IRS Warns against Frivolous Filing Positions that Rely on Foreign-Based-Income Argument

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

The proponents of this position misread the Code and regulations. Although the proponents acknowledge that Sec. 1 imposes income tax on "taxable income," taxable income consists of "gross income" minus deductions (Sec. 63) and gross income is income "from whatever source derived" (Sec. 61), they assert that Secs. 861865 and the regulations thereunder (in particular, Regs. Sec. 1.861-8) limit taxable "sources" of income to certain foreign-based activities.

That assertion is refuted by the express and unambiguous terms of the Code. Sec. 61 includes in gross income "all income from whatever source derived." As the Supreme Court stated in Glenshaw Glass Co., 348 US 426 (1955), "Congress applied no limitations as to the source of taxable receipts..." Nothing in Secs. 861865 limits the gross income subject to U. S. taxation to foreign-source income. Secs. 861865 have significance in determining whether income is considered from sources within or outside the U.S., which is relevant, for example, in determining whether a U.S. citizen or resident may claim a credit for foreign taxes paid. The source rules do not operate to exclude from U.S. taxation income earned by U.S. persons from sources within the U.S.

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

The IRS advises taxpayers that, if they file returns reflecting this theory that only certain foreign-source income is taxable, they may be subject to penalties, including (but not limited to) the accuracy-related penalty under Sec. 6662 and the frivolous return penalty under Sec. 6702. Under some circumstances, taxpayers adopting this position on tax returns may be subject to additional sanctions, including penalties for failing to file or pay under Sec. 6651 and civil fraud penalties under Sec. 6663, and may be prosecuted for criminal violations of the tax law. In addition, practitioners advocating this position may be subject, under some circumstances, to the return-preparer penalty under Sec. 6694 or aiding-and-abetting penalties under Sec. 6701, and may be prosecuted for criminal violations of the tax law.

The Service recognizes that some taxpayers may have chosen not to file or have filed incorrect tax returns, taking the position that they were not required to report wages or other income earned in the U.S. for taxation. The IRS advises these taxpayers to take prompt action to file correct returns and to comply with the tax laws. Taxpayers can obtain tax forms, including those necessary to amend previously filed returns, via the IRS Website (www.irs.gov), through the Service's TaxFax Services (from a fax machine, call: 703-368-9694 (not a toll-free number)), or by phone: 1-800-TAX-FORM (1-800-829-3676).

Notice 2001-40, IRB 2001-26