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Effectively Connected Income

Unlike FDAP income, the United States taxes effectively connected income (“ECI”) on a net basis. Effectively connected income is income that is effectively connected with the conduct of a U.S. trade or business. It also includes gains from the disposition of U.S. real property under FIRPTA, which are treated as ECI.

Generally, when determining whether income constitutes effectively connected income, the IRS employs two tests: (i) the asset-use test; and (ii) the business-activities test. The asset-use test looks to whether the income or gain is derived from assets used in, or held for use in, the conduct of the trade or business in the United States. The business-activities test looks to whether the activities of the trade or business were conducted in the United States and were a material factor in the realization of the income or gain at issue.

What Is Effectively Connected Income?

Written by Jason Freeman | Posted in Effectively Affected Income • Tax Treaties

The United States generally taxes nonresident aliens and foreign corporations on their U.S.-source income. A foreign taxpayer’s U.S.-source income falls into one of two general categories: (i) “fixed or determinable annual or periodical gains, profits, and income” (“FDAP income”) or (ii) income that is “effectively connected” with the conduct of a U.S. trade or business (“ECI”). In this post, we focus on the taxation of FDAP income.

A non-U.S. person is generally taxed on a gross basis and at a 30-percent rate on U.S.-source FDAP income, which is subject to withholding. In many cases, however, FDAP income is subject to a reduced rate of tax, or entirely exempt from tax, under the Code or a bilateral income tax treaty.

What is FDAP Income?

Written by Jason Freeman | Posted in FDAP Income • Tax Treaty Map