This article discusses the US tax treatment of “non-resident aliens” or “NRAs.” You’re an NRA if you’re NOT any of the following:
- A US citizen,
- A US permanent resident (i.e., a “green card holder”), or
- Someone who’s lived in the US long enough to pass the “substantial presence test.”
There are two very different US tax regimes potentially applicable to you—the “passive regime” and the “active regime.”
When you receive certain types of passive income (such as interest, dividends, rent, or royalties), you’re subject to a flat 30% tax. The general 30% rate may be reduced by an applicable tax treaty.
Typically, the payor of this sort of income is required to withhold tax at the applicable rate and pay that amount over to the US government. Then, you’re not required to file a US tax return—the withholding fully takes care of the tax, so there’s nothing further for you to do.
For example, if you hold stock issued by a US corporation, and the US corporation pays a dividend of $100, the US company will actually pay you only $70 (assuming a treaty doesn’t apply). The remaining $30 will go to the Internal Revenue Service.
Now, of course there are all sorts of exceptions here (just because US tax must be complicated). For example, interest is a type of passive income on which tax must be withheld, but various exceptions allow you to earn certain types of interest completely tax-free. One type of tax-free interest is interest earned on ordinary bank deposits. The US apparently wants to encourage you to keep your money in the US.
The US tax treatment of income from an active business is completely different than discussed above. A whole different regime applies.
Here’s how it works:
- You’re subject to US tax on business income only if you are “engaged in a trade or business in the United States,” or “ETBUS” for short.
- You’re ETBUS only if two things are true: (1) you have at least one “dependent agent” in the US, and (ii) that dependent agent does something substantial to further your business in the US (as opposed to something purely administrative or ministerial).
- Finally, if you can benefit from an applicable tax treaty, then you’re only subject to tax if (in addition to being ETBUS) you operate in the US through a “permanent establishment” (e.g., an office or other fixed place of business).
Let’s look at the different moving parts above in more detail.
What’s a dependent agent?
A dependent agent is basically a person who works for you so closely that the dependent agent’s actions can be said to be an extension of your own actions. So, the term definitely includes your employees. But it also includes people in two other categories:
- Individuals who work for you as an independent contractor, but who do so much work for you that they’re basically indistinguishable from an employee, and
- Companies who provide services exclusively (or almost exclusively) to you.
What’s an Independent agent?
Let’s look at the opposite of a dependent agent—an independent agent. Well, that’s a person who’s running their own business and with respect to whom you’re simply a client. So, an independent agent has their own business going on, and that business helps your business in some way.
An independent agent does things for you (the’re still your “agent”), but they’re mainly working on their own business, not yours. So, they’re independent of you-their actions are their own and aren’t an extension of your actions.
For this reason, simply using the services of an independent agent in the US doesn’t cause you to be treated as engaged in a trade or business in the US.
Why do many other tax professionals get this wrong?
There are some legitimate reasons why other tax pros get this wrong. And then there are some not-so-legitimate reasons.
US tax has a concept of income that is “US source” v. “foreign source,” and that distinction has all sorts of uses. Generally, if you sell products into the US, that income is US source.
Some tax pros make the mistake of equating “US source” with “you have to pay US tax.” But that’s simply not the case. A non-US person has to pay US tax on income only if that income is “effectively connected with a trade or business in the United States,” meaning that they have to be ETBUS and the income must be connected with the activity that makes them ETBUS.
Then, other tax pros figure that if you don’t have to pay US tax, then they won’t be able to charge you fees to file your US tax return. And they like charging you fees more than they like actually understanding how US tax really applies to you.
Let’s say you decide to sell products into the US market using Amazon’s “Fulfillment by Amazon” service (i.e., Amazon FBA). So, you buy products and have them shipped to Amazon’s warehouses, and Amazon employees package the products and ship to customers.
Is Amazon your dependent agent? No, absolutely not. Amazon has their own business going on, and you’re just one of Amazon’s many clients.
So, in this example, you’re not “engaged in a trade or business in the US,” so you’re not subject to US tax on income from selling products into the US.
Let’s wrap it up in a bow
Here’s another way to think about it. When you sell products, you’re definitely engaged in a trade or business-you’re sourcing products, doing marketing, shipping to customers, accepting returns from customers, and all the other activities that go into running a business.
But, you aren’t subject to US tax because you aren’t engaged in that trade or business in the United States. You’re engaged in that trade or business wherever outside the US you (and your dependent agents, if any) happen to be.
However, if you were to have dependent agents in the US, then you would be engaged in that trade or business in the US. You’d have people on the ground running your business from inside the United States. So, you’d be subject to US tax under the active regime.
But, if you only use the services of an independent agent (such as Amazon), then the people in the US helping you aren’t your people. They’re just people running their own business (in the case of Amazon) or people working for someone else (in the case of Amazon’s employees and independent contractors).
But what if . . .
Now, this is the point in the conversation where the “what if . . .”s usually begin. But, let me tell you, the above is really all there is to it.
So let’s handle the most common “what if . . .”s I get here:
What if I operate through a US limited liability company (an “LLC”)? If you’re the sole member (i.e., owner) of a US LLC, then the LLC is disregarded as a separate entity from you for US tax purposes. That just means that it doesn’t exist for US tax purposes—it’s a “tax nothing.” So, operating through an LLC couldn’t possibly change the US tax analysis.
What if I get paid in US dollars, held through a US bank account? Nothing above changes. The currency you’re paid in and the location of the bank where you hold that currency don’t make a bit of difference. It only matters whether or not you’re ETBUS.
What if I sell products online and my server is located in the US? Doesn’t matter. If the server on which your web page lives is in the US, then you’re just using the services of an independent agent (i.e., the hosting service). That doesn’t make you ETBUS.
But when I sell physical products into the US, won’t I have US source income? Yes, you will have US source income. But that doesn’t matter one bit. To be subject to US tax under the active regime, you have to be ETBUS. Only then are you subject to your US source income that’s “effectively connected” with your US business. But, just having US source income all by itself doesn’t make you subject to US tax.
I’ve been told to set up a US corporation, and to assign it 5% of the profit from my business. Is that a good idea? No, it’s completely unnecessary. Some people seem to think that you need a corporation in the US to shield you (or your non-US company) from directly selling into the US. However, this structure is completely unnecessary; just selling into the US isn’t enough for you (or your non-US company) to be subject to US tax. So, this structure is an expensive way to avoid a non-existent problem.
Setting up a US structure
As alluded to above, the easiest and best structure to use here is to operate through a single-member LLC organized in one of the 50 US states. That way, you can operate through a US bank account, which typically makes it easier to accept payments from US clients and connect to payment processing services.
It also provides a liability shield for your business. Only the LLC, and not you directly, would be liable if someone were to sue.
Setting up a US LLC and bank account can be a little tricky. There are lots of little details to get right, and you have to approach a bank in the right way to have any hope of getting a bank account opened in a timely manner.
I’ve set up a ton of these structures.
By using my services, you can concentrate on running and expanding your business while I deal with the minutiae of setting up your legal structure and opening a bank account.
Additionally, I do everything on a fully transparent and above-board basis. Unlike others in this industry, you won’t need to lie to the bank to open an account, and I won’t push useless ancillary services on you.
Recovering US Tax
If you’ve actually paid US federal income tax, you may be able to receive a refund of the full amount you paid depending on your particular circumstances.
To set up a US legal entity or recover US tax you’ve paid, the first step is to have a call so I can answer all your questions and we can discuss your particular situation. We can also chat through Skype instant message if you’d prefer communicating through writing.
Then, after that call, I can provide an exact quote for a flat fee to get your US structure all together and/or help you recover US tax you erroneously paid.
And now for the Audio/visuals
Click here for a discussion of these topics (and more) with me and Kiri Masters of Bobsled Marketing.
Ready to set up your US legal structure and bank account? Book a call so we can discuss your specific situation and I can answer all your initial questions.