If you are a "nonresidential alien" (not a U.S. tax resident or citizen) and plan to invest or work in the U.S., you need to consider a few questions in order to determine your U.S. income and estate tax consequences:
1. Do you plan to operate a business in the U.S.?
2. Do you plan to invest in other properties such as stocks, bonds, mutual funds, saving accounts, etc.?
3. Do you plan to invest in U.S. real estate?
4. Do you plan to immigrate to the U.S.?
5. Do you plan to obtain employment in the U.S.?
OPERATING A BUSINESS IN THE UNITED STATES Back To Top
Generally, net income (business income less operating expenses) from operating a business in the U.S. is subject to U.S. income taxes, most states (including California) also tax business’s net income.
If there is a tax treaty between your country of residence and the U.S., U.S. tax may be limited to income from business operated through a permanent establishment.
You may operate your business as one or more of the following business entities:
3. U.S. Corporation owned by a foreign corporation.
4. Partnership
SOLE PROPRIETORSHIP Back To Top
If you operate your business as an individual, any net income from the business will be subject to U.S. income tax calculated using the individual tax rate tables and reported on Form 1040NR.
To obtain liability protection for an unincorporated business you may consider operating the business as a single member limited liability company.
You may obtain liability protection for your business when it is operated in the form of a U.S. corporation.
Any net income of the business is reported on Form 1120, U.S. federal income tax is calculated by applying the appropriate rate from the corporate tax rate table to the net income. If the corporation pays state income tax, the corporation may subtract such tax from its net income to arrive at the federal net income. A Form 5472 also needs to be filed.
If the corporation has a business loss, which is not uncommon for start-up businesses, it may carry the loss back to the previous two years (five years for losses that arise in a tax year ending during 2001 or 2002) or forward to twenty future years.
If the corporation has a U.S. office, the value of the stock is includible in the foreign shareholder’s U.S. estate for estate tax purposes.
If the foreign shareholder sells the stock, and he is not considered a U.S. resident, the gain on sale is tax-free.
Distribution of earnings by the corporation to the shareholder is subject to a withholding at 30%. If your resident country has a tax treaty with the U.S., such withholding rate is generally reduced.
U.S. CORPORATION OWNED BY A FOREIGN CORPORATION Back To Top
If the U.S. corporation is owned by a foreign corporation, the value of the U.S. corporation’s stock is not included in the foreign shareholders of the foreign corporation. Therefore this is a common organizational structure for a foreign individual to avoid being subject to U.S. estate tax.
Distribution of earnings by the corporation to the foreign parent corporation is subject to withholding at 30%. If the parent corporation’s resident country has a tax treaty with the U.S., the withholding rate is generally reduced.
You may own a U.S. business with other partners and operate the business in the form of a partnership.
The partnership is required to file Form 1065 to report its income. Each partner is considered an owner of his prorata share of the business. He is subject to U.S. tax for his share of the partnership income.
The partnership is required to withhold income tax on its foreign partners’ prorata share of the partnerships income. Distributions of earnings by the partnerships to its foreign corporate partners may be subject to "Branch Profit Tax" withholding. Withholding rates are generally reduced by tax treaties.
LIMITED LIABILITY COMPANY (LLC) Back To Top
A limited liability company is an entity that provides liability protection and is treated as a partnership for income tax purposes.
Unlike a true partnership, the U.S. tax authority (Internal Revenue Service) allows an LLC to have just one owner (who is called a member). Therefore an individual operating a business in the U.S. may choose to form a "single-member LLC" to enjoy both liability protection and the simplicity of being treated as a partnership for tax purposes. Many states (including California) recognize "single-member LLC’s".
BRANCH OF A FOREIGN CORPORATION Back To Top
Some foreign corporations set up unincorporated branches in the U.S. to operate their U.S. business. When a foreign corporation has a U.S. presence, it is the net income of its U.S. branch that is taxed at corporate rates. The foreign corporation is required to report results of its U.S. operation on Form 1120 F.
Even if the U.S. branch incurs a loss, it is important to the foreign corporation to file Form 1120F to report the loss, so that the loss may be carried forward to offset income in future years. If no 1120F is filed the corporation may lose the benefit of the loss.
Distributions of profit from the branch to the foreign corporations are subject to a "branch profits tax" and withholdings is required at 30%. Tax treaties may reduce it to 5%.
BRANCH OF A FOREIGN PARTNERSHIP Back To Top
A partnership that is formed outside of the U.S. may set up a branch in the U.S. to operate its U.S. business.
A foreign partnership with a U.S. branch is required to file Form 1065. All of its partners are considered to own his prorata share of the U.S. business and therefore its net income or loss. The partnership is required to withhold from its foreign partners on their share of U.S. business income.
When distributions of profit are made by the branch to its foreign corporate partners, withholdings is required on the resulting "branch profits tax". Tax treaties may reduce the withholding rate.
INVESTMENT IN U.S. REAL ESTATE Back To Top
Rental income from real estate located in the U.S.:
Gross rental income (without any deductions) from rental of real property owned by foreign persons is generally subject to a flat 30% withholding tax. Tax treaties may reduce the withholdings rate. However, the foreign owner may make an election to treat the rental operation as a U.S. business. By making this election, expenses related to the renal property such as property taxes, interest, repairs, maintenance, utilities, and depreciation, are allowed to be deducted from rental income. The resulting net rental income is taxed at the graduated tax rates. Any resulting net loss may be carried forward to offset future rental income.
Gain on sale of the property will be subject to U.S. tax. On sale of the property, a withholding tax of 10% of the sales proceeds is required.
U.S. real estate investments include ownership of a U.S. real property holding company — USRPHC. An USRPHC is an entity whose real estate value exceeds 50% of its total asset value.
INVESTMENT IN STOCKS, BONDS, AND OTHER PERSONAL PROPERTIES
Back To TopStocks: Dividends paid by a U.S. corporation to a foreign investor is subject to a 30% tax withholding. Tax treaties may reduce the withholding rate. Gain on sale of stock by a foreign investor is exempt from U.S. tax.
Bonds and other debt instruments: Interest paid by a U.S. person or company is subject to a 30% tax withholding. Tax treaties may reduce the withholding rate. Gain on sale of a bond or debt investment attributed to its appreciation in value is exempt from U.S. tax. Interest related to a qualified portfolio loan is exempt from U.S. tax.
Other personal properties: Gain on sale of personal property investment is generally exempt from U.S. tax.
PRE-IMMIGRATION PLANNING Back To Top
Foreign persons with dependents in the U.S. may set up a grantor trust to hold businesses and investments with income distributed to their U.S. dependents without incurring U.S. income taxes. However, U.S. residents who receive more than $100,000 a year from a foreign person are required to file Form 3520.
If a foreign person intends to immigrate to the U.S. and become a U.S. resident it may be beneficial for him to complete his gifting program so that post-immigration transfers will not be subject to U.S. gift tax.
If he possesses appreciated properties, and wants to avoid paying U.S. taxes on gains it may be advisable to sell these properties before immigration. He may also want to structure his business organization before immigration so that global taxes for the overall business organization will be minimized.
The above planning ideas must be considered along with the taxation system of the immigrant’s current country of residency. If the tax rates are higher in his current country of residency, the above ideas may not be beneficial.
A foreign person may work in the U.S. as a contractor or an employee.
All income from services performed in the U.S. are generally subject to U.S. taxes, calculated at graduated tax rates.
Wages earned as an employee are subject to tax withholding on each payment.
Withholding is required on income, medical and social security taxes. An employee may be exempt from social security tax withholdings if his country of citizenship has a totalization treaty with the U.S.
If a foreign person performs service for a U.S. entity and he does not have a fixed base in the U.S., a tax treaty between his country of residency and the U.S. may exempt such service income from U.S. taxes.
An employee who is an H-1 visa holder and works in the U.S. for a portion of a year may report his U.S. income on a "number of days worked" basis.
PERMANENT ESTABLISHMENT (PE) Back To Top
Generally, any U.S. sourced income is subject to U.S. income taxes. However, if there is a tax treaty between the U.S. and your country of residence, your business income in the U.S. is only taxable if it is generated from a P.E., defined as a fixed location of businesses such as a place of management, branch, office, factory or workshop.
A tax treaty generally excludes the following from being defined as a permanent establishment.
a) the use of U.S. facilities solely for the purpose of storage, display or delivery of goods or merchandise from your country;
b) the maintenance of a stock of goods or merchandise from your country solely for the purpose of storage, display or delivery;
c) the maintenance of a stock of goods or merchandise from your country solely for the purpose of processing by another enterprise;
d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for your foreign business;
e) the maintenance of a fixed place of business solely for the purpose of carrying on, for your foreign business, any other activity of a preparatory or auxiliary character;
f) the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraph a) through e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
CONCLUSION Back To Top
The United States has been a place of opportunities for foreign investors, worker, and immigrants for centuries. It continues to be the most prosperous, educated, and business friendly society that has great appeal for investment and employment. However, there are complex income and estate tax consequences that foreign investors and workers should consider before making investment or employment decisions. Please be sure to consult competent advisors for assistance. If you would like to obtain more information in issues mentioned above, please feel free to email Eric Eng, CPA at eeng@ceallp.com.
This article is intended to provide general information only, please make sure to consult with your own advisors or contact us before taking any action.
CORPORATE TAX RATE TABLE: Back To Top
Under Construction
INDIVIDUAL TAX RATE TABLES (PROJECTED):
SINGLE INDIVIDUALS: Back To Top
Under Construction
MARRIED FILING JOINTLY AND SURVIVING SPOUSES: Back To Top
Under Construction