Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 62-9

1962-1 C.B. 35

Sec. 212

Sec. 871

IRS Headnote

Treatment, for Federal income tax purposes, of legal fees paid by a nonresident alien individual to contest a foreign tax assessed upon his income from sources within the United States.

Full Text

Rev. Rul. 62-9

The Internal Revenue Service has been requested to specify whether, in view of section 1.212-1(a) of the Income Tax Regulations, a nonresident alien individual is entitled to a deduction for legal fees paid to contest a foreign tax assessed upon the taxpayer's income from sources within the United States.

Section 212(3) of the Internal Revenue Code of 1954 provides that in the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in connection with the determination, collection, or refund of any tax. Section 1.212-1(1) of the regulations, in interpreting this statutory provision states, in part, as follows:

Expenses paid or incurred by an individual in connection with the determination, collection, or refund of any tax, whether the taxing authority be Federal, State, or municipal , and whether the tax be income, estate, gift, property, or any other tax, are deductible. Thus, expenses paid or incurred by a taxpayer for tax counsel or expenses paid or incurred in connection with the preparation of his tax returns or in connection with any proceedings involved in determining the extent of tax liability or in contesting his tax liability are deductible.  Emphasis added.

The question has been raised whether the italicized words in the preceding paragraph restrict the deduction to those expenses which pertain to Federal, State, or municipal taxes, and, therefore, by implication, deny a deduction for expenses relating to the determination, collection, or refund of taxes levied by foreign jurisdictions.

In view of the legislative history of section 212(3) of the Code, which indicates that Congress intended to allow the deduction of `any expenses incurred in contesting any liability collected as a tax or as part of the tax,' in view of the plain language of the statute, and indeed in view of the last sentence of the regulation quoted above, it is held that for purposes of applying section 212(3) of the Code, it is immaterial whether the expenses sought to be deducted thereunder relate to a foreign or domestic tax liability. See House Report No. 1337 at A59, and Senate Report No. 1622, at 218, Eighty-third Congress, Second Session. Therefore, the words, `Federal, State, or municipal,' as they appear in section 1.212(1) of the regulations, are not all inclusive but merely illustrative of the types of taxes which can bring about the deduction contemplated in section 212(3) of the Code.

The taxpayer's right to a deduction for the legal expenses otherwise allowable under section 212(3) of the Code is limited, however, by the operation of sections 265 and 871 through 873 of the Code. Section 265 provides, in general, that no amount shall be allowed as a deduction under any provision of the Code for an expense which is allocable to a class or classes of tax-exempt income. Section 871 of the Code groups nonresident aliens into three different categories and prescribes the basis for taxing each group. Irrespective of the category within which they belong, however, nonresident aliens are taxed only upon income from sources within the United States and, to the extent they are entitled to any deductions at all, such deductions (with certain exceptions not here pertinent) are allowable only if and to the extent they are connected with income from sources within the United States. See sections 872 and 873 of the Code.

If the taxpayer computes his tax liability under section 871(a) of the Code, he will not, under any circumstances, be entitled to a deduction for legal fees otherwise allowable under section 212(3) of the Code, since nonresident alien individuals falling within that category are taxed on their gross income without the benefit of any deductions.

If the taxpayer computes his tax under section 871(b) or 871(c) of the Code, the effect of sections 265 and 873 of the Code is to insure that the expenses otherwise allowable under section 212(3) of the Code will qualify for deduction only if the income with respect to which the foreign tax liability arose was income from sources within the United States, which he was required to report on a Federal income tax return, in accordance with section 871 of the Code. Thus, if the foreign income tax in question was levied upon the taxpayer's income from sources without the United States, no deduction may be allowed for any of the expenses paid or incurred by him in connection with the determination, collection, or refund of such foreign tax. Furthermore, even where the foreign income tax is based upon the alien's income from United States sources, the legal fees are not deductible to the extent that they are allocable to that portion of the foreign tax which is attributable to a class or classes of income exempt by virtue of a tax convention. See sections 265 and 894 of the Code and section 1.873-1(a)(5) of the regulations.