Thirty percent is the starting point. How much of it you actually pay comes down to one form and one treaty.
US withholding tax: 30, 15, 5 or zero percent on your income
Part of the guide US Business Taxes: Federal, State and Home Country
When money flows from the USA to you or your company in Europe, the American payer first holds back a share. How much depends on three questions: what type of income is it, is it connected to a business in the USA, and does the payer have a valid form from you, before the payment, that claims a tax treaty? This page answers the three questions in turn, covers the withholding taxes business owners often overlook, and shows the way back when too much was withheld. How to take profits out of your US corporation most efficiently, whether as a dividend, a salary or through services from your parent company, is covered in detail in Taking profits out of your US corporation.
1The starting point: 30 percent of the gross amount
American law puts the tax on foreigners' income on the payer. Under Section 1441 of the Internal Revenue Code, anyone paying a nonresident individual or a foreign partnership withholds a tax of 30 percent. Section 1442 requires the same for payments to foreign corporations, including your own company back home. This covers interest, dividends, rents, royalties, compensation and other fixed or periodic income, which the law groups under the label FDAP: fixed, determinable, annual or periodical.
The IRS sums up the consequence on its FDAP page in two sentences. The 30 percent rate, or the lower treaty rate, applies to the gross amount. No deductions or offsets are allowed. So if you license something to a US company for $100,000, without a treaty you have paid $30,000 in tax, whatever your costs were.
The source of the income decides whether the rule applies at all. For compensation for services, IRS Publication 515 says the source is where the work is performed, regardless of where the contract was signed or where the money is paid. An engineer working from Graz for a client in Ohio has no US-source income. Only when he travels to the USA for the job does the part attributable to the work there become US-source.
2FDAP or ECI: the fork in the road
Besides FDAP, the law has a second category: Effectively Connected Income, or ECI. According to the IRS, this is all US-source income connected with a trade or business in the USA. If you sell goods, services or products there, the IRS generally treats you as doing business in the USA. ECI works differently: the income is taxed after allowable expenses at the same graduated rates Americans pay, and it is reported on a tax return rather than withheld by the payer. You prove this status to the payer with Form W-8ECI.
For business owners, this fork is the single most important distinction in the whole topic. The dividend your US corporation pays you is FDAP. The profit your single-member LLC makes with its store in Florida is ECI, and it shows up on your tax return, not as withholding. Treaties follow the same split: according to the IRS note on its treaty rate table, income attributable to a permanent establishment in the USA is in most cases taxed on a net basis instead of at the reduced rate.
The tax return that goes with ECI depends on your structure; the forms are sorted out in LLC tax returns by structure. Terms from FDAP to ECI are also explained in the US business tax glossary.
4Who withholds and who is liable
The payer deducts the tax, and the payer is liable for it. The Instructions for Form 1042 put it bluntly: as a withholding agent, you are personally liable for any tax that should have been withheld, plus interest and penalties. This affects you in two roles.
As the recipient, you give the payer the right form before the first payment: W-8BEN as an individual, W-8BEN-E as a company. Without a form, the payer must withhold 30 percent. According to the Instructions, a W-8BEN-E is valid from the day it is signed until the last day of the third following calendar year, unless something changes before then that makes it incorrect. How to fill in the form is explained in Completing the W-8BEN-E for companies and LLCs and W-8BEN for freelancers and individuals; who needs to file one at all is covered in What the W-8 form is for.
As the payer, your US company is itself a withholding agent as soon as it pays interest, royalties or dividends to your company back home or to you. It collects the form, withholds the correct rate and reports by March 15 of the following year on Form 1042, plus a Form 1042-S for each recipient. According to the Instructions, the filing is due even if nothing was withheld because of a treaty. Details on deadlines and penalties are under Form 1042-S.
5Dividends from your US corporation
Which other ways of taking money out exist besides dividends, and how they compare, is a topic of its own with its own pitfalls. It is covered in detail in Taking profits out of your US corporation. LLCs are treated differently for tax purposes, as described in Taking profits out of your US LLC.
If you hold US shares privately, the same withholding tax hits every dividend. There is also a question many only notice when someone dies: American assets of non-Americans are subject to US estate tax; see US estate tax for non-US citizens.
6Withholding taxes business owners overlook
Beyond the tax on FDAP, US law has further withholding taxes that mainly affect owners of partnerships, real estate and branches. The table sums them up.
A partnership, which includes an LLC with several members, pays withholding tax under Section 1446 on the share of its US business profits allocable to foreign partners. The rate is the highest tax rate for each type of partner; the Instructions for Form 8804 give 37 percent for individuals and 21 percent for corporations. The partnership reports this on Form 8804 and gives each partner a Form 8805 to use with their own return. If an interest in such a partnership is sold, the buyer withholds 10 percent of the proceeds under Section 1446(f). More on this in the article Form 1065 and K-1.
When a foreign person sells US real estate, the buyer withholds 15 percent of the proceeds under Section 1445, or 10 percent if the buyer plans to live in the property and the price does not exceed 1 million dollars.
| Process | Provision | Rate | Who withholds |
|---|---|---|---|
| A foreign partner's share of profits in a partnership with a US business | § 1446(a) | highest rate: 37% for individuals, 21% for corporations | the partnership, reported on Forms 8804 and 8805 |
| Sale of an interest in such a partnership | § 1446(f) | 10% of the amount realized | the buyer |
| Sale of US real estate by a foreign person | § 1445 | 15% of the proceeds; 10% if the buyer will live in it and the price is up to 1 million dollars | the buyer |
7Too much withheld? How to get it back
If the form was missing or the payer applied the wrong rate, the difference is not lost, but it will not come back on its own. In the US you reclaim it by filing a return: as an individual on Form 1040-NR, which the Instructions say you can file solely to claim a refund of tax withheld at source, and as a company on Form 1120-F. The payer's Form 1042-S serves as proof. Which US tax number to use on the return is explained in the article EIN, ITIN, SSN, TIN.
