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UNITED STATES
Taxation of Nonresident Entities
Taxation of Groups of Companies
Corporate Assessments and Payments
Personal Assessments and Payments
The United States consists of fifty states, the District of Columbia, and a number of possessions and territories. The gross area of the states is about 9.4 million square kilometers (3.63 million square miles). The population of the United States is approximately 258 million.
Governments exist at the federal, state, and local levels. Powers not
specifically delegated to the federal government are reserved for the states. Federal
powers are exercised by three independent branches: executive, legislative, and judicial.
Departments and agencies assist the president, who is the chief executive of the executive
branch. The federal legislature (Congress) is composed of two chambers, the Senate and the
House of Representatives. The Supreme Court and lower tribunals make up the judiciary.
State governments have structures similar to that of the federal
government. Local governments primarily manage such basic activities as fire and police
protection, utility and traffic services, and education. Foreign investors must be aware
that, in addition to federal laws, they may be subject to state and local laws, which
often regulate business activity and impose taxes and will affect the choice of location
of a business.
Deloitte & Touche, the Deloitte Touche Tohmatsu International member
firm in the United States, provides tax, accounting, auditing, and consulting services
through 19,000 professionals serving clients in more than 100 US markets. The firm has
specialists in over twenty industries (including such fields as health care, insurance,
banking, and energy), who are available to discuss the ramifications of particular
investment strategies.
Audit Services: Robert Garland, Wilton
International Services: Robert A. Campbell, Wilton
Management Consulting Services: Pat A. Loconto, Wilton
Tax Services: Jerry P. Leamon, Wilton
Telephone: +1 (203) 761-3000
Telecopier: +1 (203) 834-2200
Forms of Business Organization. The principal forms of business entities are the corporation, limited liability company, partnership, limited partnership, branch of a foreign corporation, and joint venture. Most foreign investors starting a business in the United States form corporations. The next most common form is the branch; however, joint ventures are gaining popularity.
Corporations are subject to corporate income tax. However, some special
purpose corporations may not be subject to corporate income tax or may be subject to tax
at reduced rates.
A partnership is not taxed on its net income but serves as a conduit
through which income or loss is passed to the individual partners. Each partner is subject
to income tax on a proportionate share of partnership earnings, whether or not these
earnings are distributed. In addition to legal partnerships, US tax law treats as a tax
partnership any syndicate, group, pool, joint venture, or other organization that lacks
two of the following four corporate characteristics: limited liability, continuity of
life, free transferability of interest, and centralized management. Many limited liability
companies are structured to lack two of the corporate characteristics and are also treated
as partnerships.
Exchange Controls. The United States does not apply exchange
controls or restrictions on any types of inbound or outbound payments, except those
involving a brief list of specified countries. US currency is freely convertible into
foreign currencies without restriction, but the Treasury Department requires notification
of currency transfers above a certain amount. Profits, dividends, interest, royalties, and
other income may be transferred to foreign investors without restriction. Investments may
be repatriated without restriction.
Local Participation Requirements. Although no general laws restrict
direct investments in or acquisitions of securities by foreigners, there are many
industry-specific laws. For example, under federal law, aliens and foreign-owned
corporations are prohibited from holding radio or television broadcasting licenses. For
these purposes, a corporation is considered foreign owned if more than 20% of its capital
stock is owned by aliens, a foreign government, or a foreign-registered corporation. The
following industries are restricted to varying degrees, depending on the importance of the
industry to the nation's security: communications, defense contracting, air transport,
coastal and freshwater shipping, fishing, atomic energy, hydroelectric power, mining on
government property, and banking.
Investment Incentives. State governments compete vigorously for
foreign investment and may offer financial assistance to encourage development. About half
of the states have state-chartered development credit corporations offering loans. Loan
guarantees from municipal organizations are often coupled with state or federal aid and
may, conditionally, guarantee up to 90% of the value of loans to businesses made by
private financial institutions.
State and local governments issue industrial development bonds at
attractive interest rates and use the proceeds to build industrial facilities, which are
then leased to businesses at below-average costs. In addition, state and local
institutions may be available to assist in market analyses, feasibility studies, joint
venture partnership searches, and recruiting management.
There are no direct federal tax incentives designed specifically to
stimulate foreign investment. Click here for information on Tax
Credits. Also, the United States has nearly 200 foreign trade zones, through which
goods may be imported, exported, assembled, or manufactured free of US customs duty. In
addition, some states provide tax incentives, which may include exemption from or reduced
assessments of property taxes, exemption from sales tax, liberal rules for tax
deductibility of expenses, and incentives to encourage research and development.
The US government offers export incentives under a variety of programs,
mostly through the Department of Commerce. However, the Department of Defense provides
incentives for the export of military equipment, and the Department of Agriculture
provides incentives for the export of agricultural products. Export credit insurance is
available from the Foreign Credit Insurance Association and the Export-Import Bank of the
United States (Eximbank). Export credit is also available from the Eximbank.
All corporations organized in the United States, with a few exceptions, are subject to corporate income tax as domestic corporations. Click for information on Forms of Business Organization. Income tax is levied at the federal level, as well as by most of the states. Click for information on State and Local Taxes.
Corporate Income Tax Rates. Corporate
income tax rates. Rates on retained and distributed profits are the same. For
corporate taxable income between US$100,000 and US$335,000, there is an additional 5% tax.
Corporations with taxable income of more than US$15 million must pay an additional 3%
surtax on the excess or US$100,000, whichever is less. These surtaxes effectively phase
out the benefit of the graduated rate brackets so that, for example, corporations with
income between US$335,000 and US$10 million pay tax at a flat 34% rate.
Alternative minimum tax (AMT) is intended to ensure that
a taxpayer cannot avoid all tax liability by using excessive deductions, exemptions, and
credits. Essentially, AMT is a separate tax imposed on certain types of income and
deductions. A taxpayer must pay AMT if AMT exceeds the regular tax. Certain items of
income and expense, designated as tax adjustments or tax preference items, may result in a
corporation's being subject to AMT. AMT is computed by recalculating taxable income
according to the tax adjustments and tax preference items to determine alternative minimum
taxable income (AMTI). An exemption against AMTI of up to US$40,000 is allowed. (The
exemption phases out as AMTI increases from US$150,000 to US$310,000.) The corporate AMT
rate is 20%; certain credits may reduce the tax.
Corporations with AMTI over US$2 million pay an additional environmental
tax at a rate of 0.12% on the excess over US$2 million. The tax is imposed regardless of
whether the corporation must also pay AMT. The US Internal Revenue Service (IRS) may
impose an accumulated earnings tax at 39.6% on earnings accumulated beyond the reasonable
needs of the business.
Taxable Income. Taxable income is determined by subtracting
allowable deductions from gross income. As a rule, gross income includes all income from
any source, unless the law specifically provides otherwise; in cases of doubt, items are
includible. In addition to gross profit from operations of the corporate business, gross
income also includes rents and related payments, royalties, most types of interest, dividends, and gains from the sale of
capital assets and a multitude of items considered other income. A few examples
are income from discharges of indebtedness, recoveries of previously claimed deductions
for bad debts or taxes, prizes, and damages for patent infringement.
Deductions from gross income. A deduction is permitted for ordinary
and necessary expenses paid or incurred during the tax year in carrying on a trade or
business. Even if an expenditure is both ordinary and necessary, other questions must be
considered. For example, an expenditure that increases the life of property or its value
will be considered a capital expenditure and therefore nondeductible. This kind of cost
may be recovered through accelerated cost recovery deductions, analogous to depreciation.
Deductions must be specifically provided for in the law to be allowed. The
rules under which items are deductible are not necessarily the same as the rules under
which income items become income. That is, a deduction can be unavailable to a payer even
though the recipient is taxed on the income.
Accounting methods. On their first tax returns, taxpayers can adopt
any of the following accounting methods: cash method, accruals method, installment method,
or percentage-of-completion method. Once a method has been selected, a change requires
prior IRS approval. Use of the cash method is limited to individuals and certain types of
business entities. Most corporations use the accruals method. Businesses that have
inventories must use the accruals method. A dealer regularly selling personal property on
the installment plan may not elect the installment method. Income from a construction
contract that extends for more than one year from the date of the contract's execution
must be reported under the percentage-of-completion method.
Accounting for inventory. Businesses that sell property must keep
inventories. In general, inventory must be consistently valued under a method that
conforms as nearly as possible to the accounting practice in the trade or business that
best reflects income. Inventories of manufacturers and retailers must include direct and
indirect costs taken into account under uniform capitalization rules. Wholesalers and
retailers must include in inventory, not only the direct cost of acquisition of goods, but
also allocated indirect costs of acquisition, repackaging costs, assembly or other
processing costs, storage costs, and the general and administrative costs allocable to all
of those functions.
Inventories must generally be valued at cost, but the lower of cost or
market value may be used if the proper procedure is followed. An important feature of US
tax law is the availability of the last-in, first-out (LIFO) flow-of-cost assumption. In a
period of rising prices, first-in, first-out (FIFO) tends to show increased earnings,
while LIFO shows a decrease. LIFO is available to financially consolidated corporate
groups only if it is used in the parent's financial statements as well.
Capital gains. Capital assets are
property held by the taxpayer, not including stock-in-trade of the taxpayer, inventory,
copyrights held by the creator, depreciable assets, or receivables. Patents held for
investment and goodwill in the sale of a going business are capital assets. Although a
gain on a sale of a capital asset is a taxable gain, a loss from such a sale is not
recognized for tax purposes unless the property was held for the production of income.
Shares of stock and securities generally are considered to be held for production of
income, so a loss on their sale is a capital loss, and a gain or loss on an option to buy
or sell them is a capital gain or loss. If a business is sold, each business asset
(including goodwill) is considered separately in determining its capital asset status.
Even though the Tax Reform Act of 1986 eliminated the tax break on gains
from long-term capital assets, assets are still classified as either short- or long-term.
If an asset is held one year or less, the gain or loss is short-term; if it is held over
one year, the gain or loss is long-term.
Net capital gains are taxable at normal income tax rates. Typically, a gain
is computed as the difference between the disposal price of the asset and the tax basis
(usually, cost less depreciation). The basis is increased for capital expenditures, such
as improvements to the asset or purchase commissions for the asset. The basis is decreased
for depreciation and returns of capital. The basis is never adjusted to below zero.
A capital gain or loss is computed by separating short-term capital asset transactions from long-term capital asset transactions and adding (netting) all short-term transactions separately from long-term transactions. The gain or loss from all capital asset transactions is then netted, and the result is added to other income. Capital losses may fully offset capital gains. If a taxpayer disposes of depreciable capital property, part of the gain may be treated as ordinary income; the cost of property that is deducted as a depreciation expense is recaptured as ordinary income.
Capital gains or losses on some types of transactions, such as corporate reorganizations, may be deferred to a later date. Another transaction qualifying for a nonrecognition exception is the exchange of like-kind properties held for productive use in a trade or business or for investment (other than property held primarily for sale; stock-in-trade; and stocks, bonds, and similar instruments). Gains from involuntary conversions, such as the condemnation or destruction of property, are not currently taxed if the proceeds are reinvested in similar property or property related in service or use to the converted property within a required period.
The Foreign Investment in Real Property Tax Act of 1980 serves to tax any
disposition of a US real property interest (USRPI) by a foreign owner, regardless of
whether the disposition is connected with a trade or business. The disposition is taxed
even when the foreign owner has no other US ties. The tax rates are the same as those that
apply to US citizens. A USRPI is broadly defined and includes such interests as leases and
property held by partnerships, trusts, and estates. In some cases, a partnership interest
may be a USRPI. Any domestic corporation is subject to a test to discover whether it may
be a US real property holding corporation (USRPHC) and whether its stock may therefore be
considered a USRPI. It may be so considered unless the taxpayer can prove otherwise or
unless the corporation's stock is publicly traded and the stock seller is not a 5% owner
of the corporation.
Specific rules govern the nonrecognition of gains during otherwise tax-free
reorganizations in which stock or assets are transferred to foreign corporations. In
general, these transfers are taxed. Exceptions apply in narrow cases. A gain may not be
recognized if assets such as stock or securities are transferred; property is transferred
between a US corporation and a foreign corporation for use in the active conduct of
business; or certain partnership interests, foreign currency, certain intangibles, or the
assets of a foreign branch are transferred.
Under certain conditions, a taxpayer engaging in an outbound transfer must
enter into a "closing agreement" with the IRS, under which a transaction that
would otherwise be a taxable outbound transfer will receive tax-free treatment if no
further ownership changes take place during a five- or ten-year holding period after the
closing agreement.
Allowable Deductions. Some deductions that require special tax
treatment are:
Depreciation. The depreciation deduction
for property acquired after 1986 is based on the modified accelerated cost recovery system
(MACRS). Under the MACRS, property is subject to recovery of capital costs over a number
of years, varying depending on the type of property. Click
to see MACRS Depreciation Methods Personal property is generally deemed to be
placed in service as of the middle of the tax year (the half-year convention), and
depreciation deductions are prorated accordingly. If more than 40% of the property placed
in service in a particular year actually goes into service in the last quarter of the
year, the half-year convention is abandoned and property is deemed to be in service as of
the middle of the quarter in which it actually went into service. The mid-month convention
applies to most real property; property is treated as placed into service or disposed of
on the midpoint of the month in question.
The MACRS rules allow taxpayers to expense US$17,500 of personal property
capital additions each year per taxpayer or corporate group. These provisions effectively
permit many smaller businesses to write off the additions in the year in which they are
acquired, thus saving on paperwork.
Research and development costs. Research and development (R&D)
costs may be either capitalized or currently deducted regardless of where they were
incurred. The taxpayer can make a written election to amortize R&D costs ratably over
sixty or more months. Personal property used in connection with R&D will be
depreciable over five years based on the MACRS.
Incremental research expenses over the average expenses in a base period
may qualify for a 20% tax credit that may not exceed the tax before credits. This credit
expires 30 June 1995.
Amortization. The cost of patents, trademarks, franchises, and other
intangible assets (such as purchased goodwill) is amortizable, but
the cost of such items is recoverable only on a straight-line basis over a fifteen-year
period.
Depletion. Depletable assets, such as iron, oil and gas, coal, and
timber, are subject to an allowance for depletion under either the cost or the percentage
method. The cost method allows a deduction for each unit extracted and sold during the
year; the per-unit deduction is based on the cost of depletable assets (adjusted for prior
depletion deductions) at the beginning of the year, divided by the estimated number of
units remaining in the asset. The percentage method provides deductions based on a
specified percentage of the gross income derived from the property during the tax year
(varying, depending on the asset). The deduction cannot exceed 50% of the taxable income
from the property before depletion, nor may it, in certain instances, exceed 65% of
taxable income from all sources. However, amounts exceeding the 65% limit may be carried
forward.
Taxes. Corporations may deduct various taxes
paid to federal, state, local, and foreign governments in the ordinary course of-and
directly attributable to-a business. The common taxes deductible from gross income for
federal purposes are state and local income taxes, real property and personal property
taxes, and employment taxes. With regard to foreign income taxes, it is often more
advantageous to use the foreign tax credit than to claim
a deduction for the tax paid. Federal income taxes are not deductible, but corporations
may deduct federal taxes on payroll.
Organization and reorganization expenses. Expenses related to
incorporation, including the expenses of temporary directors, organizational meetings,
incorporation fees, and fees for accounting and legal services, must be capitalized. The
corporation may make a written election to amortize its organization expenses (and some
types of start-up expenses) ratably over at least sixty months. Taxpayers that do not
elect to amortize these expenses in the year that they are incurred may deduct them only
when the corporation is dissolved. Reorganization expenses, unlike organization expenses,
are not deductible or amortizable. Legal expenses that do not fall into the categories of
organization or start-up expenses are generally deductible.
Dividends. A domestic corporation may, with
limitations, deduct from gross income 70% of the dividends it receives from taxable
domestic corporations. This is known as the dividends-received deduction. If dividends are
received from a 20%-owned (or more) corporation, an 80% deduction is allowed, subject to
the same restrictions. When a corporation receives dividends from members of an affiliated
group, Click for information on Tax Treatments of Group
Companies it may enjoy a 100% deduction.
Interest. An accruals basis corporation generally deducts interest
as the interest accrues for the year; a cash basis corporation deducts interest only when
it is paid but can deduct currently only that portion of prepaid interest attributable to
its current year. Interest on a debt incurred to purchase or to continue to hold
tax-exempt securities is not deductible. Financial institutions are subject to special
rules governing the treatment of expenses when tax-exempt income is earned. The IRS may
challenge payments representing interest when the underlying principal assumes the
character of equity, rather than debt. No fixed guidelines are provided to distinguish
between debt and equity, but taxpayers may be guided by cases and IRS rulings affecting
other taxpayers. Recent changes to the law affect the deduction of interest paid to
related parties, especially foreign parties.
Royalties. Royalties are generally deductible, but those paid to
related parties may be challenged if they do not meet the arm's-length principle.
Bad debts. An ordinary deduction is allowed for specific bad debts
that become worthless or partially worthless during the year. Reserves for bad debts are
not permissible for tax purposes.
Charitable contributions. Charitable donations in cash or property
to qualified domestic charities or government bodies are deductible, generally up to 10%
of the corporation's taxable income before allowance of the deduction for contributions.
Excess contributions may be carried forward for five years. An accruals basis corporation
may deduct contributions authorized by its board of directors within the taxable period
and paid within two and one-half months after the end of the tax year. Substantiation
rules apply to contributions of US$250 or more.
Entertainment expenses. Entertainment expenses are 50% deductible if
the taxpayer can substantiate that it actually conducted business while entertaining and a
principal purpose of the meeting is the expectation of income or other specific benefits
and not mere goodwill. Business meals are also 50% deductible. Business gifts are
deductible up to US$25 per individual recipient. No limit applies if the gift is made to a
business or corporate entity. Receipts are necessary for expenses over US$25.
Rents. Rental payments made for property used in a taxpayer's trade
or business or for investment are deductible. Rent paid in advance for more than a
twelve-month period is not fully deductible in the year of payment regardless of the
accounting method used. The recipient, however, is taxed on the advance rent actually
received. A tenant is allowed a full deduction on a current basis for payments to cancel a
lease.
Pension and profit-sharing plans. Many businesses maintain pension
and profit-sharing plans. Contributions to qualified pension or profit-sharing plans (as
designated by the IRS on meeting certain standards) are deductible within limits. No tax
is due on employer contributions, and the income earned and accrued on employees' behalf
by the pension and profit-sharing fund is not taxed to the employees or the fund. If the
plans are not qualified, an employer may not claim a deduction until the employee reports
income, and employees must report as current income any contributions made by the employer
under the plan as long as the employees' rights are nonforfeitable, even though
distributions have not yet occurred.
Employee compensation and fringe benefits. All compensation paid or
incurred that is reasonable in terms of the services performed is deductible. Many
employers provide employees with health, accident, and group term life insurance;
discounts on merchandise purchased from the employer; and similar noncash benefits. The
related expenses are normally deductible by the employer and not taxable to the employee.
Losses. Losses are deductible in the year in which they are
sustained to the extent of the adjusted basis of the property (generally, to the extent of
the depreciated value). The loss deduction must be reduced if it is compensated for by
insurance or otherwise. Worthless securities of unaffiliated corporations are treated as
capital losses on the last day of the tax year of worthlessness. Worthless securities of
affiliated corporations are treated as an ordinary loss if more than 90% of the gross
receipts of the affiliate is from other than passive sources.
Insurance. Insurance premiums for protection of business property
against fire, theft, and other such hazards are deductible. If they are paid to a related
party, however, the IRS will challenge the deduction.
Repairs and maintenance. All repair and maintenance expenses can be
deducted. Expenditures that add to the value or useful life of the property are not
deductible on a current basis but must be capitalized and depreciated over the life of the
asset.
Tax Credits. Tax credits may be used to
offset taxes payable, dollar for dollar.
Foreign tax credit. A US corporation with
foreign-source income, such as income from branches or foreign subsidiaries, will
generally pay income tax on that income in foreign countries. The US corporation has the
choice each year either to deduct the foreign taxes paid as an expense or to use them as a
credit against US income tax. Usually, the tax credit is more beneficial.
Credit against US income tax is allowed for all income tax, war profits
tax, excess profits tax, and comparable taxes paid or accrued during a tax year to any
foreign country or US possession, with a short list of excepted countries. A US
corporation is also entitled to a credit for a share of foreign income taxes paid by
foreign companies of which it owns at least 10% of the voting shares. That credit is
allowed when the earnings taxed in the foreign country are distributed to the parent as a
dividend.
The amount of creditable foreign tax must be converted to US dollars for
tax credit purposes at the rate of exchange prevailing on the day that the foreign tax is
paid. Accrued foreign taxes are generally converted at the exchange rate in effect on the
last day of the tax year. This amount is adjusted if the exchange rate differs when the
tax is actually paid.
The foreign tax credit for any year cannot exceed the amount of foreign tax
paid or accrued. Separate limitations are imposed on foreign tax credits arising from
taxes imposed on different foreign income sources (the foreign income
"baskets"): passive income; certain interest income; financial services income;
certain shipping income; dividends from each "noncontrolled" corporation (10% to
50% owned); dividends from domestic international sales corporations; certain foreign
trading income; foreign oil and gas extraction income; certain income from US possessions;
and, finally, foreign income from all other sources. The limitation for each basket is
computed as follows:
The limitation for the foreign tax credit is determined by dividing total foreign-source
taxable income by worldwide taxable income, then multiplying the result by the U.S. in
come tax before the credit.
Any part of the credit that cannot be used because of the overall limitation may be carried back two years and forward five years.
The geographic source of gross income for the limitation is determined by specific rules.
In determining taxable income from foreign sources, all expenses directly related to
foreign gross income are deducted from that income. When computing the credit limitation,
losses in one country reduce income from others within a specific basket. Generally, the
IRS will closely scrutinize any procedure that tends to allocate income to foreign sources
and deductions to US sources (thereby increasing the allowable credit). A foreign tax
credit on income from the extraction of oil and gas follows special rules.
Targeted jobs credit. A targeted jobs credit creates the incentive to employ
individuals in high unemployment categories. The credit is calculated by applying a 40%
rate of credit to the first US$6,000 in wages paid to each qualifying employee in the
first year of employment. The credit reduces the deduction for wages.
Research and experimentation credit. The research and experimentation credit
applies to 20% of incremental research expenditures above the average in a base period
(generally, the preceding three years). Qualifying expenditures include certain in-house
costs, plus 65% of contract research (performed by a university or a research firm), but
do not include overhead costs. The credit is also available for grants for basic research
to qualified educational institutions and other scientific research organizations, subject
to limits. An amount claimed as a credit reduces the amount claimed as a deduction, unless
the taxpayer elects to reduce the credit by half of its tax effect.
Tax Treatment of Net Operating Losses. When allowable deductions exceed gross
income, the excess is termed a net operating loss (NOL). NOLs may normally be carried back
three years to recoup prior years' taxes, and any excess may be carried forward for as
many as fifteen years to reduce future taxes. In special cases, the carryback period may
be longer than three years. The taxpayer may irrevocably elect to forgo the entire
carryback period.
Numerous technical adjustments must be made in determining the amount of NOL that can be
carried forward or back and the amount of the income against which it may be applied. If
there is greater than 50% ownership change in a loss corporation within a three-year
period, an annual limit on the use of NOLs, based on a fraction of the company's value, is
generally imposed. This significantly limits the possibility of abusive tax situations
involving "shell corporations" with unused losses. Special rules apply to groups
filing consolidated returns.
A corporation may carry a capital loss back to each of the three years prior to the loss
year; any remainder may be carried forward for only five years. For corporate taxpayers,
capital losses may be used only to offset capital gains. If a group of companies files a
consolidated return, capital gains of one company may offset capital losses of another
company within the group, subject to complex limitations regarding capital losses.
Taxation of Nonresident Entities
Non-US entities (including corporations organized outside the United States) are generally subject to US tax on income from US sources and from US business operations only. Undistributed non-US income of certain foreign companies may be taxed to US shareholders under tax-haven provisions. US tax law distinguishes between a non-US entity's trade or business income, which is computed on a net basis (after subtracting allowed deductions) and its US-source passive income, which is taxed on a gross basis. The US tax rate on gross income is 30%, which may be lowered for particular income by applicable income tax treaties. A non-US entity with both kinds of income must segregate them and pay tax on both bases at the same time. The gross basis tax is normally imposed by withholding.
When a tax treaty is in effect between the United States and the investor's
home country, the United States will tax the business profits of the investor only if the
investor has a permanent establishment in the United States, as defined in the treaty. In
any treaty, the term will include a fixed place of business (office, branch, factory, and
so forth) and an agency under which the agent has authority to execute contracts on behalf
of the investor. In many treaties, an agent that has a stock of merchandise from which he
or she regularly fills orders will constitute a permanent establishment. If the foreign
investor does have a permanent establishment in the United States, the profits
attributable to it must be determined. Under virtually all of the treaties, the profits
that the permanent establishment or branch would have earned if it were an independent
entity dealing at arm's length with its head office will be attributed to it. In most
recent treaties, US tax may apply to profits that may be derived in part from sources
outside the United States. Under some older treaties, tax in no event applies to any part
of the permanent establishment profits that is derived from non-US sources.
In the absence of a treaty, a non-US corporate entity is subject to US tax
on business income considered to be effectively connected with the conduct of a trade or
business within the United States and on US-source income. The concept of engaging in
trade or business would seem to imply more or less continual, rather than isolated,
transactions, but there are no precise guidelines and, court decisions to the contrary
notwithstanding, the IRS is likely to regard even minimal US activity on the part of a
non-US entity as engaging in trade or business. Specific laws relate to income from sales
by foreign persons of personal property attributable to an office or other fixed place of
business in the United States. (The term office or other fixed place of business closely
parallels the term permanent establishment.) Under the general rules defining effectively
connected income, income from such sales of personal property is considered effectively
connected and will be subject to US tax; however, US tax on income from sales of personal
property will not be imposed when property is sold for use outside the United States and a
non-US office participates materially in the sale.
A non-US taxpayer is allowed the same deductions as a US one. For the most
part, the deductions are allowed in the same amounts and are computed in the same way as
they are for a US entity. (There are some limits on deducting accrued expenses until they
are actually paid.) The interest deduction, however, is different. A non-US entity's
interest deduction is not the amount of interest paid or accrued by the US trade or
business. Rather, it is a proportionate amount of the entity's worldwide interest expense.
This can be either more or less than the interest actually paid by the US business.
Foreign companies that operate businesses in the United States must, in
addition to the normal corporate income tax, pay an additional branch profits tax on the
"dividend equivalent amount," essentially a calculation of profits after income
tax. This tax can be deferred if the profits are reinvested in the US business. The rate
is 30%, but treaties can reduce it to the rate for intercompany dividends. To benefit from
a treaty's modification of the branch profits tax, a foreign company must be a qualified
resident of the foreign country that is party to the treaty or must meet other objective
tests.
Both the interest paid and the interest expense allocated to a branch for
deduction purposes (the two numbers may not be the same) are in most cases considered
US-source interest, subject to a withholding tax of 30%, unless a lower treaty rate is
available. As with the branch profits tax, there are limits on when a foreign company can
use a treaty to reduce this tax.
Taxation of Groups of Companies
A group of domestic affiliated corporations that meets certain ownership requirements may file a consolidated tax return that combines the separate taxable incomes or losses of the corporations in the group while eliminating the results of intercompany transactions (including dividends). Once a group files a consolidated return, IRS approval is required to discontinue consolidated filing. To file a consolidated return, a group of affiliated corporations must meet two requirements:
1. A US common parent corporation must own directly at least 80% of at
least one other corporation includible in the affiliated group.
2. Each subsidiary corporation in the affiliated group must be at least 80% owned directly by one or more of the other corporations in the group.
Extensive rules exist for the computation and allocation of tax attributes
such as NOL carryforwards and foreign tax credit carryforwards to members of a
consolidated group. Other rules assist taxpayers in calculating the respective stock bases
of parent companies in subsidiary companies and in calculating the earnings and profits of
the members and the group.
Transactions between related parties must take place at arm's length.
Congress and the IRS have imposed additional reporting and disclosure requirements with
regard to related parties, and the penalties for noncompliance are significant. The IRS is
expanding the number of audits and lawsuits involving intercompany pricing matters. In
addition, deductions for certain types of expenses between related parties, especially for
interest, have been restricted.
Annual information returns reporting the names, principal places of
business, nature of business, and countries of organization of related corporations, as
well as the nature and amounts of transactions between the reporting corporation and the
related corporations, must be filed by domestic corporations that are 25% or more owned by
foreign entities and foreign corporations doing business in the United States. Amounts
owed to a related foreign person that would constitute a deduction from taxable income on
the accruals basis may not be deducted by the US taxpayer that owes the amount until they
are actually paid or until the related foreign recipient reports the payment as
effectively connected income, whichever comes first.
Interest paid by a corporation, directly or indirectly, to a related party
is potentially limited to a percentage of the corporation's income. Interest above this
limit is not currently deductible if it is eligible for US tax exemption or reduction
under a treaty (or is otherwise exempt) and the corporation's net interest expense exceeds
50% of its adjusted taxable income. This limitation also applies to interest paid on loans
guaranteed by foreign related parties or tax-exempt entities. However, disallowed interest
that is not currently deductible may be carried forward three years and deducted in future
years if limitation situations do not apply in those years. Adjusted taxable income does
not take into account NOLs nor deductions allowable for interest, depreciation,
amortization, or depletion. The deduction for interest is not deferred if the payer has a
debt-to-equity ratio, using the adjusted tax basis of assets, of no more than one and
one-half to one.
If a foreign entity does business in the United States via a US subsidiary, regular corporate income tax of up to 35% is levied on the taxable income of the subsidiary. Additionally, tax at 30% (or a lower treaty rate) is withheld from the profits actually distributed as a dividend. A US subsidiary, unlike a US branch, is taxed on its entire income from all sources; taxable income is not limited to US-source income or income attributable to a US trade or business. A branch must pay branch profits tax on its after-tax "dividend equivalent amount" at 30% (or a lower treaty rate), just like the tax on a dividend from a US subsidiary.
If stock of a US corporation (with the exception of real property holding
companies) is sold by a foreign entity, no US tax is due on the gain as long as the shares
were not held as part of the foreign entity's US trade or business.
State taxes usually influence the decision to operate as a branch or as a
subsidiary. Click for information on State and Local Taxes.
For example, it is important to determine whether the state will tax intercompany
transfers of property and inventory between corporations differently than it would tax
transfers between divisions of the same corporation when a newly formed subsidiary will
have assets and perhaps liabilities transferred to it. Sales and real property transfer
taxes should also be considered since the legal form of the transaction frequently governs
these taxes. It is also important to plan how US subsidiary entities will interact with
each other in the ordinary course of business. Most states tax business corporations as
separate entities. Since subsidiaries, unlike branches, must deal with each other at arm's
length, taxable profits may be inadvertently created at the state and local levels.
Finally, it should be considered whether the new state operation is
expected to generate taxable losses. In general, losses of a separate subsidiary will
reduce the taxable income of an affiliated company only if the companies are eligible to
compute taxable income on a combined or consolidated basis. Frequently, state tax
authorities must consent to this in advance. Unless there is evidence of a certain level
of economic integration between two or more companies, many states will not permit such
companies to file on a combined or consolidated basis within that state.
Corporate Assessments and Payments
A foreign corporation must file a return if it engages in a US trade or business, whether or not it had income from that trade or business or owes tax; has income, gains, or losses treated as if they were effectively connected with a US trade or business; has US-source passive income, the tax on which is not fully satisfied by withholding; or overpays income tax that it wants refunded.
Returns must be filed for a period of a year, but certain taxpayers may use
a fifty-two-/fifty-three-week year. Corporations need not end their accounting period on
31 December. If the books of a taxpayer are kept on a fiscal year, the tax return must
conform to the same period. A foreign corporation that is more than 50% owned by US
interests generally must use the tax year of its majority US shareholder. A corporation
may be permitted to change its accounting period if the new period will more accurately
reflect the business cycle or is needed to conform to the accounting period of other
members of a controlled group.
A corporation, including a foreign corporation with a US office, generally
must file a tax return by the fifteenth day of the third month after the close of the tax
year. A foreign corporation that does not have a US office must file a return by the
fifteenth day of the sixth month after the close of the tax year. In both cases, an
automatic extension of time to the ninth month after the year closes may be obtained.
However, taxpayers must estimate their final tax liabilities and pay any amounts not
already paid through estimated payments or other payments at the time of filing an
extension request.
The tax return must contain the balance sheet that was made part of the
underlying financial statements and must include schedules that reconcile book income to
taxable income. Complete financial statements do not have to be attached. The contents of
a return are confidential.
The IRS operates on a system of voluntary compliance and self-assessment.
It accepts as correct the tax reported on 99% of filed returns. To change the
self-assessed tax, the IRS must audit the return. Every return is checked to verify its
mathematical accuracy. Some are then selected for a detailed audit by an IRS agent. The
IRS generally has three years from the date on which a return is filed to assess
additional tax. Similarly, the taxpayer generally has three years within which to file a
claim for refund if the original return was in error and tax was overpaid.
Taxpayers generally have to pay estimated taxes in four installments based
on the tax anticipated to be due at the end of the year. Companies with income under US$1
million may base their estimated payments on 100% of the prior year's tax. For other
companies, the entire final tax bill must generally have been paid ratably throughout the
tax year.
The tax reported on the return must be paid by the date on which the return
is due. If a return is filed after an extension has been requested and additional tax is
due, that tax must be paid with the filing of the return and will be subject to interest.
If the taxpayer has paid more tax than is due, the IRS must issue a refund within
forty-five days of the date on which the return was filed or pay interest on the refund
from the date on which the return was filed. The taxpayer may, however, choose to apply
the refund to the next year's return payments.
The IRS can assess penalties against taxpayers. One of the most common is
for the underpayment of estimated tax. A "failure to pay" penalty is calculated
at 0.5% per month of the amount of tax shown on a return that is not paid with the return
up to a maximum of 25%. A "failure to file" penalty is computed when a return
was required, but was not filed, at 5% of the amount of the tax per month up to a maximum
of 25%. When these two penalties run concurrently, the combined penalty may not exceed 5%
of the amount of the tax per month. These penalties may be abated upon a showing of
reasonable cause. The penalties may interrelate with the extension request. If the
taxpayer fails to pay the final tax with the request, the IRS will assess the failure to
pay penalty of 0.5% per month. If the percentage of underpayment is sufficiently large,
the IRS will consider the extension invalid and will assess the failure to file penalty of
5% per month.
A less common penalty is the "accuracy-related" penalty. If the
IRS examines a return and proposes a deficiency of US$10,000 (or, if greater, 10% of the
tax required to be shown on the return), a penalty of 20% of the tax increase may be
assessed. This penalty can be avoided only by showing that the taxpayer's treatment of the
item that was adjusted had "substantial authority" or by filing a special
disclosure of it with the return. If the taxpayer does not have a reasonable basis for a
position taken on a tax return, a larger negligence penalty may be imposed.
A penalty may also be assessed against an officer, shareholder, or employee
of a corporation who is responsible for carrying out the corporation's duties to deduct
and pay over payroll taxes.
The IRS will charge interest on any deficiency from the due date of the
taxpayer's return and will charge interest on any penalty from either the due date of the
return or the date on which the penalty was assessed, depending on the penalty. The
interest charged is deductible, but the penalty is not.
A resident alien is taxable on income from all sources, including sources outside the United States, at the same rates and in the same manner as is a US citizen. An alien is treated as a US resident for any calendar year in which he or she is a lawful permanent resident of the United States at any time during that year or satisfies the substantial presence test. A lawful permanent resident is an alien who holds a "green card" from the US Immigration and Naturalization Service. An individual will satisfy the substantial presence test if he or she is present in the United States for at least 31 consecutive days during the current calendar year and has been present for at least 183 days weighted over a three-year period. In computing the 183 days, the individual includes all days of presence in the current calendar year, one-third of the days of presence in the preceding calendar year, and one-sixth of the days of presence in the second preceding calendar year. This translates into an average of 121 US days per year.
A nonresident alien is taxable on the same basis as a non-US corporation:
on US-source passive income and on income considered to be effectively connected with a US
trade or business, which in an individual's case includes remuneration for services
performed in the United States (except for very minor temporary services). Dividends,
interest, and other passive investment income are subject to Withholding
Tax. Capital gains, except those on real property and US real property holding
corporations, are generally exempt unless the nonresident alien is physically present in
the United States for 183 days or more during the year of sale. This 183-day rule is
waived under some treaties. Nonresident aliens who are married to resident aliens or US
citizens may elect to be taxed as resident aliens.
Personal Income Tax Rates. There are four filing statuses,
and different rates apply to each: single, married filing jointly (or qualifying widow or
widower), married filing separately, and head of household. Personal
Income Tax Rates are progressive and are adjusted annually for inflation, with
some exceptions in the 36% and 39.6% brackets.
The alternative minimum tax for individuals is designed to prevent taxpayers who enjoy
certain tax benefits from avoiding a minimum tax liability on their income. Like the
corporate AMT it is computed separately from the regular tax,
primarily by eliminating certain deductions and adding certain tax preference items to
taxable income. The AMT is paid only to the extent that it exceeds the regular tax. In
1993, the AMT for individuals was imposed at rates from 26% to 28%, depending on the
individual's taxable income.
Treatment of Families. Married individuals are subject to different
rates based on whether they file a joint return or separate returns. Joint returns are
usually preferable but are normally allowed only if both husband and wife are residents
for the year. The head of household status applies if the taxpayer is not married and
provides at least half the cost of maintaining the home for a child, stepchild, or direct
descendant.
Married aliens becoming US residents during the course of a tax year are
taxable at the rates applicable to married individuals filing separate returns, unless
joint return rates can be elected. The election may not be advantageous because it
requires the reporting and taxation of income received from worldwide sources during the
entire year, including that part of the year during which the aliens were nonresident.
Children are taxable on their income unless the income amounts to less than US$600, in
which case a return need not be filed. Investment income of a child under the age of
fourteen is generally taxed at the parents' top marginal rate if it exceeds the sum of the
US$600 standard deduction and the greater of US$600 or the itemized deductions directly
connected to the production of that investment income.
Taxable Income. Taxable income is adjusted gross income (AGI) minus either
the allowable itemized or standard deductions, as elected by the taxpayer, and minus
personal exemptions of US$2,450 per taxpayer or dependent. AGI is gross income minus the
adjustments for expenses ordinary and necessary to carrying on one's trade or business,
capital losses (with certain limitations), alimony paid to a former spouse, and other
fairly specific deductions. Gross income is income from all sources.
Itemized deductions include limited medical deductions, charitable
deductions, property taxes, mortgage interest on up to two of the taxpayer's personal
residences, unreimbursed employment expenses, and union dues. Only a limited amount of
interest paid or accrued on a residence for acquisition and home equity indebtedness is
deductible. Certain itemized deductions, such as expenses incurred to produce investment
income, can only be deducted to the extent that they exceed 2% of AGI.
Investment income, except capital gains, is taxed at the same rate as other
income. The maximum tax rate for long-term assets of individuals cannot exceed 28%.
Because this creates a significant differential in effective rates between ordinary income
and capital gain income for high-income individual taxpayers, the law contains several
provisions designed to prevent the conversion of ordinary income to capital gain income.
Rules for computing Capital Gains are similar to those
of corporations. Capital assets of an individual include household furnishings, the
personal residence, and automobiles. The basis for calculation may be increased to current
market value on property acquired by individuals through inheritance. An individual may
deduct up to US$3,000 in capital losses. However, losses on personal assets (for example,
houses and personal automobiles) are not allowed.
A noncorporate taxpayer holding qualified small-business stock acquired at
original issue after 11 August 1993 for more than five years may exclude 50% of any gain
on the sale or exchange of the stock, subject to limitations.
Certain benefits in kind are tax free to employees. However, group term
life insurance premiums, to the extent that they exceed the cost for a US$50,000 policy,
are taxable to employees, and some benefits, such as living allowances, are taxable as
additional compensation.
Tax Credits. Tax due may be offset by credits, such as the foreign tax credit, the credit for the elderly
or disabled, the child or dependent care credit, and the earned income credit.
Losses. In general, losses are deductible in computing AGI only if
they arise in connection with an attempt at earning income. A deduction is limited to a
loss incurred in a trade or business; a loss incurred in a transaction entered into for
profit; and a loss arising from a fire, storm, shipwreck, other casualty, or theft. A
business casualty loss is fully deductible. A personal casualty loss is subject to a
US$100 floor and a 10%-of-AGI floor. Generally, a loss is deductible only for the tax year
in which it occurred.
Losses are categorized, and losses in some categories are restricted in use
to income in that category. Passive losses may offset only passive activity gains. Renting
out one's property is generally considered a passive activity. Only up to US$25,000 of the
losses may be used per year under this exemption.
Any net loss from a capital asset transaction is deductible from ordinary
income up to US$3,000 in one year (US$1,500 for married taxpayers filing separately).
Capital losses that exceed capital gains and the US$3,000 deduction limit may be carried
forward to future years until completely used.
An individual may not deduct a loss from a sale of residential property
that was not purchased for investment unless at the time the property is being rented or
otherwise used to produce income. The loss may be either a capital loss or an ordinary
loss, depending on the nature of the property.
Personal Assessments and Payments
The tax year for individuals is the calendar year. Tax is paid in advance by employer withholding or estimated payments. The balance of tax due is paid when the tax return is filed, usually on 15 April. Like corporate income tax, personal income tax is self-assessed. Penalties may be assessed against individuals in circumstances similar to those applying to corporations. Click for information on Corporate Assessments and Payments.
The standard US withholding tax rate is 30%, but lower rates may apply under double tax treaties. The taxes to nonresidents. For residents, such items are usually included in taxable income.
Dividends. Dividends paid by a US corporation to a nonresident are
generally subject to a 30% withholding tax.
Interest. Interest paid by a US person to a nonresident is generally
subject to a 30% withholding tax. Interest includes payments with respect to coupon bonds,
registered bonds, promissory notes, open account indebtedness, or bank deposits. Interest
classified as portfolio interest-which is interest paid to an unrelated lender on certain
bearer and registered obligations and interest on bank deposits-is exempt if it is not
effectively connected with a US trade or business.
Royalties. All royalty payments to a nonresident for the use of
property in the United States are generally subject to withholding tax at 30%.
Personal Service Compensation. Compensation received by a
nonresident alien for services rendered in the United States for a US employer is normally
taxable as effectively connected income. Payments for such services are subject to
withholding, sometimes at the statutory 30% rate and sometimes at the lower domestic
withholding tax rates. Thus, withholding may exceed the actual tax imposed on such
payments. If this happens, the nonresident alien may recover the excess when he or she
files a tax return. In limited cases, withholding can be adjusted to equate the tax.
Compensation received by a self-employed nonresident alien for the
performance of personal services in the United States is subject to withholding at 30%,
even though the tax may be less (for example, because a treaty exempts such income from US
income tax). It is sometimes possible to reduce the withholding to equate the tax. Taxes
withheld may be applied against the ultimate tax as computed on the return that must be
filed. Taxes withheld in excess of the ultimate liability may be refunded.
Partnership Income. A partnership (foreign or domestic) that has
income effectively connected with a US trade or business must withhold tax at the highest
applicable US rate (39.6% for individuals or 35% for corporations) on the effectively
connected income allocable to its foreign partners. A partner may offset this withholding
against his or her tax liability when filing a tax return for the year or may claim a
refund of any excess. This withholding therefore functions as an estimated tax deposit.
The partner's distributive share of income that is not effectively connected with a US
trade or business is not subject to this requirement but is subject to withholding at 30%
(or a lower treaty rate) to the extent that it represents the payment of fixed or
determinable annual or periodic income (FDAPI).
Income Effectively Connected with a US Trade or Business. Except
under the withholding requirements for partnerships and for dispositions of US real
property interests, income received by a nonresident alien that is effectively connected
with a US trade or business is exempt from withholding. If the proper filing requirements
are met, this includes amounts received as business income, which are interest, dividends,
rent, royalties, salaries, wages, premiums, annuities, compensation, remuneration, and
other FDAPI. FDAPI is a broad concept encompassing payments that are either fixed in
amount or based on a specific calculation. Payments not made on an annual or periodic
basis may nevertheless be classified as FDAPI. That the length of time during which
payments will be made may vary due to someone's will or the happening of an event will not
alter the character of the payment.
Branch Remittances. A branch profits tax is imposed at the rate of
30% on the "dividend equivalent amount" of the US branch of a foreign
corporation. For information on Nonresident Entities If
a foreign corporation is a qualified resident of a treaty country, the treaty may prevent
the imposition of the tax or reduce it. The qualified resident test for the branch profits
tax is more difficult to meet than the normal treaty rules regarding residence when
anti-treaty-shopping rules are not contained in the treaty. Thus, a recipient of certain
types of income might qualify for some treaty benefits, such as a reduced withholding rate
on interest payments, but might not meet the definition of a qualified resident for
purposes of the branch profits tax.
In general, interest paid by a US trade or business is treated as if it
were paid by a domestic corporation and is subject to what is known as branch-level
interest tax. In addition, if interest allowable as a deduction exceeds certain interest
paid by a US trade or business of a foreign corporation, this excess is treated as
interest paid to the foreign corporation by a wholly owned domestic corporation and is
subject to what is known as branch excess interest tax. The rate in both cases is 30%,
unless a treaty provides otherwise.
Rates Under Double Tax Treaties. The United States has concluded
double tax treaties on dividends, interest, and royalties paid to recipients. Click to see Withholding Tax Rates for Treaty Countries
The federal government does not impose a net wealth tax, nor are there any federal trade or business license taxes or stamp taxes (except for certain excise taxes).
Social Security. The social security program is financed by
taxes levied under the Federal Insurance Contributions Act (called FICA taxes). Employees
are taxed on their first US$60,600 of taxable wages at a rate of 6.2% (the old-age,
survivors, and disability insurance tax). They are also taxed at a rate of 1.45% on the
whole of their taxable wages (the hospital insurance tax). The employer must withhold the
employee's FICA taxes. Employers pay FICA taxes at the same rates but may deduct their
share of the axes.
Social security totalization agreements may affect both the taxability of
wages and social security coverage for aliens employed in the United States and US
citizens employed abroad. If there is no totalization agreement, wages of aliens for
services performed in the United States are subject to FICA taxes, regardless of where the
wages are paid.
Self-Employment Tax. Under the Self-Employment Contributions Act
(SECA), an individual who carries on a trade or business as a proprietor or partner or who
render services as an independent contractor is liable for self-employment taxes on any
earnings received for the performance of services that are not wages and, therefore, are
not subject to FICA taxes. Self-employment tax rates and limitations are equivalent to
those under FICA; however, the self-employed individual pays both the employer and
employee portions of the tax. Nonresident aliens are not subject to SECA taxes.
Unemployment Taxes. The federal government imposes a tax of 6.2% on
the first US$7,000 of nonexempt wages paid by an employer to an employee during the year.
No contributions are required on the part of the employee.
Estate and Gift Taxes. A uniform rate structure applies to lifetime
gifts and transfers occurring at death. While the tax is imposed on the transferor,
subsequent income from the transferred property is taxed to the beneficiary. Rules for US
citizens or resident aliens and for nonresident aliens differ.
Transfer taxes for US citizens and resident aliens are progressive,
starting at 18% and increasing to 55%. As an offset against taxes, a unified credit is
available (currently US$192,800), which, in effect, permits taxpayers to transfer
US$600,000 of value before incurring either an estate or gift tax liability. In addition,
an annual exclusion from gift tax of US$10,000 per donee (US$20,000 for married couples)
is permitted if the donee will have a right of immediate possession or enjoyment of the
property. Most inheritances or gifts from one spouse to the other are not subject to
either federal estate or gift tax if the recipient is a US citizen as property so
transferred will eventually be subject to tax in the estate of the other spouse.
For residents, estate tax is levied on all the decedent's property,
wherever situated, based on fair market values either at the date of death or, upon
election, six months after the death. Various deductions are allowed.
In the case of nonresident aliens, the taxable gift or estate consists only
of property located in the United States (including shares of domestic corporations and
cash deposits). Rates are the same as those for US citizens and resident aliens.
Nonresident aliens are allowed a unified credit of only US$13,000 (subject to change by a
treaty). The unlimited marital deduction and the US$10,000 annual exclusion are available
if the transfer is to a US citizen. No marital deduction is allowed when a transfer is
made to a spouse who is not a US citizen unless it is made through a qualified trust, but
the annual exclusion is increased to US$100,000 rather than US$10,000. Other deductions
are allocated pro rata between the decedent's gross estate located in the United States
and the decedent's entire gross estate.
Excise Taxes. The United States imposes several significant
excise taxes on the purchase or use of a product regardless of whether any profit is
derived from its sale. Certain excise taxes are also levied on the manufacture, sale, or
consumption of various commodities within the United States, including diesel fuels; large
trucks, buses, and trailers; alcoholic beverages; cigarettes; and local and toll telephone
and teletypewriter services. In most cases, the tax is borne directly by the consumer or
may be passed on to the consumer. The seller, however, is responsible for the actual
collection and payment of the tax. When a domestic commodity is subject to excise tax,
excise taxes are also imposed on corresponding foreign imports.
A luxury automobile tax is imposed at a rate of 10% on the excess of the
cost of the car over US$32,000. The tax is not deductible by the purchaser. It may not
apply if the car is used exclusively in a trade or business.
Fuels Tax. A levy of 4.3 cents per gallon is imposed on
transportation fuel, including gasoline and diesel, aviation, and special motor fuels used
for highway and waterway transportation. The tax on commercial aviation fuel takes effect
on 1 October 1995.
Transportation Tax. A tax of 4% on gross income derived from
international transportation activities is imposed on foreign entities. One-half of the
income attributable to international transportation beginning or ending in the United
States is generally deemed US-source income.
The states and an increasing number of municipalities levy taxes on income, property, sales, inventory, franchises, and so forth. Click to see State Tax Rates Foreign companies contemplating operations in the United States must consider both the cost and complexity of state and local taxes. Large companies that operate in many different states file hundreds of tax forms each year. Rates vary greatly, and the tax formats and rules are seldom similar.
Corporate Income or Franchise Tax. Most states and some local
governments impose an income tax or franchise tax on domestic corporations (incorporated
in the state) and foreign corporations (incorporated outside the state) for doing business
in the state. A corporation is generally considered to do business within a state if it
maintains an office, plant, or inventory there-or pays wages there-and has gross receipts
from sales within a state, but even the solicitation of sales by its employees may make a
corporation subject to tax in a state.
A franchise tax is generally imposed on the income or capital of a
corporation. Most states use federal taxable income (with some modifications) as a
starting point for determining state taxable income. Some use net worth, capital, gross
receipts, economic income, or a combination of methods. Many states have a minimum tax,
based on capital, which is imposed whether or not a profit was earned for the year or even
if a loss was incurred.
In most cases, to prevent double taxation, a state attempts to tax
companies with multiple-state operations only on income that is earned within that state.
Usually, the state will apportion a percentage of an entity's total income and impose a
tax on that amount. However, double taxation can occur when different tax methods are
used, when apportionment formulas differ, or when different criteria are used to determine
the extent to which out-of-state sales are taxed by the home state. To determine the
amount of a corporation's taxable income (or capital), most states use a three-part
formula involving the relative receipts, property, and payroll within that state as
compared with the total of those items, either worldwide or in all states. Generally, an
average of the three factors will determine the apportionment percentage.
Individual Income Tax. As state income tax laws differ, the
following comments apply merely to the general question of who is subject to tax. An
individual who maintains a permanent home in a state and has spent a specified period
within it is normally taxed on net income from all sources both within and outside the
state. The same rule normally applies to income taxes imposed by cities. An individual who
does not meet the state or city residence requirements is considered a nonresident and is
taxed only on net income from property, services, or business operations within the state
or city. When it is difficult to allocate income from within and without the jurisdiction,
an apportionment formula may take into account payroll, rents, sales, or similar factors.
When more than one state taxes the same income, a credit may be available in the state of
residence.
Estate or Inheritance Tax. States may impose estate or inheritance
taxes. The tax paid generally equals the difference between the estate tax credit allowed
on the federal estate tax return and the estate or inheritance tax imposed by the state
(if it is less than the federal credit for state death tax). Generally, a state will limit
its tax on the property of a nonresident decedent to the real or tangible personal
property within that state. Factors that determine residence within a state include the
location of an individual's principal residence, the amount of time spent at homes within
and outside the state, place of voting, and membership in clubs. A credit is available for
any tax imposed by another state for property in that state.
Sales and Use Taxes. Most states impose a sales tax on retail sales
of tangible personal property. The consumer bears the tax; the retailer merely acts as the
collector. Most jurisdictions that impose sales taxes also impose a complementary use tax
on the use or consumption of tangible personal property purchased outside but brought into
the state of residence. The use tax is designed to discourage purchases from another state
that has a lower sales tax or none at all. Many counties and municipalities also impose
sales or use taxes. Not all purchases are subject to sales tax in each state, and some
states tax a limited range of services.
Property Taxes. Jurisdictions below the state level usually impose
property taxes on owners of real property. Some tangible (and sometimes intangible)
personal property is also taxable in many states. The assessment is generally based on a
percentage of fair market value. Property taxes are deductible for income tax purposes.
Miscellaneous Taxes. States have the power to regulate various
occupations and professions; engaging in a business, trade, or profession often requires a
license granted by the state. Many states impose unemployment taxes. Other major state
taxes include those on motor fuels; motor vehicle registration; cigarettes, cigars, and
tobacco products, unless shipped in interstate commerce; alcoholic beverages; and some
stock transfers.
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