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The Tax Prophet Newsletter   Issue # 36 Special Edition June, 2006


In This Issue:
Source of Payment
U.S. Taxpayers

Taxation of


The U.S. government announced that it will pay the $25 million bounty on Abu Musab al-Zarqawi to the Iraqi who tipped off al-Zarqawi's whereabouts. There is a debate in tax newsgroups whether the bounty is subject to U.S. taxes.

Surprisingly, many tax professors say "yes," reasoning that since the bounty payment is from the U.S. government, the payment is therefore "U.S.-source" and subject to the flat-rate withholding of 30% on payments made to a foreigner on U.S.-source income. If true, Mr. Tipster would net $17.5 million after taxes.

Leaving aside the potential political fallout from offering a bounty to catch terrorists, then imposing a 30% tax on the payment, source-of-income issues are increasingly prevalent in today's global economy.

Source of Payment

Assume Mr. Tipster was an Iraqi resident and citizen who was performing personal services within Iraq. Although the bounty payment emanates from U.S. sources, personal services are sourced where the services are performed.

Here, his services were performed in Iraq; consequently, the services would be considered foreign source income and not taxable under U.S. law, unless Mr. Tipster was a U.S. resident or citizen.

Note: This same rule applies to independent contractors working in foreign countries who receive payment for their services from a U.S. company. This situation arises frequently in the software companies when programmers living and working in foreign countries are hired over the internet.

U.S. Taxpayers

A bounty or reward is taxable to a U.S. taxpayer regardless of the source of payment. For instance, if the Iraqi government paid a reward to a U.S. taxpayer, the income is taxable, even if the services were performed in Iraq. U.S. taxpayers are taxed on their world-wide income, regardless of source.

Unless the taxpayer was in the business of collecting bounties or rewards, the income would not be subject to payroll taxes since collecting a bounty or reward is not income from a business or employment. It is reported as other income on Form 1040, line 21, the same place where prizes and awards, gambling winnings and other non-business or non-compensation type income is reported.


U.S. tax law often operates counter-intuitively. Many in the tax community assumed a U.S. government payment was automatically U.S.-source income. Not true. Personal services are generally sourced where the services are performed and if the services were performed in a foreign country, the income is foreign-source.

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All contents copyright 2006 Robert L. Sommers, attorney-at-law. All rights reserved. This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet is a registered trademark of Robert L. Sommers.