Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 79-6

1979-1 C.B. 244

Section 911

IRS Headnote

Foreign earned income exclusion; severance pay; statutory requirement. A. U.S. citizen, a cash basis, calendar year taxpayer entitled to exclude foreign source earned income, was employed in a foreign country from 1955 through 1975. On December 31, 1975, taxpayer received as severance pay a determinable amount based on prior years' compensation. The sole basis for the payment was a 1974 amendment to the source country's law. The payment qualifies as earned income and the portion attributable to 1974 and 1975, subject to certain limitations, is excludable under section 911(a) of the Code.

Full Text

Rev. Rul. 79-6

Advice has been requested whether an amount paid to a United States citizen in 1975 as severance pay is excludable from gross under section 911(a) of the Internal Revenue Code of 1954, under the following circumstances.

A is a United States citizen who files returns for the calendar year using a cash receipts and disbursements method of accounting. For the entire period January 1, 1955, through December 31, 1975, A was employed by S corporation in foreign country X and was a bona fide resident of X.

X had a law from 1955 through 1973 that provided certain rights to persons employed in X. Among those rights was a right to severance pay if an employee was discharged for an unjustified cause or retired normally. The terms, "unjustified cause" and "normal retirement" are defined in X's law; however, A's separation from employment with S was for a cause not covered by those terms. The amount of severance pay required by the law to be paid by the employer was based on a percentage of the employee's annual gross salary paid by the employer for each year of employment in X. The severance pay was not an amount received for refraining from rendering personal services or engaging in competitive activity or an amount received as consideration for cancellation of an employment contract.

In 1974, X announced plans to nationalize the property and business of S and other corporations in the same business as S. Also, in 1974, X amended its severance pay statute to provide, with one exception, that all terminated employees are entitled to severance pay, regardless of the reason for termination. The exception was that employees discharged for serious misconduct are not entitled to severance pay. On December 31, 1975, S closed its business in X, and in accordance with X's law paid A the severance pay.

Section 911(a)(1) of the Code provides an exclusion from gross income for earned income attributable to services performed outside the United States by a United States citizen who is a bona fide resident of a foreign country. However, section 911(c)(4), enacted in 1962, provides that amounts received for the performance of services, after the close of the taxable year following the taxable year in which the services were performed, may not be excluded under section 911(a). This limitation, in general, applies to amounts received after December 31, 1962, that are attributable to services performed after December 31, 1962. See the Revenue Act of 1962, section 11(c), Pub. L. 87-834, (1)(B) of the Revenue Act of 1962 1962-3 C.B. 111, 152. Section 11(c) provides an exception for amounts received after December 31, 1962, for services performed before that date, if the taxpayer had a right in existence on March 12, 1962, to those amounts.

Section 911(b) of the Code, in part, defines the term "earned income" to mean wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered.

Section 1.911-1 of the Income Tax Regulations contains rules for the exclusion of foreign source earned income for services performed before 1963, and section 1.911-2 contains rules for services performed after 1962. Section 1.911-1(c)(1)(ii)(a)(2) provides that the rules contained in section 1.911-1 apply to amounts received after December 31, 1962 for services performed before that date, but only if on March 12, 1962, there existed a right described in section 1.911-1(c)(2) to receive such amounts.

Section 1.911-1(c)(2) of the regulations, provides, in part, that a right referred to in subparagraph 1.911-1(c)(1)(ii)(a)(2) shall be considered to exist on March 12, 1962, if such right (whether forfeitable or nonforfeitable) is embodied in a contract or provision of foreign law in force on March 12, 1962, that provides for the payment of determinable amounts in the nature of compensation for past services.

The following examples from section 1.911-1(c)(4) of the regulations illustrate the application of the foregoing provisions:

Example (1). A, a United States citizen who files his returns for the calendar year using a cash receipts and disbursements method of accounting, is privately employed and a bona fide resident of Sweden for the entire period January 1, 1962, through December 31, 1963. A is employed under a written employment contract in force throughout the entire period which provides for compensation of $3,000 per month payable on the 10th day of the succeeding month. A receives $3,000 on January 10, 1963, attributable to services performed on or before December 31, 1962; such amount is excludable from A's gross income under paragraph (a) of this section since the right to receive such amount existed on March 12, 1962, under an employment contract in force on that date.

Example (2). The facts are the same as in example (1), except that A's employment contract expires on October 31, 1962, and is renewed on that date without any change in terms. The result is the same as in example (1) since the new employment contract is essentially a continuation of the old contract.

Example (3). The facts are the same as in example (2), except that the renewed employment contract provides for an increase in A's salary to $3,200 per month. A receives $3,200 on January 10, 1963, which is attributable to services performed on or before December 31, 1962; $3,000 of the amount received on January 10, 1963, is excludable from A's gross income under paragraph (a) of this section since, to that extent, the new employment contract is essentially a continuation of the old contract; $200 of the amount received on January 10, 1963, is governed by the rules set forth in section 1.911-2.

The two specific issues in this case are: (1) does the December 31, 1975 severance payment to A qualify as earned income for purposes of the exclusion provided by section 911(a)(1) of the Code, and (2) if it does, to what extent, if any, does section 911(c)(4) limit the amount of the exclusion?

Issue (1)

The facts with respect to A show that the severance payment that A received from S qualifies for the section 911(a)(1) exclusion, if it is earned income within the meaning of that section. Earned income, as defined in section 911(b), includes wages, salaries, and other amounts received as compensation for personal services actually rendered. The severance payment made by S to A was required by the law of X, but the right to the payment depends upon the employment relationship that existed between S and A. Also, the entire amount of the payment was in direct proportion to A's compensation from S, because it was based on a percentage of A's annual gross salary paid by S for each year of A's employment in X. Section 1.911-1(c)(2) of the regulations provides that if on March 12, 1962, a right to a payment is embodied in a provision of foreign law that provides for the payment of determinable amounts in the nature of compensation for past services, the payment could qualify for the section 911(a)(1) exclusion. Thus, the fact that this severance payment is required by law, rather than the employment contract or relationship does not preclude it from qualifying as earned income, as defined in section 911(b).

Accordingly, because the severance payment from S to A provides for the payment of a determinable amount in the nature of compensation for past services it qualifies as earned income for purposes of section 911(b) of the Code.

Issue (2)

In the instant situation, A's right to severance pay, as it existed on March 12, 1962, was limited to an unjustified discharge by S or normal retirement. A's employment with S was terminated, because S's business was nationalized and this is neither a normal retirement nor an unjustified discharge. Thus, A's receipt of severance pay was not based on a right that existed on March 12, 1962, but arose because of a 1974 change in X's law, which authorized severance pay for all terminations except discharges for misconduct.

Accordingly, because on March 12, 1962, A did not have any right to severance pay in the event that S discharged all employees and closed its business, all the severance pay that A received in 1975 is subject to the rules of section 1.911-2 of the regulations. In accordance with those rules and with section 911(c)(4) of the Code, the portion of severance pay received by A in 1975 that is attributable to services performed in 1974 and 1975, subject to applicable limitations, may be excluded from gross income under section 911(a), but the portion received in 1975 that is attributable to services performed in the years 1955 through 1973 is not excludable from gross income under section 911(a).