Figures: tax year 2026
A domestic corporation generally includes worldwide income in its federal tax computation, including income earned through foreign operations. Source rules explain the sourcing of income by assigning each item to a geographic category independently of its inclusion in taxable income.
A foreign tax credit can relieve double taxation of qualifying foreign source income. Credit limitations generally use foreign-source taxable income after applicable deductions, with separate categories for passive income, foreign branch income, net tested inclusions and general income. Gross receipts do not establish credit capacity.
KEY: Determine whose income it is before determining its source. A foreign customer's payment can produce U.S.-source income, and foreign-source income can enter a domestic corporation's current tax computation.
The diagram separates the three inquiries:
Income categories explain sourcing of income through different connecting facts. The following defaults apply to both domestic and foreign corporations, subject to the exceptions discussed below.
Foreign source income requires checking statutory exceptions after identifying the ordinary sourcing rule. Interest from deposits at a domestic bank's foreign commercial banking branch generally has foreign source; qualifying interest...
Common mistakes
- Allocating inventory receipts. Marlow's purchased inventory contributes to the source schedule; allocating $200,000 overstates income by $140,000.
- Applying an automatic equal split. Dividing Marlow's $120,000 domestic production profit equally would misclassify $60,000 as foreign source under the supplied facts.
- Following the payment address. Norvale's Paris deposit remains $20,000 of U.S.-source interest because the debtor is domestic.
Bottom line
- A domestic corporation generally includes worldwide income; foreign source classification does not itself create an exemption.
- Services follow performance location, rents follow property location, and royalties follow the territory of use.
- Purchased inventory generally follows sale location; taxpayer-produced inventory follows production, subject to applicable special rules.
- Foreign corporations distinguish gross taxation of nonconnected U.S.-source FDAP from net taxation of ECI and available treaty modifications.
Exam shortcut
Mark the income owner first, then underline the controlling location fact for each item. Ignore payment routing unless a stated exception makes it relevant. Before allocating inventory, subtract cost of goods sold. Label purchased and taxpayer-produced goods separately, and look for production-asset data when manufacturing spans countries. Reconcile both geographic columns to the same total income. A location-only change should transfer income between columns without changing the combined total.
The full lesson (about 6,035 words, 40 min read) adds 4 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.A4
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