HR364-119

What This Bill Does

The Territorial Tax Equity and Economic Growth Act changes residence and income-source rules for U.S. possessions. Section 937's bona fide residence rule is amended so a person satisfies the presence element by substantial presence under section 7701(b)(3)(A) principles with a 122-day threshold, without several exception rules, in Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, or the Virgin Islands. The bill also changes source and effectively connected income rules. For income from sources outside the relevant possession, section 864(c)(2) principles, rather than section 864(c)(4)-like rules, apply to determine whether the income is effectively connected with a trade or business in the possession. For U.S. activities that are only preparatory or auxiliary, the income is not treated as U.S.-source or effectively connected with a U.S. trade or business. It also adds section 932 to a cross-reference in section 865(j)(3). The amendments apply to taxable years beginning after December 31, 2024.

Who Benefits and How

Bona fide residents of U.S. possessions benefit from a clearer 122-day substantial-presence rule. Puerto Rico taxpayers benefit from revised source and effectively connected income rules. Guam, American Samoa, Northern Mariana Islands, and Virgin Islands businesses benefit from rules that can protect possession-centered activity from U.S.-source characterization. Territorial economic development agencies benefit from tax changes intended to attract and retain business activity.

Who Bears the Burden and How

Treasury tax policy staff must issue guidance on the revised residence and source rules. IRS examiners must apply the 122-day test and distinguish preparatory or auxiliary U.S. activities from U.S. trade or business income. Tax advisers must document possession residence, source, and business-connection positions under the new tests. Federal revenue may decline if more income qualifies for possession-favorable treatment.

Key Provisions

• Modifies possession residence rules using a 122-day substantial-presence test.
• Amends the rule to cover Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, and the Virgin Islands.
• Revises how non-possession-source income is treated as effectively connected with a possession trade or business.
• Bars preparatory or auxiliary U.S. activities from being treated as U.S.-source or U.S.-connected income.
• Requires the new tests to apply to taxable years beginning after December 31, 2024.