If you’re thinking of opening up a foreign owned U.S. business, read on for what you need to know about your taxes and how you can potentially save on them.
What qualifies as a foreign owned U.S. business?
A foreign owned U.S. business is a separate business entity registered in the U.S., but owned by a non-U.S. resident or citizen. The IRS definition of foreign persons as:
- Non-resident alien individuals
- Foreign companies, corporations, partnerships, or their U.S. branches
- Foreign trusts or estates
- Any other person who is not a U.S. person
The individuals who own these businesses are subject to net-basis taxation on any income that’s connected to business conducted in the United States.
What about income that’s earned on business conducted outside of the United States? That income isn’t liable for taxation. This means theoretically you can have a foreign owned U.S. business that does not conduct business in the United States and isn’t paying U.S. income taxes.
For example, if you have a Delaware established corporation that sells goods online with a fulfillment facility based in Europe and the United States, only income earned on goods sales to American citizens or fulfilled by the U.S.-based facility is subject to taxation.
Determining what you’ll be taxed on is called engaged in trade or business in the United States, or ETOB.
What qualifies as ETOB?
The technical definition of ETOB is a business that:
- Has one or more dependent agents in the United States. These dependent agents are employees or companies who almost exclusively work for the business, and
- The dependent agent is more than an administrative role. They make substantial contributions in furthering your business in the United States or the business or dependent agent is, as the IRS views it, conducting “considerable, continuous, and regular” business in the United States.
Unfortunately, there isn’t a precise definition of “considerable, continuous, and regular” business. What the IRS uses to determine this is:
- Regularity of activities
- Regularity of transactions
- Production of income
- Ongoing work that furthers the interests of your business
In basic terms, the IRS definition of trade or business is “activity carried on for the production of income from selling goods or performing services.” You qualify as engaging in trade or business in the United States if the selling, production, or provision of goods or services is done, in part, on American land.
There are more explicit examples of what does not qualify your business as ETOB. Any personal services performed abroad, digital products (including web design), or selling physical products shipped from outside the United States will not incur U.S. taxes. This is because the goods and services are not provided in or from the United States.
The simplest rule of thumb is whether business is conducted on American soil or with an American citizen. Goods that are stored in and shipped out of an American facility? Likely ETOB. But if those goods are stored abroad and are not sold in the United States? Likely not ETOB.
A key component of defining whether your business is ETOB or not is documentation. If income cannot be proven to be foreign-sourced, it’s more likely your business will be assumed to be ETOB than not. Essentially, it’s on the business to prove it’s not ETOB.
The bottom line
You can establish a business in the United States and only pay taxes on activity that occurs in the country. For foreign owned businesses, it’s a good opportunity to open up a U.S. branch without worrying about income taxes paid on all business conducted.
Before you start operating, it’s important to have solid recordkeeping practices to prove what was and wasn’t U.S. business activity. A great start is getting your bookkeeping in order.
With Bench, you can save hours every week by having our team of pros do your bookkeeping. We help businesses stay tax compliant and in the know on their financial health. Learn more about our small business tax services.
