Domestic corporations and foreign corporations that earn income from the Unites States are subject to U.S. tax. Domestic corporations include those which are created or organized in the United States. Foreign corporations include those which are not created or organized in the United States; that is, foreign corporations operating in the United States directly. A domestic corporation is taxed on its worldwide income at graduated tax rates on a net basis (i.e., after allowable deductions). The corporate tax rates range from 15% for income up to $50,000, to 35% for income over $18.3 million. A foreign corporation, on the other hand, is taxed only on its U.S.-source income. Its U.S.-source income is taxed in one of two ways. Fixed, determinable, annual, and periodic income (“FDAP”) is taxed on a gross basis at a flat rate, currently 30%.
FDAP includes income such as dividends, interest, rents, and royalties. Income that is effectively-connected (“ECI”) with a U.S. trade or business is taxed on a net basis at graduated rates, similar to a domestic corporation. Corporations engaging in transactions with related parties may be subject to limitations on deductions for certain payments (e.g., earnings stripping) and may be required to disclose related party transactions on their annual tax return.
Dividend income from a U.S. corporation is generally taxable to the recipient. Dividends paid to non-U.S. persons are subject to withholding tax at 30%, subject to reduction under a treaty. Dividends paid to U.S. individual shareholders are taxed to the individual at either ordinary income tax rates (the top marginal tax rate for individuals is currently 39.6%) or at the qualified dividend tax rate (the top effective tax is currently 20% plus a 3.8% surcharge). Dividends paid to U.S. corporations are taxed to the recipient corporation at ordinary income tax rates but are eligible for a dividend received deduction that exempts 70% to 100% of the dividend income from taxation.
The United States imposes a branch profits tax on the branch income of a foreign corporation for income derived in the United States. The tax applies on a gross basis at 30% of “dividend equivalent amounts” which are distributed, or treated as distributed, on an annual basis from a foreign corporation’s U.S. trade or business (i.e., its U.S. branch) to the foreign corporation, absent treaty protection. A branch for this purpose includes a foreign corporate partner’s general or limited partnership interest in a partnership which is engaged in a U.S. trade or business. The branch profits tax is a substitute tax for what would be a tax on a profits distribution if the branch had been incorporated as a U.S. corporation. For this reason, many foreign enterprises conduct their activities in the United States through a domestic corporation.
Financing of a U.S. business venture may be affected by the branch interest tax, which applies a 30% withholding tax to the interest paid or deemed paid by the branch of a foreign corporation to foreign persons. The 30% withholding rate can be reduced by a U.S. income tax treaty.
Individuals are subject to U.S. taxation on their worldwide income if they are considered to be a U.S. citizen, resident, or green card holder. Individuals that are not U.S. citizens, residents, or green card holders (“non-resident aliens”) are subject to U.S. taxation on their U.S.source income. A non-resident alien becomes a U.S. resident if he or she is physically present in the United States for 183 days or more, where a day in the current year is counted 1 time, a day in the prior year is counted at 1/3 time, and a day in the second prior year is counted at 1/6 time. Thus, a foreigner can become a
U.S. resident by spending 122 days in the United States for each of three years.
U.S. citizens, residents, and green card holders are subject to tax at graduated rates. The individual tax rates vary from 10% to 39.6%, and the levels at which they apply vary depending on the taxpayer’s filing status (single, married filing jointly, married filing separately, or head of household). U.S. individual taxpayers are subject to tax on most income and are eligible for a dizzying number of deductions, credits, and allowances that are almost as complex as they are numerous.
Non-resident alien individuals are subject to tax only on U.S.-source income, like a foreign corporation. FDAP income is subject to withholding on the gross amount of the income at a flat rate, currently 30%. ECI is subject to tax on a net basis at graduated rates, like that of a U.S. individual taxpayer.
U.S. citizens who relinquish citizenship and long-term residents who terminate their residency are subject to a “mark-tomarket” income tax on any unrealized gain on their property as if it had been sold for its fair market value on the day before expatriation or residency termination. Any net gain is reduced by approximately $693,000, adjusted annually for cost of living increases.
Beginning in 2013, a 3.8% tax (the “Medicare tax” or the “NIIT surcharge”) is imposed on the net investment income of individuals, estates, and trusts that have gross income exceeding a certain threshold, which generally starts at $200,000. Investment income includes interest, dividends, royalties, rents, capital gains and income from business activities in which the taxpayer does not materially participate. The NIIT generally does not apply to non-resident aliens.
Fiscally-transparent entities such as partnerships or joint ventures are not subject to tax at the partnership level. Rather, the partners in a partnership are subject to tax on their share of the partnership’s taxable income. An LLC organized in the United States is treated similarly for tax purposes as a partnership, but it may elect to be treated as a corporation for tax purposes. An “S” corporation is a small U.S. corporation that meets certain requirements (such as having no foreign shareholders, no corporate shareholders, and under 100 total shareholders) and is treated as fiscally-transparent, similar to a partnership or LLC. All of these fiscally-transparent entities are required to report information about their partners, members, or shareholders for tax purposes.
If a partnership has foreign partners, it may be required to withhold tax on their foreign owners’ shares of income even if distributions have not been made. Furthermore, if such a fiscally-transparent entity is considered to be engaged in a U.S. trade or business, foreign owners will also be deemed to be engaged in a U.S. trade or business.
Disregarded entities (such as a single-member LLC) are another form of fiscally-transparent entity. Unlike a partnership, U.S. disregarded entities are not subject to reporting and withholding requirements, although there have been recent indications that reporting requirements may be applied in the future.
A grantor trust is disregarded for income tax purposes and all of its income is taxable to its grantor. Alternatively, non-grantor trusts are treated as separate taxable entities. U.S. beneficiaries of foreign trusts that make distributions must disclose such information with the filing of their annual income tax returns.
Capital gains are generally subject to tax at ordinary income tax rates for corporations and at reduced rates for individuals, which range up to 20% (28% for depreciation recapture). U.S. individuals are also subject to the NIIT surcharge of 3.8% on capital gains. Foreign persons are generally not subject to U.S. tax on U.S.-source capital gains provided they are not effectively-connected with a U.S. trade or business. However, gains from the disposition of real property are taxable in the United States under the Foreign Investment in Real Property Act discussed below.
Capital gains are taxed separately within separate categories of capital gains based on the type of property and its holding period. Capital losses are deductible only up to the amount of capital gains for corporations and only up to the amount of capital gains plus an additional $3,000 for individuals. Corporations can carry back an excess capital loss for 3 years and carry it forward for 5 years. Excess capital losses can be carried forward indefinitely for individuals.
Under FIRPTA, special income tax and withholding rules apply to income from the sale of US real property interests by certain entities and/or foreign persons.
Under these rules, a foreign person generally is subject to withholding at 15% of the gross proceeds on the disposition of U.S. real property at the time of closing to assure that its U.S. tax obligations are met, including filing a U.S. income tax return. A refund can be claimed for any excess tax withheld over the actual tax imposed, which is calculated as though the U.S. real property was effectively-connected income.
Value added tax (“VAT”)
The United States does not impose a VAT.
The United States does not impose a national sales tax. Generally, state and certain local governments each impose their own sales tax on the sale of tangible personal property and certain services within its jurisdiction. Generally, no sales tax is imposed on the sale of tangible personal property that will be resold. In other words, unlike the VAT tax, which imposes an assessment at each stage in the sales process, each state generally imposes its sales tax on the ultimate end user of the product.
Most (but not all) of the 50 U.S. states, as well as some cities, impose corporate and personal income taxes, sales taxes, estate taxes, real estate taxes, et al. Nexus of the entity or individual in a particular state or city is an important factor in determining taxability. The rates can vary significantly from state to state, up to 13%, with most falling in the 5-10% range. In addition, there are often differences between the calculation of taxable income for state and city purposes than from the U.S. federal taxable income.
The United States has entered into several tax treaties with countries around the world. Generally, the U.S. treaties follow a U.S.-specific model that is similar to but different from the OECD model treaty. The U.S. treaties restrict the ability of the federal government to impose taxes under certain circumstances. However, they provide relief for double taxation for taxes imposed by the U.S. federal government only and do not apply to the income taxes of any states or cities in the United States.
The United States has also entered into many information exchange treaties and Inter-Government Agreements to facilitate the sharing of taxpayer information to reduce fraud and tax evasion.
As with most countries, the United States has detailed rules regarding transfer pricing to ensure that all transactions between related parties are made at an “arm’s length” standard, which generally means at similar terms that unrelated parties would interact.
The United States imposes an estate and/or gift tax on values exceeding around $5.5 million, subject to annual change. This exemption threshold applies once for the individual’s lifetime gifts and estate tax. Individuals who are not U.S. citizens but who have U.S. situs assets generally are not be eligible for this exemption and will generally suffer US estate taxes on US situs assets valued in excess of $60,000.
Several states impose an estate (or gift) tax as well.