The Taxation of Resident and Non-Resident Business Owners
Tax Rules as a Non-Resident-Alien US Business Owner - When setting up a U.S business as a non-resident, its important to understand the potential tax implications so that you can plan accordingly. If you are not a U.S citizen or permanent resident and you operate a U.S business from outside the country (or are thinking about setting up a U.S company) the rules are fairly clear. The U.S taxes non-resident aliens according to where services are performed, not where customers or entities are based, which is an appealing prospect for foreign based entrepreneurs. The fiscal landscape however is complex and it’s important to understand fully where you may be categorized according to your status.
The U.S taxes citizens and non-citizens in different ways. Generally speaking, taxable citizens for taxation purposes are considered U.S nationals, green card holders and those who pass the substantial presence test within the Unites States within a given tax year and can also be considered an ‘alien’ in taxation terminology. An alien is any individual who is not a U.S. citizen or U.S. national. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.
The Substantial Presence Test
You will be considered a United States resident for tax purposes if you meet the substantial presence test for the calendar year. To meet this test, you must be physically present in the United States (U.S.) on at least:
• 31 days during the current year, and
• 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
• All the days you were present in the current year, and
• 1/3 of the days you were present in the first year before the current year, and
• 1/6 of the days you were present in the second year before the current year.
You were physically present in the U.S. on 120 days in each of the years 2012, 2013, and 2014. To determine if you meet the substantial presence test for 2014, count the full 120 days of presence in 2014, 40 days in 2013 (1/3 of 120), and 20 days in 2012 (1/6 of 120). Since the total for the 3-year period is 180 days, you are not considered a resident under the substantial presence test for 2014.
Days of Presence in the United States
You are treated as present in the U.S. on any day you are physically present in the country, at any time during the day. However, there are exceptions to this rule. Do not count the following as days of presence in the U.S. for the substantial presence test.
• Days you commute to work in the U.S. from a residence in Canada or Mexico, if you regularly commute from Canada or Mexico.
• Days you are in the U.S. for less than 24 hours, when you are in transit between two places outside the United States.
• Days you are in the U.S. as a crew member of a foreign vessel.
• Days you are unable to leave the U.S. because of a medical condition that develops while you are in the United States.
• Days you are an exempt individual (see below).
For details on days excluded from the substantial presence test for other than exempt individuals, refer to Publication 519, U.S. Tax Guide for Aliens.
The term United States (U.S.) includes the following areas.
• All 50 states and the District of Columbia.
• The territorial waters of the United States.
• The seabed and subsoil of those submarine areas that are adjacent to U.S. territorial waters and over which the United States has exclusive rights under international law to explore and exploit natural resources.
• The term does not include U.S. possessions and territories or U.S. airspace.
Tax Rules as a Non-Resident-Alien US Business Owner - Do not count days for which you are an exempt individual. The term "exempt individual" does not refer to someone exempt from U.S. tax, but to anyone in the following categories:
• An individual temporarily present in the U.S. as a foreign government-related individual under an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas.
• A teacher or trainee temporarily present in the U.S. under a "J" or "Q" visa, who substantially complies with the requirements of the visa.
• A student temporarily present in the U.S. under an "F," "J," "M," or "Q" visa, who substantially complies with the requirements of the visa.
• A professional athlete temporarily in the U.S. to compete in a charitable sports event.
If you exclude days of presence in the U.S. for purposes of the substantial presence test because you were an exempt individual or were unable to leave the U.S. because of a medical condition or medical problem, you must include Form 8843, Statement for Exempt Individuals and Individuals With a Medical Condition, with your income tax return. If you do not have to file an income tax return, send Form 8843 to the address indicated in the instructions for Form 8843 by the due date for filing an income tax return.
If you do not timely file Form 8843, you cannot exclude the days you were present in the U.S. as an exempt individual or because of a medical condition that arose while you were in the U.S. This does not apply
if you can show, by clear and convincing evidence that you took reasonable actions to become aware of the filing requirements and significant steps to comply with those requirements.
Who Must File?
If you are any of the following, you must file a return:
• A nonresident alien individual engaged or considered to be engaged in a trade or business in the United States during the year.
• A nonresident alien individual who is not engaged in a trade or business in the United States and has U.S. income on which the tax liability was not satisfied by the withholding of tax at the source.
• A representative or agent responsible for filing the return of an individual described in (1) or (2),
• A fiduciary for a nonresident alien estate or trust, or
• A resident or domestic fiduciary, or other person, charged with the care of the person or property of a nonresident individual may be required to file an income tax return for that individual and pay the tax (Refer to Treas. Reg. 1.6012-3(b)).You should first determine whether, for income tax purposes, you are a nonresident alien or a resident alien (read further on page 4 of the publication or Google “substantial presence test” as there are exceptions for individuals traveling from Mexico).
• A nonresident alien usually is subject to U.S. income tax only on U.S. source income. Under limited circumstances, certain foreign source income is subject to U.S. tax. See Foreign Income in chapter 4. The general rules for determining U.S. source income that apply to most nonresident aliens are shown in Table 2-1 (on page 13).
A nonresident alien’s income that is subject to U.S. income tax must be divided into two categories:
1. Income that is effectively connected with a trade or business in the United States, and
2. Income that is not effectively connected with a trade or business in the United States. The difference between these two categories is that effectively connected income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to U.S. citizens and residents. Income that is not effectively connected is taxed at a flat 30% (or lower treaty) rate.
A taxpayer identification number must be furnished on returns, statements, and other tax-related documents. If you do not have and are not eligible to get an social security number, you must apply for an individual taxpayer identification number (ITIN). An employer identification number (EIN) is required if you are engaged in a trade or business as a sole proprietor and have employees or a qualified retirement plan.
You must furnish a taxpayer identification number if you are: 1) an alien who has income effectively connected with the conduct of a U.S. trade or business at any time during the year, 2) an alien who has a U.S. office or place of business at any time during the year, 3) a nonresident alien spouse treated as a resident, or 4) any other alien who files a tax return, an amended return, or a refund claim (but not information returns).
Which Income to Report?
A nonresident alien's income that is subject to U.S. income tax must generally be divided into two categories:
- Income that is Effectively Connected with a trade or business in the United States
- U.S. source income that is Fixed, Determinable, Annual, or Periodical (FDAP)
- Effectively Connected Income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to U.S. citizens and residents. Effectively Connected Income should be reported on page one of Form 1040NR, U.S. Nonresident Alien Income Tax Return. FDAP income is taxed at a flat 30 percent (or lower treaty rate, if qualify) and no deductions are allowed against such income. FDAP income should be reported on page four of Form 1040NR.
Which Form to File
Nonresident aliens who are required to file an income tax return must use:
• Form 1040NR, U.S. Nonresident Alien Income Tax Return or,
• Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens with No Dependents, if qualified. Refer to the Instructions for Form 1040NR-EZ to determine if you qualify.