Mastering the Effectively Connected Income Rules for Foreign Persons Engaged in Inbound Transactions

Description

Nonresident foreign persons with economic activity in the United States are generally subject to U.S. income tax only on income they receive that is U.S.-sourced; this income is categorized as either income effectively connected with a U.S. trade or business or FDAP income. Because the tax rates, reporting mechanics, and withholding requirements are different for ECI than for FDAP, tax professionals must become familiar with the ECI rules to avoid paying unnecessary tax and penalties.

Income that is considered ECI receives more favorable tax treatment than FDAP income. Income that is considered “effectively connected” with a U.S. trade or business is taxed at graduated rates on a net income basis according to IRC Section 871(b). The definition of ECI is broad, and includes numerous special exceptions, rules, treaty applications and elections. Failure to classify eligible income as ECI is a costly mistake for tax advisers.

Income that qualifies as FDAP is subject under Section 871(a) to a flat 30% on gross receipts without any allowance for deductions. Additionally, FDAP income is subject to withholding requirements. Failure to remit withholdings on nonresident FDAP income can lead to significant penalties for the withholding agent and the taxpayer.

Listen as our experienced panel provides in-depth guidance on the ECI rules, and gives detailed best practices on available elections and other planning and reporting mechanics.