the NRA flight attendants and make the payments from the foreign branch, since the foreign branch office is not separately incorporated, the Taxpayer will inevitably bear all expenses of the foreign branch which makes this factor less significant. Other factors used for determining the existence of a common law employment relationship such as whether the individual is full-time, maintains a continuous relationship, and realizes profits and losses, are not relevant for the present inquiry as the current inquiry accepts Taxpayer’s representation that the NRA flight attendant are employees of the Taxpayer, and seeks only to establish whether services performed by the NRA flight attendants are performed for the Taxpayer’s foreign office for purposes of section 861(a)(3)(C). 8 Although, the handling of payroll by the foreign branch office is relevant with respect to the intent of the parties, the actual payment of the salaries out of the branch offices’ funds is not significant since the expenses will ultimately be borne by the Taxpayer.

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Hiring decisions are made by a panel comprised of two supervisors located in the United States and the foreign branch manager. While the foreign branch office initiates the recruitment process through pre-screening, scheduling, and ranking the candidates, the entire panel is involved in making the hiring decision and both offices participate in the initial training of the candidate in the United States, which must be completed before a candidate can be hired. Neither a U.S. office, nor the foreign branch office has the ability to unilaterally hire a candidate who will be based in a Foreign Country.

In a similar manner, decisions to terminate a NRA flight attendant must be made jointly by the regional manager located in the United States and the foreign branch manager. While decisions to fire a NRA flight attendant are generally initiated by the branch manager, the branch manager must consult with the regional manager before terminating the employee.

The IRS Field office has taken the position that the NRA flight attendants do not perform services for the foreign branch offices. This position is based primarily on the following factors, 1) the flight attendants do not perform services within the Foreign Country in which they are based, rather they perform services on an airplane which is owned by the headquarters in the United States and is subject to the control of the pilot who is an employee of the headquarters in the United States, 2) the headquarters is responsible for scheduling the routes for the aircrafts, determining the number of flight attendants required for each flight, and maintains the centralized computer system which the flight attendants use to bid for their hours, and 3) the foreign branch cannot hire or fire the NRA flight attendants without the involvement of personnel from the United States.

We do not agree that these factors are sufficient, or in some cases relevant, to render a decision that the NRA flight attendants are providing services for a U.S. office rather than the foreign branch offices for purposes of section 861(a)(3)(C). The fact that the headquarters owns the aircraft and directs the routes on which the flight attendant provides services does not amount to actual control over the NRA flight attendants for this purpose. Similarly, ongoing programming and maintenance of the centralized computer system does not necessarily equate to decision-making responsibility over the NRA flight attendants’ schedules. In fact, to the degree that there is some level of supervision and decision-making authority over scheduling of shifts, the facts indicate that it belongs to the foreign branch manager.

The requirement that the foreign branch office consult with the headquarters prior to hiring or firing personnel is the most convincing argument for the proposition that the NRA flight attendants are not performing services for the foreign branch offices. However, just as the foreign branch offices cannot hire or fire without consulting with personnel in the United States, the personnel in the United States also cannot hire or fire without active involvement of the foreign branch office. When one examines the level of involvement of the foreign branch office and the personnel in the United States in the hiring, performance review, and firing process, including the application of local

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labor laws, it appears that the foreign branch office maintains a higher level of involvement.

Thus, upon weighing all of the factors, we conclude that, for purposes of section 861(a)(3)(C), the weight of the evidence points toward a determination that the NRA flight attendants are performing services for the foreign branch offices in which they are based.

1)(c) What impact, if any, does the included-excluded rule provided in section 3402(e) have on the determination of wages of a NRA flight attendant for income tax withholding purposes?

If the business visitor exception does not apply, at least some of the pay a NRA flight attendant receives from Taxpayer for services performed on flights that touch the United States will be U.S. source effectively connected income, and, therefore, wages subject to U.S. income tax withholding. Section 3402(e) contains the included-excluded rule for U.S. income tax withholding purposes. Section 3402(e) provides that if the remuneration paid by an employer to an employee for services performed during one- half or more of any payroll period of not more than 31 consecutive days constitutes wages, all the remuneration paid by the employer to the employee for the period is deemed to be wages; but if the remuneration paid by the employer to the employee for services performed during more than one-half of the payroll period does not constitute wages, then none of the remuneration paid by such employer to such employee for such period is deemed to be wages. Although there is no dispute between the IRS field office and the Taxpayer in this case on the application of the included-excluded rule, we set forth the analysis as to why the included-excluded rule in section 3402(e) does not impact this case so as to be clear about the basis on which certain wages paid by Taxpayer to NRA flight attendants are subject to U.S. income tax withholding.

For purposes of applying the rule, amounts paid by Taxpayer to NRA flight attendants that are not U.S. source income are also not wages. See section 31.3401(a)(6)-1(b) and Rev. Rul. 79-318, 1979-2 C.B. 352.

Section 31.3402(e)-1(a) provides that for purposes of the included-excluded rule, the relative amounts of time spent performing services that generate section 3401(a) wages and non-section 3401(a) remuneration determine whether all the remuneration for services performed during the payroll period is treated as ”included” or “excluded.” Section 31.3402(e)-1(b) provides that if one-half or more of the employee's time in the employ of a particular employer in a payroll period is spent performing services the remuneration for which constitutes wages, then all the remuneration paid the employee for services performed in that payroll period is deemed to be wages. Conversely, section 31.3402(e)-1(c) provides that if less than one-half of the employee's time in the employ of a particular employer in a payroll period is spent performing services the

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remuneration for which constitutes wages, then none of the remuneration paid the employee for services performed in that payroll period is deemed to be wages.

The effect of applying section 3402(e) in cases where less than half of a NRA’s remuneration is effectively connected income from a U.S. source, would be to make effectively connected remuneration not subject to wage withholding, and, therefore, subject to 30 percent withholding under section 1441 unless the employee and employer entered into a voluntary withholding agreement under section 3402(p).

Section 1.1441-4(b)(1) requires 30 percent withholding tax on amounts paid to NRAs as U.S. source effectively connected income, unless an exception applies. Section 1.1441-4(b)(1)(i) and (ii) generally provides an exception from section 1441 withholding if the effectively connected income is subject to withholding under section 3402, or would be subject to withholding under section 3402 but for the provisions of section 3401(a) (other than the exception under 3401(a)(6)). Section 1.1441-4(b)(1)(vi) provides an exception from section 1441 withholding if the NRA’s U.S. source effectively connected compensation is exempt from withholding under section 3402 because of the included-excluded rule of section 3402(e), provided the employee and his employer enter into an agreement under section 3402(p) to provide for the withholding of income tax upon payments of income described in section 31.3401(a)- 3(b)(1) of the regulations. If the section 3402(e) exception applies and a section 3402(p) agreement is in effect, the employer is relieved from withholding under section 1441 and instead withholds under the wage withholding tables that apply for purposes of section 3402.

There was no agreement under section 3402(p) between Taxpayer and any of its NRA flight attendants in this case. Thus, if the compensation were excepted from section 3402 withholding because of section 3402(e), 30 percent withholding under section 1441 withholding would apply.

Withholding on the wages at the 30 percent rate would likely result in overwithholding whereas income tax withholding under section 3402 should more closely approximate the income tax liability of the NRA flight attendant because the NRA flight attendant’s effectively connected income is subject to graduated income tax rates by section 871(b)(1) and section 3402 withholding is generally computed under income tax withholding tables that reflect graduated rates.

Legislative history to section 3401(a) indicates an intent to avoid overwithholding under section 1441. Section 3401(a)(6), as presently worded, was added to the Code by section 103(k) of Pub. L. 89-809 to provide for an exception from wages for such services as may be designated by regulations prescribed by the Secretary or his delegate. When this provision was enacted, one of the concerns expressed in the legislative history was that withholding on effectively connected compensation should be at the graduated rates under section 3402 rather than at the 30 percent rate under

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section 1441, because the effectively connected income of the NRA is subject to graduated rates of income taxation. See H. R. Report No. 1450, 89th Cong., 2d Sess., 1, 24 (1966); Sen. Rep. No. 1707, 89th Cong., 2d Sess. 1, 30.

Applying the included-excluded rule would exclude remuneration for services performed within the United States (i.e., effectively connected income) from withholding under section 3402 if less than 50 percent of the remuneration was for services performed within the United States. This result would frustrate the intended result of Congress by overriding the intent of section 3401(a)(6), as reflected in the regulations under section 31.3401(a)(6)-1.

Further, the conclusion that the included-excluded rule does not apply in this situation is consistent with a revenue ruling and case law applying the similar FICA rule. See Rev. Rul. 79-318, 1979-2 C.B. 352, and Inter-City Truck Lines, Ltd. v. United States, 408 F.2d 686 (Ct. Cl. 1969), which are discussed more thoroughly in section 2)(b) below. The ruling and the case held that the FICA included-excluded rule was inapplicable in the case of a Canadian truck driver who performed less then one-half of his services within the United States and the remainder of his services outside the United States.

Following the analysis from this case and this ruling, only remuneration for services that is subject to U.S. income tax and is wages for federal income tax withholding (or is one of the enumerated exceptions from wages) is counted in applying the included-excluded rule. This maintains the integrity of the rule that generally, NRAs are not subject to U.S. income tax on remuneration from services performed outside the United States. Rather, the rule applies when the individual has two streams of U.S. source income from the employer – one that is subject to U.S. income tax withholding and one that is not. This approach is reflected in the examples under the section 3402(e) regulations, where the amounts received by the employees (whether included in or excluded from wages) are in either event included in gross income.

1)(d) Taxpayer’s Position.

Taxpayer posits several other arguments in addition to the business visitor exception as to why it was not required to withhold U.S. income tax from the remuneration it paid the NRA flight attendants. Each of these arguments is analyzed below.

1)(d)(i) Taxpayer’s U.S. income tax withholding liability under section 3402 should not be computed by taking into account the one withholding allowance to which a NRA is entitled when no Form W-4, Employee’s Withholding Allowance Certificate, is filed by the NRA flight attendant.

Taxpayer argues that section 31.3402(f)(1)-1(a) provides that a NRA individual is not required to file a Form W-4 to claim a withholding exemption, and therefore, each NRA flight attendant should be treated as having one withholding exemption for purposes of

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calculating the U.S. income tax withholding liability of Taxpayer. We disagree with the Taxpayer’s interpretation of the relevant legal authority.

Section 3402(f)(1) provides that an employee receiving wages shall on any day be entitled to the withholding exemptions listed in the subparagraphs of section 3402(f)(1).

Section 31.3402(f)(2)-1(a) states that the employer is required to request a withholding exemption certificate from each employee. If the employee fails to furnish a certificate, the employer is to consider such employee as a single person claiming no withholding exemptions.

Section 3402(f)(6) states generally that a NRA individual who is not a resident of Canada or Mexico is only entitled to one withholding exemption.

Section 31.3402(f)(6)-1 provides in effect that generally a NRA individual who is not a resident of Canada or Mexico and who is not a resident of Puerto Rico during the entire taxable year, is allowed under section 3402(f)(1) only one withholding exemption.

Section 3402(l)(1) states for purposes of applying the withholding tables prescribed by sections 3402(a) and (c) to a payment of wages, employees will be treated as single unless there is a withholding exemption certificate furnished by the employee in effect indicating the employee is married.

Section 31.3402(l)-1(c) states that for purposes of sections 3402(l)(2) and 31.3402(l)- 1(b) (related to furnishing employer an exemption certificate indicating marital status), an employee will be considered single if either the employee or the employee’s spouse is, or on any preceding day within the same calendar year was, a NRA.

Section 31.3402(f)(1)-1(a) provides that except as otherwise provided in section 3402(f)(6) (see § 31.3402(f)(6)-1), an employee receiving wages shall on any day be entitled to withholding exemptions as provided in section 3402(f)(1). In order to receive the benefit of such exemptions, the employee must file with his employer a withholding exemption certificate as provided in section 3402(f)(2).