As we know, there are two main mechanisms available to US persons to avoid being taxed in the US (in the case of the foreign tax credit, while also paying taxes overseas):
– The foreign tax credit (FTC) and
– The foreign earned income exclusion (FEIE)
The mechanics of the foreign tax credit require the income to be souced to a country other than the US (using US tax concepts), whereas the foreign earned income exclusion requires income to have been earned “from
sources within a foreign country or countries which constitute earned income attributable to services performed by such individual”. As such, the income could not be excluded using the FEIE.
This makes the case of income earned in international water particularly interesting (or sad based on your perspective).
In the following ruling http://www.mkappcpa.com/pdf/EdwardClarkTCMemo2008-71.pdf , the tax court ruled that income earned in international water could not be excluded using the foreign earned income exclusion.
Further, if you consider foreign tax credit, income needs to be sourced to a foreign country. IRC section 863(d) states that “Source Rules for Space and Certain
(1) In general.–Except as provided in
regulations, any income derived from a space or
(A) if derived by a United States
person, shall be sourced in the United States
* * *
* * * * * * *
(2) Space or ocean activity.–For purposes of
(A) In general.–The term “space or
ocean activity” means–
* * * * * * *
(ii) any activity conducted on or
under water not within the jurisdiction
(as recognized by the United States) of
a foreign country, possession of the
United States, or the United States”
, meaning that the income earned on internation waters by a US person is sourced to the US. As such the foreign tax credit is not available, and only a foreign tax deduction (as an itemized deduction on Schedule A) would be avalaible, although much less beneficial than either the FTC or the FEIE.