Q:  How do I claim tax benefits under the new Extraterritorial Income (ETI) Exclusion regime?

A:  The ETI exclusion provides an automatic exemption of gross income in computing the U.S. taxable income of eligible taxpayers.  The exclusion is automatic in the sense that it operates by law and no election is required, like the Foreign Sales Corporation (FSC) rules.  You merely file your U.S. tax return as usual and exclude the amount of qualified income.  Be on the alert for guidance from the IRS for reporting the exclusion in a U.S. tax return.  For example, presumably, a Schedule M or other adjusting entry will be required to reconcile taxable income per the books with the taxable income reflected on the final U.S. tax return.

Taxpayers claiming the ETI exclusion can receive a 15-30% reduction in their U.S. tax bill under new Sec. 114 of the Internal Revenue Code of 1986 (“Code”).  This exclusion was added in November, 2000, and is effective for qualified income earned after October 1, 2000.  This means that many U.S. individuals and companies can not only reduce their tax bill immediately in 2000, but also in future years!  By not claiming the exclusion in 2000, many eligible taxpayers are leaving money on the table for the IRS.

For companies with an existing FSC as of September 30, 2000, an election must be filed with the IRS to claim ETI benefits in 2000 and 2001, unless the FSC revokes its election or is liquidated.  IRS guidance for claiming the ETI exclusion in 2000 is expected before year-end.  Tax practitioners must decide whether to claim FSC or ETI benefits for their 2000 tax provision and return.  In addition, many practitioners may prefer to wait and claim a tax refund on an amended return.