How non-US business owners selling into the USA are taxed is probably the most misunderstood topic in all of international US tax law. That is why we have given it a whole page and take a closer look at how US tax on profits can be avoided (even with a US LLC). We also show you why so many people get this wrong.
For an overview of the US tax system , see our beginner's guide.
Non-US business owners in the USA
This article covers how the US taxes non-resident aliens, or NRAs for short. You are an NRA if you are NONE of the following:
- a US citizen,
- a permanent resident (for example a green card holder), or
- someone who, under the Substantial Presence Test, spent enough time in the USA in the tax year in question to become liable for US tax (with or without a visa; this can happen with fewer than 183 days in the USA per year).
If any of these applies to you, you are not a non-resident alien and the information here does not apply to you. NRAs need to know two very different US tax regimes: the passive regime and the active regime. Let's look at each in turn.
You will find more on the US tax system in our beginner's guide.
The passive regime
If you receive certain types of passive income, you are subject to a flat US withholding tax of 30%. This general rate of 30% can, however, be reduced by an applicable tax treaty (often to 15%).
This passive income includes:
- Interest
- Dividends
- Rental income
- Royalties
As a rule, the payer of this kind of income must withhold the tax at the applicable rate and pay it over to the US government. Because the withholding settles the tax in full, you as the recipient have nothing more to do and do not need to file a US tax return.
So if, for example, you own shares in a US corporation and it pays a dividend of $100, the company pays you only $70 (assuming no treaty applies). The remaining $30 goes to the US tax authority (the IRS).
There are, however, plenty of exceptions to keep in mind. Interest, for instance, is generally passive income subject to withholding, yet various special cases let you receive certain kinds of interest completely tax-free. One of them is interest on ordinary bank deposits. The US clearly wants to encourage investors to keep their money in the country.
The active regime
The tax treatment of income from an active business in the USA is completely different. Foreign business owners fall under a separate regime, which works like this:
- Only business profits attributable to a trade or business carried on in the USA are subject to US tax. This is known as "ETBUS", short for "engaged in a trade or business in the United States".
- ETBUS is triggered by (1) at least one so-called dependent agent (for example an employee) in the USA who (2) contributes substantially to developing the business there (as opposed to purely administrative tasks).
- If you can rely on a double tax treaty, you are only taxable in the USA despite being ETBUS as defined above if you have a US permanent establishment (for example an office or another fixed place of business).
To make this clearer, let's look at each of these conditions in detail.
What is a dependent agent?
A dependent agent is essentially someone who works so closely for you that their actions can be seen as an extension of your own. The term definitely includes your employees. But it also covers two other groups:
- people who work for you as independent contractors but do so much work for you that they are essentially indistinguishable from an employee, and
- companies that provide services exclusively (or almost exclusively) to you.
What is an independent agent?
Now for the opposite of a dependent agent: the independent agent. This is someone who runs their own business and for whom you are simply a customer. The independent agent has a business of their own. That business helps yours in some way, but nothing more.
An independent agent does things for you (they are still your agent), but they mainly work on their own business, not yours. That makes them independent of you: their actions are their own, not a continuation of yours.
That is why simply using the services of an independent agent in the USA does not mean you are treated as doing business in the US.
Why do so many tax experts get this wrong?
There are some legitimate reasons why other tax professionals get this distinction wrong. Much of it, though, is less excusable and something an expert really should get right.
US tax rests on the distinction between US-source and foreign-source income. This distinction is made in various ways. If you sell products into the USA, the profits are usually US-source income.
Some tax professionals make the mistake of equating US source with US taxation. But US-source income is not always subject to US tax. A non-US person's income is only taxed in the US if it is actually connected with a trade or business in the USA. In other words, the person must be ETBUS as described above, and the income must also be connected with the activity that makes them ETBUS.
Other so-called tax pros feel they cannot charge you for filing a US tax return if you owe no US tax. Billing you matters more to them than understanding whether you are actually subject to US tax.
Here is an example. Say you decide to sell products on the US market using Fulfillment by Amazon, or Amazon FBA. You buy products, have them delivered to Amazon's warehouses, and Amazon staff pack them and ship them to customers.
Is Amazon your dependent agent? No, absolutely not. Amazon has its own business, and you are just one of its many customers.
In this example, then, you are not ETBUS, meaning you are not doing business in the USA. So you are not subject to US tax on income from selling products into the USA.
The devil is in the details
You can look at it another way. When you sell products, you are definitely carrying on a business: you source products, do marketing, ship to customers, handle returns and do everything else that goes into running a company.
But you are not subject to US tax because you are not running that business on the ground in the US. You carry on your business where you (and any dependent agents) are, outside the USA.
If, on the other hand, you have a dependent agent in the USA, you are doing business in the US. There are people on the ground running your business from there, and under the active regime you are taxable in the USA.
If you only use the services of an independent agent (such as Amazon), the people helping you in the USA are not your staff. They are simply people running their own business (Amazon) or people working for someone else (Amazon's employees and independent contractors).
What if...?
This is usually the point in a conversation where the "what if..." questions start. Yet everything above already answers what you need to know.
If you are still unsure, here are the most common points of confusion:
What if I operate through a Limited Liability Company (a US LLC)?
If you are the sole member (the owner) of a US LLC, the LLC is not treated as separate from you for US tax purposes. Put simply, it does not exist for US tax purposes. This kind of LLC is called an exempt LLC. Doing business through an LLC changes nothing about the US tax analysis or the criteria above.
What if I am paid in US dollars into a US bank account?
Again, nothing changes. Neither the currency you are paid in nor the location of the bank that receives it makes any difference. The only thing that matters is whether or not you are ETBUS.
What if I sell products online and my server is in the US?
That does not matter. If the server hosting your website runs in the US, you are simply using the services of an independent agent (the hosting provider, acting as an independent contractor). That does not make you ETBUS.
If I sell physical products in the US, don't I have US-source income?
Yes, you will have US-source income. But that does not matter at all. To be taxed in the US under the active regime, you have to be ETBUS. Only then are you taxable, and only on the US income effectively connected with the US business. Having US-source income alone does not create US tax liability.
I was told to set up a US corporation and allocate 5% of my business profit to it for its payment processing services. Is that a good idea?
No, it is completely unnecessary. Some people seem to think you need a US company to shield you (or your non-US business) from direct sales into the US. But this structure is entirely unnecessary: selling into the States alone does not make you (or the company) taxable in the US. It is an expensive way to avoid a problem that does not exist.
Setting up a US structure
As mentioned, the simplest and best structure for foreign entrepreneurs in the US is a single-member LLC, also called an exempt LLC, formed in one of the US states.
Operating through such an LLC gives you a number of advantages:
- You can open your own US bank account with traditional American banks (unlike fintech providers such as Mercury, these require a US director). That makes it easier to accept payments from US customers and to process them through payment processors.
- An LLC gives your business liability protection. If you are sued, only the LLC is liable, not you personally (or the non-US entity you mainly operate through).
- US customers like buying from US sellers. With an LLC and a US address, you look just like any other US seller and come across as established and trustworthy.
- A US LLC can get credit from Amazon itself, a US bank or other sources.
Setting up a US LLC and a bank account can be a little complicated. There are many small details to get right. You also need to approach the right bank to have any chance of opening a bank account in good time. On top of that, your LLC has to file IRS Form 5472, which is required of every company with 25% or more foreign ownership. Find out more about the exempt LLC's filing obligations, with all the details, here.
For more on the US tax system, see our beginner's guide.
Mount Bonnell Advisors has already set up many of these structures for NRAs. When you work with us, you can focus entirely on running and growing your business while we handle the finer points of the US structure and your tax matters. Our sister site zerotax.llc specializes in exactly these structures, the US LLC without a US permanent establishment.