How Foreign-Owned U.S. Corporations and Non-Residents Are Affected Under the Tax Reform
Foreign-owned U.S. corporation taxes
There are many foreign-based business owners who are concerned with making the correct decisions regarding the selection of IRS forms. It is advisable to find someone who has experience in this area to help make the proper decisions and help walk you through the process. To get an in-depth understanding it may be a good idea to read through Publication 519 “U.S. Tax Guide for Aliens” on the IRS website. Here are some helpful things to note
With the new 2017 tax legislation, foreign-owned U.S. corporations are generally subject to the federal rate of 21% for income tax, and 3% to 12% or state tax. These corporations are also subject to a statutory withholding tax of 30% on dividends paid to foreign shareholders. However, when paid to those who reside in countries that have income tax treaties with the U.S. that tax rate can be reduced to 5%.
The new tax act brought two aspects what could affect the income tax of foreign-controlled U.S. corporations, one more favorable than the other. On one side, U.S. companies are limited in deductible interest expense for federal taxes. In order to calculate these corporations taxable income, interest expense is only deductible up to 30% of their net income. On the other side, if a corporation’s income contains more than 10% return on its depreciable tangible assets and manufactures products to be sold abroad the corporation could be subject to a 21% federal income tax rate.
Different income tax rules apply to U.S. Corporations that have transactions with foreign entities. For one, All U.S. based companies under foreign control must file an annual report specifying transactions with and payments to their foreign counterparts. Additionally, to determine their federal and state income tax rates they must report the income tax from transactions with foreign affiliates and shareholders. Lastly, under the new tax codes, corporations that belong to multinational groups and have yearly receipts totaling at least $500 million could be subject to a 10% minimum tax if they make deductible payments of purchase depreciable property from foreign counterparts that would otherwise reduce their federal income tax liability below a certain amount.
There are two categories that the IRS uses to tax foreigners living in the U.S. The two distinctions are resident aliens and nonresident aliens. Resident aliens are taxed on income generated in the U.S. and income from foreign sources. They file the same 1040 income tax return as U.S. citizens. Nonresident aliens only pay taxes on income generated in the U.S. and in some cases are exempt from contributing to Medicare and Social Security. They file the 1040NR income tax return.
If you qualify as a nonresident alien, the IRS only requires that you pay income tax on the money that you made in the united states. There are two categories of nonresident income that are subject to U.S. taxes. The first category is ECI(effectively connected income). This would be money made from a job in the U.S. or the profits from a business you run in the U.S.
The second category is FDAP(fixed, determined, annual, or periodical income. This category essentially covers anything ECI doesn’t, such as dividends and interest on investments, alimony, Social Security benefits(85 percent) and even scholarships.
One big difference between the taxes of a resident of the U.S and nonresident taxes is withholdings, deductions, and exemptions. As an example U.S. citizens are required to have income tax withheld from their paychecks while nonresident aliens can submit IRS form W-8ECI to claim some income is connected to (ECI), which is exempt from withholding.
Self-employed U.S. residents are required to pay a self-employment tax in April to cover contributions to Social Security and Medicare. Non-resident aliens are not required to pay the self-employment tax but if they are employed by a U.S. business they will have to contribute to Social Security and Medicare. There are exceptions for foreign researchers and teachers.
Nonresident aliens will complete the 1040NR when it’s time to file for taxes in April. They won’t be able to file as married filing jointly or as head of household. The only available filing statuses will be single, married filing separately, and qualifying widow(er).
Standard deductions cannot be claimed by nonresident aliens although they can itemize deductions related to ECI. Some of the things that will fall into that category are expenses related to a U.S. business, state and local taxes, unreimbursed medical expenses, and charitable contributions. There are some other common deductions that you could claim like IRA contributions, health savings account contributions, moving expenses, student loan interest, and self-employed health insurance premiums. Most of the time nonresident aliens can claim only one personal exemption, but no exemptions for dependents or spouse. Mexican and Canadian residents can claim a spousal exemption as long as the spouse has no earned income. They can also claim all qualifying children and relatives. South Korean and Indian residents can also claim spousal and dependent exemptions in certain cases.
The limits for late filing are tighter for nonresident aliens coming in at 16 months or forfeit all refunds and credits. Whereas U.S. citizens and residents have up to three years to file late.
There are also exceptions with regards to foreign students, employees of international organizations, teachers, trainees, and diplomats and their families to qualify as nonresident aliens including if they spend more than 183 days in the U.S. These visa holders are called “exempt individuals” because they are exempt from counting the days they spend in the U.S. This can be a large tax advantage because as a nonresident alien one only has to pay taxes on income generated within the United States. Also, any scholar, student, teacher, diplomat or trainee holding a qualified visa is exempt from withholding Medicare and Social Security. Those who are self-employed with the same visa are not required to pay the self-employment tax.
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