Expanding your business to the United States can have significant tax implications for foreign investors and enterprises. Understanding U.S. taxation rules is critical to avoid unexpected liabilities and ensure compliance.
This guide explains the basics of U.S. taxation for foreigners doing business in the U.S., including income types, entity-specific rules, and international tax treaty considerations.
Types of Income for Foreigners in the U.S.
Foreigners doing business in the U.S. are generally taxed on two categories of income:
-
Effectively Connected Income (ECI)
-
Income connected with a trade or business conducted in the U.S.
-
Taxed on a net basis at graduated rates ranging from 10% to 35%, depending on the taxable amount and entity type.
-
-
Fixed or Determinable Annual or Periodic (FDAP) Income
-
Income not connected to a trade or business, such as interest, dividends, rents, royalties, or services.
-
Taxed at a flat 30% rate on a gross basis.
-
Note: International tax treaties may reduce these rates under certain conditions.
What Does “Engaged in a Trade or Business” Mean?
Whether a foreign person or entity is engaged in a U.S. trade or business depends on economic activity conducted within the U.S.
-
Activities must generally be regular, continuous, and substantial to qualify.
Special Provisions
-
U.S. Real Estate Sales: Gains from selling U.S. property are taxed as effectively connected income.
-
Rental Property: Owning and renting U.S. property may constitute a trade or business if activity is regular and substantial. Passive receipt of rent usually does not trigger trade or business taxation.
Taxation of U.S. Entities with Foreign Involvement
U.S. Partnership with Foreign Partners
-
Each foreign partner is deemed engaged in a U.S. trade or business.
-
Income is reported separately, and the partnership must withhold taxes, generally at 30% unless treaty benefits apply.
-
Income is taxed at graduated rates (10%–35%), with withheld amounts applied to the partner’s tax liability.
U.S. Corporation with Foreign Shareholders
-
Corporations are taxed at standard U.S. corporate rates (15%–35%).
-
Distributions to foreign shareholders generally require 30% withholding, unless reduced by treaty.
Foreign Partnerships
-
Foreign partnerships doing business in the U.S. must file U.S. income tax returns.
-
Foreign partners with ECI allocations must also file personal returns and pay U.S. income tax.
Foreign Corporations
-
Taxed at graduated rates (15%–35%) on effectively connected income.
-
May also be subject to a branch profits tax of 30% on repatriated earnings, potentially increasing the effective tax rate up to 54.5%.
Withholding Requirements
Foreign persons receiving U.S. income are generally subject to withholding. Key points:
-
Withholding agent: Any entity controlling, paying, or disposing of U.S. income.
-
Standard withholding rate: 30% on gross payments, unless treaty reductions apply.
-
Forms used:
-
W-9 for U.S. persons
-
W-8 series (W-8BEN, W-8IMY, W-8ECI, W-8EXP) for foreign persons
-
Withholding agents must file Form 1042-S and an annual Form 1042 to report and remit taxes withheld.
International Tax Treaties
International treaties aim to avoid double taxation.
-
Limit each country’s right to tax foreign residents.
-
Require countries to allow credits for taxes paid abroad.
-
Define residency for individuals and corporations to prevent dual taxation.
-
Establish rules for dividends, interest, royalties, real property, business profits, and personal services.
Complexities of International Taxation
U.S. taxation for foreign businesses is complex and varies depending on the entity, income type, and treaty provisions. Each situation may have unique reporting and compliance requirements.
Professional Advice Recommended:
If you are doing business internationally, it is crucial to engage an experienced tax advisor to navigate U.S. tax rules and ensure compliance.