Effectively Connected Income
Under most circumstances, a foreign person that engages in a trade or business in the United States will have what’s called Effectively Connected Income (ECI) with regard to all income generated from that business in the United States.
Engaging in a trade or business means any services performed within the United States. There are categories that the IRS mentions which help in determining whether one is engaged in a “trade or business”. According to the IRS, the following will create ECI:
- Is the person engaged in providing services or selling products within the United States?
- Is this person running a business that performs services or providing products in the United States?
- Did the person at anytime during the year generate a gain or loss on the sale of real property within the United States?
While this list does not cover every scenario, certain types of income never generate ECI. Income that is considered “fixed, determinable, annual or periodic” (FDAP) does not create ECI. Examples of FDAP income include:
- Rents
- Royalties
- Pension income
- Interest
- Dividends
Income categorized as FDAP is always subject to a 30% tax, usually withheld by the payee. Unlike FDAP, once a person is designated as having ECI, rather than be subjected to a fixed withholding rate of 30%, this person will be allowed to take deductions (usually ordinary and necessary expenses) and pay tax at graduated rates.