Taxation of U.S. Non-Resident Aliens and Foreign Corporations Baker College of Muskegon
Taxation of U.S. Non Resident Aliens and Foreign Corporations
Throughout this quarter we have learned how different entities are taxed, but we have not learned how foreign corporations and nonresident aliens are taxed. The purpose of this research paper is to discuss the basic concepts of how these two entities are taxed in the United States.
A foreign corporation is any corporation that is “not organize under the laws of the United States, any states, or the District of Columbia” (United States international tax site: foreign corporation, 2012). The United States has jurisdiction to tax foreign corporations, but only if they are engage in business in the United States or receives income from sources within the United States. There are two circumstances where foreign corporations are subject to U.S. income tax. The first circumstance is net income effectively connected with a U.S. trade or business is taxed at a normal corporate income tax rate (United States international tax site: foreign corporation, 2012). The second circumstance is that any U.S. source income not effectively connected with a U.S. trade or business is taxed at a 30% rate. If a foreign corporation is unsure if income is effectively connected with a U.S. trade or business, they can refer to tax code 91 RC section 864 (c) which contains the rules in determining if its effectively connected.
Moreover, U.S. source income is separated into 2 categories; periodic income and other income. Periodic income is any gains or losses on the sale of capital assets. “It also includes fixed or determinable annual or periodic gains, profits, and income,” (United States international tax site: foreign corporation, 2012). Some examples of this are interest and dividends, rents and royalties, salaries, wages, and fees. Other income is classified as effectively connected if the taxpayer has a trade or business in the United States.
Therefore, how do we determine if periodic income is connected or not? There are two types of tests that can help determine this. There is the “asset use” test which looks at the asset that generated the income and determines if it is used in the U.S. trade or business. There is also the “business activity” test which tries to “determine if the U.S. trade or business was a material factor in the realization of the income” (United States international tax site: foreign corporation, 2012). Moreover, foreign source income can only be connected if the corporation has an office or fixed place of business in the United States. The next question in mind is determining what is considered an “office” or “fixed” place of business. According to the USA-International-Offshore-Company website, an office or fixed place of business will be classified as so, if it maintains an office, factory, mine, store, or other fixed asset. Overall, any establishment that is used for the business will be consider a fixed place.
Moreover, there are restrictions on the types of income that can be considered effectively connected. The main four are as follow: A. Rent and Royalties
B. Interest and Dividends (banks, financial institutions, and stock or security trades only) C. Sale of inventory
D. Insurance premium income
Any foreign corporation that has U.S. source income that is not effectively connected is taxed at a 30% on gross basis. Deductions are not allowed in computing taxable income. If a foreign corporation has both effectively connected and non-effectively connected income, it must allocate its deductions between the two. Not all of the basic concepts that were discuss above will be true for every foreign corporations. Depending on their tax treaty it will most likely be different.
The rest of the paper will discuss how nonresident aliens are taxed. The first thing to explain is what is a nonresident alien? A...
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