## Facts

- George and Esther Rousku were U.S. citizens and bona fide residents of Canada during 1967.
- George Rousku operated an automobile body-repair business in Ontario as a sole proprietorship, requiring provincial licensing.
- In 1967, the business used significant shop machinery and tools (e.g., air compressors, welding and paint-spraying equipment); equipment and tools had a book value of $4,023.
- Rousku rented and later purchased the shop building; in April 1967 he bought the premises for $38,000 and made monthly payments.
- The business purchased repair parts totaling $61,420.19 in 1967 and maintained an average parts inventory of about $2,500.
- The shop employed five licensed workmen; Rousku performed some repair work but primarily estimated jobs, supervised employees, assigned work, and inspected completed repairs.
- The business had gross receipts of $121,253.50 in 1967.
- The Commissioner determined a 1967 deficiency of $734.73, applying the § 911(b) limitation on the ground that capital was a material income-producing factor.

## Issues

1. Whether capital was a material income-producing factor in the taxpayer’s Canadian automobile body-repair business under I.R.C. § 911(b), triggering the 30% limitation on treating business income as foreign earned income.

## Decision

- The Tax Court held that capital was a material income-producing factor in the body-repair business.
- The court applied the § 911(b) 30% limitation to the taxpayer’s business income.
- The deficiency determination was sustained to that extent.

## Legal Principles

- Under I.R.C. § 911(b), when both personal services and capital are material income-producing factors in a business, only a limited portion of the business income may be treated as “earned income” for the foreign earned income exclusion.
- Capital is ordinarily a material income-producing factor when the business requires substantial inventories or substantial investment in plant, machinery, or other equipment.
- Capital is not material when the enterprise’s gross income consists principally of compensation for personal services and any capital investment is merely incidental.
- A repair business employing multiple workers and relying on significant equipment, premises, and sales/use of parts inventory may be treated as materially dependent on capital even though technical skill is important.

## Conclusion

The Tax Court concluded that the taxpayer’s automobile body-repair operation depended materially on capital through its premises, machinery, and parts inventory, so § 911(b) limited the portion of business income eligible for the foreign earned income exclusion to 30%.


Rousku v. Commissioner, 56 T.C. 548 (1971)