What is a “foreign corporation” and how is it taxed by the US? A foreign corporation, for US income tax law purposes, is any corporation not organized under the laws of the United States, any state, or the District of Columbia. Income earned by a foreign corporation is subject to US income tax under two circumstances:
First, if the corporation is considered to be engaged in a US trade or business, the net income of the corporation that is “effectively connected” with a “US trade or business” (USTB) is taxed at normal corporate income tax graduated rates on a net basis. This means after deduction of relevant expenses and the like. The current maximum income tax rate is now 35%.
Second, if the corporation earns US source income that is not treated as “effectively connected” with a “US trade or business” it is usually taxed on a gross basis. This tax is at a flat 30% withholding rate (or lower Treaty rate). Withholding at source is done by the US payor of the income and the funds are subsequently paid over to the IRS.
Tax Planning :
When a foreign corporation engages in US activities, it is often difficult to successfully argue that a US trade or business does not exist. Since this is generally the case, what can be done to minimize the US tax bite?
Certain planning techniques are available. It may be possible to structure the profits received by the foreign corporation to yield income that is not treated as being derived from “US sources” (thus, relieving the tax burden). Other tax planning techniques are available to segregate foreign and US activities to limit taxation only to the profits earned on the US activities. These techniques may also help shield the foreign corporation’s books and records from IRS scrutiny. In all cases, careful planning is required to optimize the best tax strategy in each particular instance.
Tax Filings :
Finally, in addition to any tax returns, when a foreign corporation is engaged in a USTB, certain information filing may be required with the US tax authorities as well as compliance with certain record maintenance and book-keeping rules. See e.g., Form 5472 . You can learn more about the Form 5472 filing rules at my blog posts here and here. If you should have filed the Form, but did not, you can be subject to a penalty of $10,000. Since noncompliance can result in stiff penalties, it is always best to get the full picture from a qualified tax professional before expanding an overseas business into the US.
Services we offer :
- Name Availability Search
- Preparing Foreign Qualification Documents
- Registered Agent Service
- Planning to Develop Business Operations