Our foreign direct investment team regularly fields inquiries from international companies and existing international clients regarding establishing U.S. business operations. (See Does My International Company Need to Register in the U.S. and How Does My International Company Do Banking in the U.S.?) This post will answer questions for foreign companies regarding when they must pay U.S. federal and state income taxes, which is an entirely independent analysis from deciding whether your company needs to register in the United States.
First, you need to recognize that your law firm will generally stay within its core area of expertise and focus on the legal requirements of your business rather than the execution of your tax obligations, which rests with you as the business owner or manager. Foreign companies typically should engage a U.S.-based accounting firm to help with ensuring its tax filings are completed on time and accurately. This may mean you need to hire a CPA firm with international tax expertise and a local CPA firm where you do business in the U.S. Or you may want to hire one international CPA firm to deal with both your international and domestic tax obligations. Our law firm often helps our clients find the right accounting firm.
Many of our international clients have been very successful in their home countries and have started to engage in some U.S. sales. These sales may be accomplished directly from abroad to consumers, from abroad through brokers, or by directly engaging in U.S. business operations in the U.S. Many of these companies understand the potential perils of doing business internationally and want to ensure they are exactly compliant to avoid any business or immigration issues for owners and employees.
U.S. Federal Income Tax
All U.S.-based income is initially subject to U.S. income tax unless an income tax treaty applies between the United States and a foreign company’s home country. If a tax treaty applies, the foreign company can claim a reduction in U.S. federal income tax if the foreign company already paid income tax in the foreign company’s home country on that U.S.-based income. The U.S. has an income tax treaty with 68 countries, many of them dating back decades. You may be surprised at some of the countries on the list: Venezuela, Russia, Malta, Switzerland, and Cyprus, for example, and others that are not on the list: Singapore, Hong Kong, British Virgin Islands, Bermuda, Argentina, and Brazil.
Generally, as soon as an international company closes its first U.S. sale, it will incur some U.S. federal income tax obligations. If as an international company you want to continue to do business with the U.S., you will want to do everything you can to take advantage of income tax savings under an applicable income tax treaty, even if it means first setting up a new subsidiary in a country that has an income tax treaty in place with the U.S.
As an international business you can generally determine how you want to be taxed at the U.S. federal level. You should consult with legal and tax counsel to help you choose your optimal U.S. federal tax classification (C corporation, partnership (LLCs and partnerships), and sole proprietor (S corporation status is not available to companies with international owners).
U.S. State Income Taxes and Related Taxes
U.S. state income taxes vary from state to state, and not all states honor the effect of an international income tax treaty. For instance, both California and New Jersey require payment of state income tax based on revenue from sales in their states even if a tax treaty with a foreign country exists at the U.S. federal level.
You will need to check each state’s requirements where you make sales to determine whether and when they require payments of income tax or a similar tax. For instance, Washington does not have a state income tax, but it has a gross receipts tax that is similarly based on sales within Washington. This means the gross receipts tax is seen as outside the effect of an income tax treaty. See below:
|State||Income Tax||Other Tax||Comments|
|Washington (WA)||None||Gross receipts tax (0.484% of gross receipts)||Gross receipts = gross income or gross sales from WA buyers|
|California (CA)||8.84% of net income for corporations||Depends on current business operations||Only based on CA sales, not U.S. or worldwide sales|
|New Jersey (NJ)||6.5-9.0% of net income (percentage change based on income bands)||None identified based on current operations||Only based on NJ sales, not U.S. or worldwide sales|
States generally require sellers to collect and remit monthly or quarterly payments of sales tax that is collected on retail sales, so you want to ensure that you are collecting the appropriate amount of tax for each transaction.
None of these states requires a company or its U.S.-based brokers to collect sales tax from wholesale buyers because sales tax is only collected on retail sales. But international companies should collect and should require that their brokers collect a reseller permit from each wholesale buyer to keep in their tax records. The reseller permit does not need to be shown at each transaction but can be kept on file for the life of the buyer-seller relationship.
Many states also require an excise tax to be paid on certain transactions, which are not considered a sales tax.
Additional U.S. Tax Questions to Ponder
As you are digesting this information, keep in mind the following questions:
- Do you want to engage in business with the U.S. directly by becoming the seller, or do you want to form a new company in a country to take advantage of an income tax treaty?
- If you will be engaging directly in business with the U.S., how will that entity be taxed? (We will provide a future blog post to help with this decision)
- How important is it to you to simplify your U.S. obligations, and would it be more beneficial to form a wholly-owned U.S. subsidiary company to simplify your U.S. state registrations, tax payments, and U.S. banking?