- 1 Inbound Transactions & US International Tax
- 2 Nonresident Investment into the United States
- 3 FDAP (Fixed, Determinable, Annual and Periodic)
- 4 ECI (Effectively Connected Income)
- 5 Common Types of Income from Inbound Transactions
- 6 Election from FDAP to ECI for Inbound Transactions
- 7 Form 5472
- 8 FIRPTA & Inbound Transactions
- 9 Inbound Transactions can be Complicated
- 10 About our International Tax Law Firm
Inbound Transactions & US International Tax
Inbound Transactions and US International Tax: When it comes to International Tax and the IRS, most transactions can essentially be broken down into two main categories: inbound transactions and outbound transactions. When US Persons invest outside the United States, that is referred to as an outbound transaction. When a nonresident alien (may include individuals or entities) invests into the United States, it is referred to as an inbound transaction. The focus of this article will be inbound transactions. With the enactment of the TCJA, the rules have changed a bit — but the overall concept remains the same — even though the tax outcome may be a bit different. Let’s review the basics of Inbound Transactions & US International Tax.
Nonresident Investment into the United States
When a foreign person invests into the United States, it is considered an inbound transaction. There are many different types of inbound transactions — and whether or not the specific transaction is taxable will depend on the specific category of income and country of residence. From a baseline perspective, when foreign persons invest into the United States, there are two main categories of income — FDAP and ECI:
FDAP: Fixed, Determinable, Annual and Periodic
ECI: Effectively Connected Income
Depending on what type of category income the investment falls into, will determine what tax implications may be.
FDAP (Fixed, Determinable, Annual and Periodic)
In general, FDAP refers to investment income (Fixed, Determinable, Annual and Periodic). It requires a 30% withholding – unless the nonresident can take a treaty position to reduce the withholding requirement and/or reduce the final tax impact.
ECI (Effectively Connected Income)
ECI (Effectively Connected Income) is treated different. Effectively Connected Income is typically taxed at the same progressive tax rate as a US Person. Unlike the strict FDAP rules, with ECI, the nonresident alien can take deductions/expenses associated with income – which can minimize the income tax consequences.
Common Types of Income from Inbound Transactions
When foreign individuals invest in the United States, typically the sourcing rules go as follows (noting, that there are exceptions, exclusions and limitations)
Dividends are typically considered US source income and taxes are withheld in United States.
Capital gains and source outside of United States for non-US persons.
Real Estate Gains and Rental Income
Generally, real estate is considered to be taxable by the US government and therefore sourced in the US (Capital Gains and Rental Income)
Election from FDAP to ECI for Inbound Transactions
Since FDAP required an automatic withholding of 30% for FDAP, in some circumstances a taxpayer may be able to elect for their FDAP income to be treated as ECI — which then allows them to take certain deductions and apply certain expenses that are not applicable for FDAP.
The IRS Form 5472 refers to information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Depending on the type of entity and types of transactions that the foreign person is conducting inbound into the United States will impact whether Form 5472 is required or not.
FIRPTA & Inbound Transactions
FIRPTA is the Foreign Investment in Real Property Tax Act. The idea behind FIRPTA is that capital gains generated from the sale or transfer of US Real Property Interest is taxable to nonresidents — which is different than the general rule that US sourced capital gains is not taxable to nonresidents. FIRPTA was developed to ensure that the US can collect taxes on USRPI. While FIRPTA it has very specific withholding requirements, there are certain exceptions that may limit or eliminate the need to withhold certain(IRSS)
Inbound Transactions can be Complicated
In conclusion, the tax rules involving inbound transactions can be very complicated. That is because depending on the category of income and status of the taxpayer, it may result in unintended US tax consequences. The nonresident may have various elections available to them – and there are many exceptions, exclusions and limitations to be aware of.
About our International Tax Law Firm
Golding & Golding specializes exclusively in international tax and specifically, IRS offshore disclosure.
Contact our firm for assistance.