What Are the Non-resident Taxes Rates for Profits and Income in the United States?
The global nature of today’s economy means that business ventures increasingly reach overseas to leverage established business operations and processes in new markets. The United States remains an extremely promising market for foreign corporations and companies to enter into and thrive. Likewise, the United States remains a promising nation for foreign investment. The United States is a stable, business-friendly country where domestic and foreign companies receive equal protection under the law. Furthermore, U.S. consumers do not typically discriminate on the basis of the country of origin of the product or service.
However, the United States is also home to a complex tax system. The success of a business owner’s or investor’s overseas efforts can often turn on his or her ability to understand the U.S. tax regime. For instance, actions by the foreign owner or investor can affect the tax rate and amount of nonresident tax paid on profits in the United States. The experienced Tax Lawyers and CPAs of the Tax Law Office of David W. Klasing can provide strategic international tax guidance to individuals overseas with U.S.-based income. Whether this income is from a business or the sale of property, our tax law firm can provide guidance that will help you minimize the tax paid. To schedule a reduced-rate consultation at Irvine or Los Angeles law offices or online call 800-681-1295.
Who Qualifies as a Nonresident Alien?
Nonresident aliens generally only face limited U.S. tax treatment for their U.S.-sourced income. However, the individual must qualify as a “nonresident alien” under U.S. tax law to receive this treatment. This is important because individuals considered U.S. persons for tax purposes are subject to taxation on their worldwide income. Thus, it is extremely important for individuals from China and other nations to protect their status as “nonresident aliens” under U.S. law. The failure to do so often results in significantly greater tax obligations.
Non-U.S. citizens are considered nonresidents unless they meet one of two conditions. The first is they meet the green card test. In short, individuals who meet this test are individuals who are lawful permanent residents at any time during a particular calendar year. U.S. resident status will continue unless affirmative action to renounce the status is undertaken by the individual or action by a U.S. court or USCIS occurs.
The second and often more relevant test is the substantial presence test. Individuals who may travel to the U.S. to manage their business or investment should be particularly wary of this test because sufficient physical presence alone can establish resident status for tax purposes. Any individual who is in the United States for at least 31 days in the previous calendar year and 183 days during the 3-year period that includes the current year and the 2 years immediately before that can be considered a resident for tax purposes. Days present in the year previous to the current year are weighted as 1/3 of a day. Days present in the year two years previous to the current year are counted as 1/6 of a day. A substantially more thorough explanation of the rule and its exceptions is available in Publication 519, U.S. Tax Guide for Aliens.
For those who qualify as and maintain their non-resident tax status, there are generally two different nonresident tax rates that you can face. The first is for income that is considered effectively connected income (ECI) from business activity. The second rate is for income that is considered fixed, determinable, annual, or periodic (FDAP).
What Tax Treatment can a Nonresident Alien Expect for U.S.- Based Business Income?
One threshold concept that is important to understand is that in the area of U.S. tax law, not all income is treated equally. All income that is received from sources and endeavors in the United States connected to trade or business activity is considered Effectively Connected Income (ECI). Typically, individuals must be engaged in U.S. business or trade activities to be able to characterize and treat income as ECI.
Effectively connected income can cover an array of business opportunities and ventures. The key distinction is whether the income is connected with a trade or business occurring in the United States. Examples of income typically associated with ECI include:
- Individuals who are members of a partnership conducting business activities in the U.S.
- Income when the individual is temporarily present in the United States as a nonimmigrant on an “F,” “J,” “M,” or “Q” visa. Any taxable portion of a U.S.-based fellowship grant or scholarship while under these visas is typically considered ECI.
- Income derived from ownership of a business that engages in the sales of products or services within the United States.
- Income from the rental of real property may also be treated as ECI on the election of the taxpayer.
One exception to the general principle is that income associated with trade or business occurring in the United States are companies engaging only in certain financial transactions. For instance, if your business is engaged solely in trading in stocks, securities, commodities, or hedging transactions, you will not typically be considered as engaging in U.S.-based trade or business, and thus, the income will not normally be characterized as ECI. However, if the levels of trading meet certain levels, the trading is active, and it occurs through a resident independent contractor or an office of the nonresident taxpayer located within the United States, the income may be considered ECI.
What Tax Rates Will a Nonresident Pay on Effectively Connected Income (ECI)?
Benefits of income being taxed as ECI include the fact that it will be taxed at either graduated rates under U.S. law or lesser rates under an applicable tax treaty. Additionally, since deductions are permitted against ECI income, these deductions can often be leveraged to reduce taxable income and thus potentially decrease graduated tax rates and the overall amount of tax paid.
Furthermore, due to provisions of the Internal Revenue Code (IRC) or tax treaties, certain types of FDAP income can also receive treatment as ECI income. For instance, IRC Sec 871(d) permits nonresidents to treat investments in U.S. real estate as ECI and avoid potentially harsh FDAP taxation. So it is always best to consult with an experienced tax lawyer or accountant regarding IRS and international tax treaty rules before making assumptions regarding the tax treatment of income.
What Tax Treatment Can a Nonresident Alien Expect from Investment Income or Interest?
For most non-business income, income is treated as fixed, determinable annual, and periodic income (FDAP). FDAP income can include any income that is received as or derived from interest, rent, dividends, or royalties. However, the breadth of what is considered FDAP income is much broader. Consider that the terms “fixed” and “determinable” are simply descriptive of the nature of FDAP income. Likewise, it is irrelevant whether the payment is issued in a series of transactions or a single transaction provided that the income falls within the scope of the definition of this class of income. As such and over time, the scope of FDAP can reach a seemingly infinite array of income flows. However, generally, generally, FDAP income can be characterized as passive income.
Since foreign taxpayers often have limited or no assets located in the United States the IRS can easily reach, this tax is collected through withholding. At a basic level, withholding is a government requirement for the payor of an item of income to withhold or deduct tax from the payment to the foreign recipient. FDAP income is subject to a flat tax rate of 30%. Furthermore, deductions are not available for FDAP income. Since the 30 percent tax applies to gross income, the flat tax can apply to income never actually received by the nonresident. Information regarding flat rate FDAP taxation on nonresidents is set forth in IRC §871(a) and 881.
Discuss Nonresident Tax Rates with an Experienced U.S.-Based Tax Professional
Understanding the characteristics and acts that can affect an individual’s status as a nonresident is essential to avoid additional taxation. Furthermore, gaining a grasp of the tax rate a nonresident will face due to the type of income they have and the actions they have taken is essential. Furthermore, working with a qualified tax professional who can explore and explain potential means to minimize nonresident taxes is often a key element to overseas success in the U.S. market.
The Strategic Tax Lawyers and CPAs of the Tax Law Offices of David W. Klasing can provide insightful guidance as to how nonresident businesses and investors can navigate the international tax system. To schedule a reduced-rate consultation with an experienced international tax professional, call the Tax Law Offices of David W. Klasing at 800-681-1295 or contact us online today.