NONRESIDENT ALIENS ENGAGED IN A US TRADE OR BUSINESS

Two important definitions determine the US tax consequences to Nonresident Aliens (NRAs) with US source income: "the conduct of a US trade or business" and "effectively connected income." Specifically, in order for an NRA's noninvestment income to be subject to US taxation, the NRA must be considered engaged in a US trade or buiness and must earn income effectively connected with that business.

General criteria for determining if a US trade or business exists include the location of production activities, management, distribution activities, and other business functions. Trading in commodities and securities ordinarily does not constitute a trade or business. Dealers, however, need to avoid maintaining a US trading office and trading for their own accounts. Corporations (other than certain personal holding companies) that are not deealers can trade for thier own accounts. There are no restrictions on individuals who are not dealers.

The Code does not explicitly define a US trade or business, but case law has defined the concept as activities carried on in the US that are regular, substantial, and continuous. Once an NRA is considered engaged in a US trade or business, all US-source income other than fixed, determinable, annual, or periodic income (FDAP) and capital gain income is considered effectively connected to that trade or business and is therefore subject to US taxation.

EXAMPLE: Vito, an NRA, produces wine for export. During the current  year, Vito earns $500,000 from exporting wine to unrelated wholesaler in the US. The title to the wine passes to the US wholesalers in NY. Vito has no offices or employees in the US The income from wine sales is US-source income, but because Vito is not engaged in a US trade or business, the income is not subject to taxation in the US.

Assume that Vito begins operating a hot dot cart in NYC. This activity constitutes a US trade or business. Consequently, all US-source income other tha FDAP or capital gain income will be taxed in the US as income effectively connected with a US trade or business. Thus, both the hot dog cart profits and the $500,000 in wine income will be taxed in the US.

FDAP and capital gain income may be considered effectively connected income if the assets that generate this income are used in, or held for use in, the trade or busines (the asset-use test) or if the activities of the trade or business are a material factor in the production of the income (the business-activities test). As long as FDAP and capital gain income are not effectively connected with a US trade or business, the tax treatment of these income items is the same whhther NRSs are engaged in a US trade or business or not.

EXAMPLE: Ingrid, an NRA, operates a US business. During the year, cash funds accumulate. Ingrid invests these funds opn a short-term basis so that they remain available to meet her business needs. Under the asset-use test, any income earned from these investments is effectively connected income.

Effectively connected income is taxed at the same rates that apply to US citizens and residents, and deductions for expenses attributable to that income are allowed. NRAs with effectively connected income are allowed a deduction for casualty and theft losses related to property located within the US, a deduction for qualified charitable contributions, and one personal exemption. NRAs with income effectively connected with the conduct of a US trade or business may also be subject to the AMT.

NONRESIDENT ALIENS NOT ENGAGED IN A US TRADE OR BUSINESS

Certain US-source income that is not effectively connected with the conduct of a US trade or business is subject to a flat 30% tax. This income includes dividends, interest, rents, royalties, certain compensation, premiums, annuities, and other fixed, determinable, annual or periodic (FDAP) income. This tax generally is levied by a withholding mechanism that requires the payors of the income to withhold 30% of gross amounts. This method eliminates the problems of assuring payment by nonresidents, determining allowable deductions, and, in most instances, the filing of tax returns by nonresidents. Interest received from certain portfolio debt investments, even though US-sourced is exempt from taxation. Interest earned on deposits with banking institutions is also exempt as long as it is no effectively connected with the conduct of a US trade or business.

Capital gains not effectively connected with the conduct of a US trade or business are exempt from tax, as long as the NRA individual was not present int he US for 183 days or more during the taxable year. If an NRA has not established a taxable year, the calendar year is used. NRAs are not permitted to carry forward capital losses.

I hope this helps.