Quick answer: A foreign person pays U.S. tax two very different ways. Passive U.S.-source income is taxed at a flat 30% on the gross amount. Income effectively connected with a U.S. trade or business (ECI) is taxed at graduated rates on net income — but only if you file a return. File late enough and you can lose every deduction and be taxed on gross receipts instead.
This is the question behind most “do I owe U.S. tax?” conversations with foreign owners of U.S. entities. It is also an area where a lot of confident advice circulates in both directions, and the honest answer for some common fact patterns is that the law is unsettled.
Two regimes, very different math
| FDAP income | Effectively connected income | |
|---|---|---|
| What it is | Passive U.S.-source income — interest, dividends, rents, royalties | Income connected with a U.S. trade or business |
| Rate | Flat 30% | Graduated rates (individuals) / 21% (corporations) |
| Base | Gross — no deductions | Net — after deductions |
| Code | Sec 871(a) individuals; Sec 881 corporations | Sec 871(b) individuals; Sec 882 corporations |
| Collection | Withheld at source | Return filed by the taxpayer |
ECI treatment is usually better for an operating business, because you are taxed on profit rather than revenue. The catch is that it requires filing, and it carries the compliance obligations that come with it.
What creates a U.S. trade or business
There is no statutory definition. Section 864 lists some inclusions and exclusions but never defines the term. The standard comes from case law: activities in the United States — conducted directly or through an agent — that are considerable, continuous, and regular.
The IRS states plainly that this is determined “on the basis of the facts and circumstances in each case.” There is no bright line, no revenue threshold, and no day-count test.
The regulations contain only two safe harbors — trading in securities and trading in commodities. Neither covers selling physical goods. There is no equivalent safe harbor for e-commerce or inventory sales.
Older cases sketch the boundaries. In De Amodio, a foreign owner’s U.S. rental real estate managed by agents was a U.S. trade or business even though the owner was never present. In Piedras Negras, a Mexican broadcaster selling advertising to U.S. customers through an independent agent, with the broadcasting done abroad, was not. In Handfield, a foreign manufacturer selling through an independent U.S. distributor was found not to be engaged in a U.S. trade or business on those facts.
Force of attraction
Once a U.S. trade or business exists, Section 864(c)(3) sweeps in essentially all U.S.-source income other than FDAP — whether or not it is directly related to that business. So the USTB question is the hinge. Answer it yes, and a lot follows automatically.
Whether income is effectively connected decides the rate, the return and the withholding
The same dollar of profit can be taxed on a net basis at graduated rates or hit with a flat thirty percent gross withholding, depending on how the activity is characterised. Foreign owners often discover the distinction after the withholding agent has already remitted, at which point recovery means filing and waiting.
We plan this for foreign-owned US entities before the money moves. Call 631-349-1661 or send us the details and we will give you a straight answer.
The Amazon FBA question — honestly, it is unsettled
The common fact pattern: a non-U.S. seller ships inventory to U.S. fulfillment centers, a marketplace handles storage and delivery, title passes to U.S. buyers in the United States, and the seller has no U.S. employees or office.
You will find firms asserting confidently that this creates no U.S. trade or business, and others asserting equally confidently that it plainly does. Neither position rests on on-point authority.
What is actually true:
- The IRS’s own published guidance states that profit from the sale in the U.S. of inventory property is effectively connected trade or business income. That language cuts toward ECI.
- Where title passes in the U.S., the income is generally U.S.-source — a necessary condition for ECI.
- There is no safe harbor covering inventory or e-commerce sales.
- There is no published ruling, case, or Chief Counsel Advice squarely addressing marketplace fulfillment. The “no U.S. trade or business” position rests on analogy to mid-century cases involving dedicated independent distributors, which are materially different arrangements.
- The IRS generally will not rule on whether a taxpayer is engaged in a U.S. trade or business — it is treated as inherently factual.
So this is a real risk decision, not a settled answer, and it turns on specifics: title and risk-of-loss terms, the degree of the seller’s involvement, the contract with the marketplace or 3PL, and whether any decision-making happens in the U.S.
Anyone who tells you this is obvious in either direction is overstating what the law supports.
Treaties can change the answer
If you are resident in a country with a U.S. income tax treaty, the treaty generally taxes business profits only where they are attributable to a permanent establishment — a narrower test than the domestic U.S. trade or business standard.
Most treaties exclude from permanent establishment status a facility used solely for storage, display or delivery of the enterprise’s goods. That exception is directly relevant to warehouse-based fulfillment.
A useful detail: international efforts narrowed this storage exception through a multilateral instrument, but the United States did not sign it. Most U.S. bilateral treaties therefore retain the broader, older exclusion unless separately renegotiated.
Two conditions apply. You must satisfy the treaty’s limitation on benefits article. And a treaty-based return position must be disclosed on Form 8833 — the narrow exception for FDAP rate reductions does not cover a “no permanent establishment” position. Failing to disclose carries a penalty of $1,000 for individuals and $10,000 for corporations.
The rule that turns a tax problem into a disaster
This is the part most foreign owners have never heard, and it is the strongest argument against waiting to see whether the IRS notices.
Sections 874(a) and 882(c)(2) allow deductions and credits against ECI only if a true and accurate return is filed. The regulations set the outer boundary: where no return was filed for the preceding year, the return must be filed by the earlier of 18 months after its original due date, or the date the IRS mails a notice stating that no deductions will be allowed.
Miss that window and the IRS can deny every deduction — including cost of goods sold — and tax you on gross effectively connected income.
Consider what that does to a distribution business. On $2,000,000 of U.S. sales with $1,700,000 of costs, real profit is $300,000. Denied deductions means tax computed on $2,000,000. The liability can exceed the entire economic profit of the business — several times over.
The protective return
This is the standard answer to genuine uncertainty. Where it is unclear whether you have a U.S. trade or business, you can file a timely protective return — preserving your right to deductions if the IRS later determines ECI existed, without conceding that it does.
For a seller in the unsettled fact pattern above, this is often the proportionate response: it costs relatively little and removes the catastrophic downside, without requiring you to concede a position you believe is correct.
What gets filed
- Foreign individual — Form 1040-NR. Due the 15th day of the 4th month after year end if you had wages subject to U.S. withholding or a U.S. office; otherwise the 15th day of the 6th month.
- Foreign corporation — Form 1120-F, on the same 4th-month / 6th-month split depending on whether there is a U.S. office or place of business.
- Foreign-owned U.S. single-member LLC — the LLC is disregarded, so the owner is the taxpayer and files whichever of the above applies to them.
Foreign corporations face an additional layer: the branch profits tax under Section 884, generally 30% of the dividend equivalent amount, on top of the regular tax on ECI. It exists to neutralize the advantage of operating through a branch rather than a subsidiary, and many treaties reduce the rate.
Two obligations that are independent
This trips up nearly every foreign owner of a U.S. LLC, so it is worth stating flatly:
- Form 5472 is required based on reportable transactions, regardless of income or tax liability. You can owe zero U.S. tax and still have this filing obligation and a $25,000 penalty for missing it. See Form 5472 filing requirements.
- An income tax return is required based on whether you have ECI.
Concluding “I have no ECI, so I have nothing to file” is the single most expensive mistake in this area. The two questions are unrelated.
Frequently asked questions
Does selling to U.S. customers automatically create ECI?
No. Selling to U.S. customers from abroad is different from carrying on a business in the U.S. The analysis turns on where activity occurs, where title passes, and whether the activity is considerable, continuous and regular.
I store inventory in a U.S. warehouse. Do I have ECI?
Unsettled, and fact-dependent. There is no safe harbor and no on-point ruling. If you are treaty-resident, the storage and delivery exception to permanent establishment may protect you even if a domestic U.S. trade or business exists — but that position must be disclosed on Form 8833.
What if I have not filed for several years?
Get it assessed quickly, because the 18-month deduction deadline runs independently of whether the IRS has contacted you. Each year that closes without a return risks converting a manageable tax on profit into a tax on gross receipts.
Is a protective return an admission that I owe tax?
No. It preserves your deductions if the IRS later disagrees with your position, without conceding that ECI exists.
Are there withholding rules I should know about?
Two common ones. A partnership with ECI must withhold on the amount allocable to foreign partners under Section 1446. And a buyer of U.S. real property from a foreign person generally withholds 15% under FIRPTA, with gain on U.S. real property automatically treated as ECI.
Get the analysis done before the deadline decides for you
The uncomfortable feature of this area is that the worst outcome does not come from taking a wrong position. It comes from taking no position and letting the filing window close.
We work with foreign owners of U.S. entities and cross-border sellers nationwide on ECI analysis, treaty positions, protective filings and the related information reporting. Schedule a consultation.
General information current as of publication, not tax advice. Whether you have a U.S. trade or business is highly fact-specific and, for some arrangements, genuinely unsettled.
If you own a U.S. entity as a foreign person, the filing is downstream of the bookkeeping. See how we structure the books to support it on our foreign-owned U.S. business accounting page.
Whether or not a foreign owner has effectively connected income, the reporting obligation stands on its own. A foreign-owned single-member LLC with no ECI and no US tax due still has to file, and the Form 5472 instructions walk through each part of that filing, including the pro forma Form 1120 it has to be attached to.
Talk to an accountant who works in your industry
Precision Accounting & Consulting works with contractors, law firms, medical practices and property owners across the country. If something on this page raised a question about your own books, send it over and we will give you a straight answer.