US tax requirements for foreign founders are different from US tax requirements for US citizens and can be confusing. You have to understand the differences in tax filing for US and international profits to effectively file an international business tax return. This article will explain the common tax filing requirements for international founders in different cases. So, how is an international founder eligible to be taxed in the US?
Common Tax Types for International Founders
There are three main tax types for international founders in the US in 2022: the individual income tax, the business income tax, and the payroll tax. The individual income tax is the main source of federal income tax revenue for most people. The business income tax is imposed at the state level and is therefore collected by states. The payroll tax is a tax paid by employees on their income but is not imposed on employers. However, regarding the foreign founders, there are certain types and tax issues that are usually discussed.
Status of Foreign Participants for Tax Purposes
Foreign citizens can have two possible statuses for US federal tax purposes: resident alien or non-resident alien. This status directly affects the details of taxation of income of foreign participants received through an LLC.
Thus, the income of foreign residents is subject to taxation in the general order for all US citizens, that is, on income from activities around the world. Foreign residents are required to report their income (including dividends, wages, service fees, etc.) both in the US and in other countries. Foreign non-residents, in turn, will have to pay taxes only on effectively connected income from sources in the United States (“effectively connected income”) and on a number of other income.
Two tests are commonly used to determine the status of a particular person: the green card test and the substantial presence test. If during the calendar year (January 1 to December 31) a foreign citizen meets the criteria of one of these tests, then he will be considered a foreign resident.
According to the Green Card Test a resident for tax purposes is considered as a resident for tax purpose. The Substantial Presence Test includes counting eligible days in the USA.
Taxation of Income of Foreign Non-Residents
Foreign non-residents are required to pay taxes if they are “engaged in a U.S. trade or business”. All the income they receive from such businesses is recognized as effectively connected income. Participation in an LLC engaged in business in the United States is treated as such involvement on the part of the member.
Legislatively, the criteria for “engaging in business in the United States” are not established. The decision to recognize the activities of a particular organization as involved is made individually. At the same time, judicial practice confirms that the following factors have the greatest weight:
- The company has a “dependent agent” (an employee or entities dealing with the company on an exclusive or near-exclusive basis) in the United States;
- The activity must be regular, substantial, and ongoing (during at least part of the tax year);
- The activity is not secretarial, routine, or casual (for example, forming a company to receive dividends from investments in US companies, paying lawyers or accountants to maintain a company, etc.).
- Examples of activities involved in doing business in the United States would be the provision of services by a person located in the United States or the receipt of income from the sale of movable property in the United States.
The presence of an office, employees (not independent contractors) but persons hired under an employment contract and are subject to be paid for their work in the United States are also factors taken into account when assessing business involvement in the United States. As an international founder, you will be obliged to pay wages ( for example through an online generation of any kind of a pay stub) and carry out other issues related to employees (it can be also done online, for example). As a general rule, when a foreign nonresident engages in business in the US, all income (See 6 CFR § 1.864-4(b)) derived in the US from such activities is treated by the IRS as effectively related income subject to US taxation.
Effectively related income is taxed at the rates applicable to US citizens and foreign residents. Also subject to taxation in the United States is other income of foreign non-residents (Annual or Periodical (FDAP) income or Fixed or Determinable), which includes a large amount of passive income, such as interest, dividends, royalties, income from renting real estate, etc. FDAP tax is fixed at 30%.
Sole Proprietor / Single Owner with a Personal Income Tax Filing Requirement
The filings include the preparation of:
- Rental real estate property according to Schedule E
- Individual tax return according to Form 1040
- According to Schedule B/D the inclusion of income from one brokerage account.
- Foreign Single Owner or (Foreign Single Member LLC)
You will not be required to file 1040NR or pay personal income taxes if you are not considered “Engaged in US Trade or Business”. You are required to pay taxes within the USA case if you have FDAP income. Your filings will include Form 5472 and Form 1120.
- Non-US Multi Owner with US Sourced Income
You will be eligible to fill out the following forms:
- 1040 NR and ITIN to do 1040 NR
- Partnership return preparation according to the Form 1065
- 8813, 8805, and 8804 tax form preparation
- In case you have up to 4 members you will need to fill the tax forms according to the Schedule k-1, K-2, and K-3
- Rental real estate preparation according to the form 8825
This article provides an overview of the US tax filing requirements for international founders. The tax requirements can be confusing, but after reading this article you will be able to prepare your tax forms easily. For more information, read our other articles on the subject.