If you’re a Pakistani freelancer or founder working with US clients, someone has probably told you that money from a US company automatically counts as US income. That’s wrong. It’s one of the most common mix-ups we see among NRPs trying to figure out their Form 1040-NR. The IRS doesn’t really care where the check comes from. It cares about where you did the work.

That distinction matters more than people realize. It changes what you owe, what you report, and whether you’re filing correctly in the first place. Get the sourcing wrong and you either overpay tax on income that was never US-taxable to begin with, or you underreport something you should’ve flagged. Either way, you’re exposed.

What Determines Your Income Source?

The IRS splits income into two buckets, US source and foreign source. For nonresident aliens this split decides basically everything, since a 1040-NR only taxes US source income plus a narrower category called effectively connected income, or ECI, meaning income tied to actively running a business inside the US. Foreign source income generally stays off that form entirely.

Here’s the part that trips most people up: the IRS looks at where the activity happened, not where the payer sits. A US company can pay a Pakistani contractor, and that payment can still be 100% foreign source if the contractor never set foot in the US to do the work. Activity location decides the source. Payer location doesn’t. That holds no matter what currency is involved – USD, PKR, USDT through a crypto wallet, a Payoneer transfer, none of it changes sourcing. The IRS cares where you worked, not what currency landed in your account.

Resident aliens get taxed on worldwide income, similar to US citizens. Nonresident aliens only get taxed on US source income and ECI. So before you even think about deductions or credits, figure out which category your income falls into first. That depends on where your hands were on the keyboard, not where the invoice was issued.

Earned Income: The ‘Where You Work’ Rule

For personal services, the sourcing rule is fairly straightforward. Income gets sourced to wherever you physically performed the work. Not where your client is headquartered. Not where the contract was signed. Not where the bank wired the money from. Just the location of your body while you did the job.

Take a software developer in Karachi doing contract work for a startup based in Austin, Texas, for the past two years. She invoices in dollars, gets paid through a US payment processor, her client is incorporated in Delaware. None of that touches the sourcing question. Because she does 100% of her work from her apartment in Karachi, her income is 100% foreign source. The 1040-NR doesn’t even need to see it.

Now flip it. Say that same developer gets invited to a 10-day accelerator program in San Francisco, and she keeps working her normal hours, billing the same client for the same kind of work. Those 10 days are now US source income, because the activity happened on US soil. The other 355 days stay foreign source. This is mixed location work, and it basically means splitting one client relationship into two different tax treatments depending on the calendar.

When this happens, the allocation is time-based. You count days worked inside the US versus outside, then divide the income proportionally. Not glamorous work, and it’s exactly the kind of detail a lot of casual filers skip, usually because nobody ever told them it existed. The same trap applies to founders flying out for fundraising trips or batch programs like Y Combinator. A few weeks of work on US soil can quietly pull a slice of an otherwise tax-free year into US source territory, and the only way to handle it cleanly is tracking those days as they happen, not trying to reconstruct them later from memory.

This is also where the W-8BEN becomes relevant. If you’re a Pakistani freelancer being paid by a US client and your work is genuinely foreign source, the W-8BEN is the form you hand that client to certify you’re a nonresident alien, so withholding doesn’t get applied the way it would for a US person. It doesn’t change your sourcing – sourcing is decided purely by where you worked – but it’s the practical paperwork that stops a US client from over-withholding on payments that were never US-taxable to begin with.

Passive Income Sourcing for Investors

Earned income has its own rule, but passive income, money coming from capital sitting somewhere rather than work being done, follows different logic depending on the type.

Interest income generally gets sourced to wherever the payer, like a bank or borrowing entity, is based. So if a Pakistani investor holds a US savings account, that interest is US source. Dividends get sourced based on where the paying corporation is incorporated, meaning dividends from a US company land in your US source bucket while dividends from something listed on the PSX stay foreign source. This is also why a Pakistani investor’s US brokerage dividends get treated completely differently from their domestic stock dividends, even when both portfolios are managed in exactly the same way.

Rental income just follows the property. Own a rental unit in Lahore? That income is foreign source, full stop, even if the tenant happens to pay you through a US bank transfer. Royalties get sourced to wherever the underlying property or right is actually being used, which matters a lot more for tech founders licensing software – more on that below.

There’s also a sharper rule worth knowing if you hold shares in a foreign corporation with meaningful US business ties. If more than 25% of that foreign company’s gross income, averaged over the past three years, is effectively connected to a US trade or business, part of its dividends gets reclassified as US source, even though the company itself is foreign. Catches more people than you’d expect. If a Pakistani founder sets up a holding structure somewhere like Singapore or the UAE, and that holding company ends up doing a meaningful chunk of business with the US, those “foreign” dividends can quietly turn partially US-taxable. It’s not the country of incorporation driving this, it’s how much of the company’s actual income ties back to US business.

Special Considerations for Pakistani Tech Founders

Software and IP create their own sourcing puzzle, and honestly it doesn’t get talked about enough. Royalties from licensing software get sourced to wherever the software is used, not where the developer who wrote the code lives. So if a Pakistani-built SaaS product is licensed to a customer in Ohio, that royalty income is US source, regardless of the fact that every line of code was written in Islamabad.

Here’s the divide worth holding onto. If you’re a freelancer, your source is your keyboard, wherever it physically sits. If you’re a SaaS founder licensing a product, your source is your customer’s browser, wherever they happen to be using it. Same general tech industry, completely different sourcing logic, because one of you is selling labor and the other is selling a license to use something already built.

One detail that catches a lot of founders off guard: where your servers live doesn’t matter at all. Hosting your app on AWS US-East doesn’t make a Pakistani-built product’s income US source. The IRS doesn’t care that your infrastructure sits in Virginia. It cares about where your customer is sitting when they use what you built. A Pakistani SaaS company can run entirely on US cloud servers and still have its licensing income come out almost entirely foreign source, as long as the customer base is foreign too.

For freelancers working with US companies from inside Pakistan, the earned income rule still holds. You stay foreign source as long as you’re physically in Pakistan doing the work. Things get complicated the moment a founder starts splitting time between Pakistan and the US, attending demo days, fundraising trips, accelerator programs. Each one of those US visits potentially creates a slice of US source income that needs separate tracking, even if it’s small.

Compliance and Form 1040-NR

Everything above exists for one practical reason: your 1040-NR depends entirely on correct sourcing. Get the source wrong and the whole filing rests on a shaky foundation, since nonresident aliens generally don’t report foreign source income on this form at all.

The most common mistake, call it the Delaware myth, is assuming that because your company is incorporated in Delaware, or your client pays from a US bank account, your income must be US source. It isn’t, not automatically. A Delaware LLC paying a Pakistani contractor for work done entirely from Pakistan still produces foreign source income, full stop. State of incorporation tells you nothing about where the actual work happened, and mixing the two up is how people end up overpaying tax they never owed in the first place.

The flip side is just as costly. Nonresident aliens who report their full foreign income on a 1040-NR anyway, treating it like a regular US return, end up handing over money for taxes that were never owed and can’t get it back later. The form is narrower than that by design. Stuffing it with income it was never meant to capture doesn’t make you safer, it just means paying for a mistake that was entirely avoidable.

Correct sourcing also feeds directly into your Foreign Tax Credit position. If you’ve correctly identified income as foreign source and already paid tax on it in Pakistan, that groundwork is exactly what lets you claim credit for those Pakistani taxes against any US liability tied to that same income. Skip the sourcing step, or get it backwards, and the FTC math falls apart before it even starts.

None of this replaces actual legal or tax advice tailored to your situation. It’s meant to help you understand the framework well enough to ask the right questions and avoid the most common sourcing mistakes, whether you’re filing it yourself or working with a 1040-NR filing service that already understands the Pakistan-US corridor.

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