I quoted 30 per cent and it was a real rate on a real page, just not the one that applied to them

In January a client in Rotterdam asked me what rate the United States would charge on money their US LLC had collected, and I gave a number without asking a second question. The number was 30 per cent. It was a real rate, printed on a real page, and it was the wrong one for their situation by a distance that would have cost them most of a year's profit.

I was wrong because I had put their income in the wrong bucket before checking which one it belonged in. There are 2 buckets and the difference between them is not really the rate at all. The difference is whether you are allowed to subtract anything before the rate touches the money. Once the forms are in, the account comes next, and the US banks in Bank Index each name who supervises them.

So this letter is about that split. It covers the effectively connected income test, the us trade or business definition underneath it, the flat charge on everything sitting the other side of that line, and a 16 month clock that quietly decides whether your deductions still exist. Single member llc foreign owner tax turns on the bucket long before it turns on the rate.

Two buckets, and the rate is the smaller half of the story

Do i pay us tax on my llc as a non resident splits into 2 questions the moment you look at the guidance. The service divides a nonresident's taxable income into income effectively connected with a trade or business in the United States, and US source income that is fixed, determinable, annual or periodical.

For the first bucket the page is 1 sentence long. “Effectively Connected Income, after allowable deductions, is taxed at graduated rates.” Those are the same rates a citizen pays, and the income goes on page 1 of Form 1040-NR.

For the second bucket the sentence is almost as short and considerably less friendly. “FDAP income is taxed at a flat 30 percent (or lower treaty rate, if qualify) and no deductions are allowed against such income.” That income goes on Schedule NEC instead, and the guidance repeats the point elsewhere in 6 words: “Deductions and netting are not allowed against FDAP income.”

Read those 2 sentences next to each other. One bucket taxes profit and the other one taxes revenue.

A business with 100,000 dollars of receipts and 70,000 of costs is looking at 30,000 of profit in the first bucket and 100,000 of exposed gross in the second. That is my arithmetic on their numbers rather than an example from the service, but it is the whole reason the bucket matters more than the percentage does.

Where the line runs

The line is the trade or business test. When a foreign person is engaged in a trade or business in the United States, US source income connected with the conduct of that business is effectively connected income and is taxable there.

For work done by a person rather than by a warehouse, the guidance gives 1 standard and no number to go with it: “the business activities must be considerable, continuous and regular to qualify as a USTB”.

Everything about the us trade or business definition sits in that phrase.

An aside about the three adjectives

I went looking for a threshold under that sentence twice, once in 2023 and once again this week, and the second time I printed the page so I would stop rereading it on a screen. There is no number under it. No count of days, no dollar figure, no list of trades.

My instinct is that the vagueness is deliberate, because a bright line about presence would be gamed inside a quarter by anybody with a calendar and a cheap flight. I would not defend that as more than an instinct. It has nothing to do with what you owe, and I raise it because people keep asking me for the number and I would rather say plainly that none is published than invent a comfortable one.

Anyway, back to what is written down, because more of it is written down than the vagueness suggests.

Two exclusions, stated cleanly

The first is printed in capitals on the page. If your only US business activity is trading in stocks, securities or commodities through a US resident broker or other agent, hedging transactions included, you are NOT engaged in a trade or business there. That one protects a passive investor.

The second runs the other way. If you are a member of a partnership that at any time during the year is engaged in a US trade or business, you are considered to be engaged in one yourself, which catches a sleeping partner who has never been near the operation, has no say in how it is run and may not know which state the partnership files its own return in.

Two further categories arrive whether you want them or not. Gain and loss on the sale of a US real property interest is taxed as though you were engaged in a US trade or business, capital asset or not. Rental income from real property can be treated as effectively connected if you elect that under section 871(d), which is a choice and not an accident. A fourth case catches students rather than owners, because a US source scholarship received by a nonresident student or trainee holding F, J, M or Q status is treated under section 871(c) as connected with a US trade or business, and that has nothing to do with any of this beyond showing how many separate doors open into the same room.

What sits in the flat bucket

The second bucket is wider than most owners expect, and the definitions are unusually plain. “Income is fixed when it is paid in amounts known ahead of time.” “Income is determinable whenever there is a basis for figuring the amount to be paid.” Periodic simply means paid from time to time, and the guidance says outright that it does not have to be paid annually or at regular intervals.

The listed examples run from the obvious to the specific. Dividends, interest, royalties, pensions and annuities, alimony, rents, scholarships, prizes, and compensation for personal services including commissions. Then, further down the same list, purses paid to nonresident boxers for prize fights and prizes awarded to nonresident golfers in tournaments. I enjoy that list more than is reasonable, because somebody clearly had to add each of those lines after an argument.

Two figures on that page are worth carrying in your head. US source FDAP income includes 85 per cent of any US Social Security benefit. And a royalty of 5,000 dollars is FDAP whether it arrives as 10 payments of 500 or as 1 payment of 5,000, which is the service's own example of why the shape of the payment changes nothing.

The 183 days that are not the 183 days you are thinking of

Capital gains have their own rule and it turns on presence rather than on activity. Where a nonresident individual was present in the United States for 183 days or more during the tax year, net gain from sales of capital assets from US sources is taxed at 30 per cent or the lower treaty rate. Net gain here means US source capital gains minus US source capital losses.

Below 183 days there is generally no tax on those gains at all, with 5 named exceptions covering effectively connected gains, timber, coal and domestic iron ore with a retained economic interest, certain contingent payments from patents and copyrights, certain transfers of substantial rights in patents, and original issue discount obligations.

Then comes the sentence I would put on a poster. The guidance says this “is not the same as the 183-day test used in the substantial presence test”. Two rules, the same number, different questions, and I have watched somebody conflate them in a spreadsheet and reach an answer that was wrong in both directions at once.

The 16 month clock nobody mentions

Here is the fact that changed how I answer this question, and it is 3 sentences of ordinary guidance that almost nobody quotes.

“To get the benefit of any allowable deductions or credits, you must timely file a true and accurate income tax return.” Then the definition of timely, which is looser than you would expect and harder than it looks: “For this purpose, a return is timely if it is filed within 16 months of the due date just discussed.” And then the consequence, stated without softening: “The Internal Revenue Service has the right to deny deductions and credits on tax returns filed more than 16 months after the due dates of the returns.”

Sit with what that does to the arithmetic. The first bucket is only better than the second because of deductions. Miss the return by more than 16 months and the service can take the deductions away, at which point income you correctly placed in the graduated bucket starts behaving like the gross one without ever having moved.

The same trap is spelled out for property. If you have no US business activities but elect to treat income from real property as effectively connected, you must file a true and accurate return on time to take any allowable deductions against it. The election is worth nothing on its own. It is worth something only if the return arrives.

Two due dates, and which one is yours

There are 2 deadlines and the guidance sorts you into 1 of them by a test about payroll and premises rather than about residence.

If you are an employee receiving wages subject to US income tax withholding, or you have an office or place of business in the United States, you file by “the 15th day of the 4th month after your tax year ends”, which for a calendar year is generally 15 April. If neither applies to you, you file by “the 15th day of the 6th month after your tax year ends”, generally 15 June.

Most owners I deal with sit in the June group and assume they sit in the April one. That costs nothing when they file early. It costs interest when they do not.

Form 4868 buys an automatic extension of the time to file, and it has to be filed by the regular due date of the return.

An aside about the sailing permit

While I had Publication 519 open I found something that has no bearing on your LLC and which I have not been able to stop thinking about since. Before leaving the country, “all aliens (with certain exceptions) must obtain a certificate of compliance”, popularly known as a sailing permit, obtained by filing Form 1040-C or Form 2063.

I do not know how often that permit is enforced in practice, no figure for it is published anywhere I looked, and I am not going to pretend otherwise. It sits in current guidance with 2 form numbers attached to it, Form 1040-C and Form 2063, and after 9 years of reading this material I had never once heard anybody mention it, which makes me wonder what else is sitting in these pages that nobody quotes. Right, back to the 2 buckets and the money in them.

What I cannot tell you

Whether your particular work amounts to a US trade or business, because no threshold of days, dollars or clients is published anywhere in the guidance I have read, and I am not going to build one out of a phrase that contains 3 adjectives, no number and no worked example. The test is the phrase.

Whether a treaty lowers your rate is the second thing I cannot answer from here. Many treaties reduce or remove tax on capital gains, and Publication 901 carries a table of the ones that exempt Social Security. Yours is 1 of roughly 60 such documents and I have not read it.

Whether the service would accept a late return and leave the deductions alone anyway. People say it happens often enough. I have no source that says so, so I am leaving it as somebody else's claim rather than repeating it as though it were mine.

What I can tell you is what I got wrong in January, and it was not the 30 per cent. I answered a question about a rate when the question underneath it was about a bucket, and the bucket is decided by what the business actually does rather than by where its owner sleeps. The filing side of all this, the pro forma return that a foreign owned LLC has to send whether or not any tax is due, is a separate problem with a separate number attached, and I have written about it elsewhere on this site.