International Tax
International tax involves the taxation of U.S. taxpayers with foreign activities, and foreign persons or entities with income-generating activities within the U.S. International business transactions have increased rapidly with economic expansion and the growth of new markets. The tax consequences associated with such transactions are complex and require consideration of U.S. tax laws, foreign tax laws, and international tax treaties.
The United States generally taxes U.S. citizens, residents, and corporations on their worldwide income. Although U.S. entities doing business abroad have many forms and structures, the most typical entity conducting business outside the United States is through a foreign corporation (a corporation organized in a foreign country).
Prior to 1962, taxpayers were able to defer the payment of taxes through the use of a foreign corporation. U.S. taxpayers conducting a foreign activity through a foreign corporation generally paid no U.S. tax on the income from such activity until the corporation repatriated such income by paying a dividend. In 1962, a complex body of tax laws was enacted to limit the deferral of taxes for domestic shareholders of foreign corporations. A foreign corporation's U.S. shareholders will be subject to U.S. tax on certain income items of the foreign corporation, if it is considered a controlled foreign corporation under the U.S. tax law. A foreign corporation is a controlled foreign corporation if on any day during the foreign corporation's taxable year; U.S. shareholders own more than 50% of the total combined voting power of all the voting stock or the total value of the stock. U.S. shareholders include U.S. citizens, residents, partnerships, or corporations.
Essentially, the law provides that U.S. shareholders of controlled foreign corporations are required to report their pro rata share of what is termed the corporation's "subpart F income." Subpart F income (named for a particular section of the tax code) includes foreign base income that is relatively movable from one country to another and that is subject to a low rate of foreign tax. Such income includes, but is not limited to, insurance income, sales income, and services income.
The laws governing U.S. taxation of foreign corporations conducting business within the United States are also very complex. Income earned by a foreign corporation is subject to U.S. income tax if the income is considered U.S. source income. The term "source income" refers to where the income is earned, as determined by the U.S. tax code. Generally, income is U.S. source if the income was derived from sales or services performed within the United States or from the rental or disposition of tangible property located within the United States.
The amount of U.S. tax imposed on foreign taxpayers with U.S. source income depends on whether the income is effectively connected with a U.S. trade or business. If it is, the net income is taxed at graduated rates the same as a domestic corporation; if it is not (generally U.S. source investment income), the gross U.S. source income is taxed at a high fixed rate. Effectively connected income refers to income generated by U.S. trade or business activities.
U.S. citizens or permanent residents living abroad are also subject to U.S. tax on their worldwide income. U.S. taxpayers working or living abroad will also most likely be subject to tax in the foreign country. The U.S. tax law provides an exclusion for certain foreign earned income for U.S. citizens or permanent residents working abroad to mitigate the effect of double taxation. The foreign earned income exclusion is limited an inflation-adjustable fixed amount plus certain foreign housing costs in excess of a stated amount.
U.S. individuals and corporations subject to double taxation may also qualify for a foreign tax credit.
Foreign nationals who are considered resident aliens for U.S. tax purposes are also subject to U.S. tax on their worldwide income. Generally, a foreign national is considered a resident alien for tax purposes if that individual resides in the United States for a period in excess of 183 days. With the exception of the years of entry and departure, such resident aliens are taxed the same as U.S. citizens.
Foreign nationals who are not residents of the United States are considered nonresident aliens for tax purposes. Such nonresident aliens are subject to U.S. tax on U.S. source income. U.S. source income would include such items as compensation for services performed in the United States, rental income from property located in the United States, and the gain from the sale of real property located in the United States.
The United States has income tax treaties with a number of foreign countries. Under these treaties, residents of foreign countries may be taxed at a reduced rate or may be exempt from income taxes on certain items of income they receive from sources within the United States. These reduced rates and exemptions vary among countries and specific items of income. However, the U.S. tax code will apply in the absence of a treaty or applicable treaty provision.
Worksheet: International Business Plan
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