US Individual Income Tax Rates
Generally, income consists of compensation from employment services, interest and dividends, income or loss from self-employment, capital gains and losses, rents and royalties and income or loss from pass-through entities. Allowable deductions include medical expenses, home mortgage and investment interest, state, local and real estate taxes, casualty losses, charitable contributions and other business and investment-related miscellaneous deductions.
Limitations exist for the amount of losses and deductions that may be claimed by a taxpayer. Most deduction limitations are based upon the income levels of the individual.
Income tax rates vary depending upon the filing status of the taxpayer. The five categories of filing status are:
(1) single
(2) married filing a joint return
(3) married filing separate returns
(4) head of household
(5) qualifying widow(er) with dependent child.
The current maximum tax rate is 35%.
The US requires employers to withhold federal and state income taxes, social security and Medicare from an employee's salary. These taxes must be remitted to the government on a periodic basis. Self-employed individuals are required to make quarterly estimated payments equal to at least 90% of their actual tax liability in most cases. Higher income individuals may need to pay in 100% of the current year's tax or 110% of the prior year's tax. Penalties and interest may be assessed for underpayment of these taxes.
Special tax rates apply to capital gains and dividend income of individuals. The rate is based on the length of time that the asset is held as well as the type of capital asset. Many dividends also receive a preferential tax rate. Non-resident individuals are typically subject to tax on income from US sources and are generally not taxed on US source capital gains unless the gains are directly or indirectly related to sales of US real property. Many non-resident individuals do not receive preferential tax rates on dividend income.
In addition to the regular income tax, individuals may also be liable for other taxes on their tax returns. These taxes include the alternative minimum tax (AMT), selfemployment tax, social security and Medicare tax and qualified retirement plan tax.
Most states and some municipalities also impose income taxes that vary in rates and bases. The US imposes other taxes on individuals such as gift tax and estate tax.
Residence – Aliens who have entered the U.S. as permanent residents and who have not officially surrendered or lost the right to permanent U.S. residence are taxed as U.S. residents. Also taxed as residents are individuals who meet a "substantial presence test", which requires, subject to further considerations, either physical presence in the U.S. for 183 days or more during a calendar year, or at least 31 days during a calendar year and a cumulative presence of 183 days or more based on a weighted number of days during the calendar year (taken at whole value) and the 2 immediately preceding calendar years (taken at 1/3 value for the first preceding calendar year and at 1/6 for the second).
Taxable income – Individuals generally must include nearly all gross income from whatever source derived in their taxable income (including in their compensation for services all forms of remuneration and allowances and the value of other perquisites that are not specifically exempted, fees and commissions, dividends, interest, royalties, rents, gains from dealings in property and income from a partnership). Nonresident aliens exclude non-ECI in computing taxable income and are subject to U.S. tax on the gross amounts of such income, generally collected on receipt via withholding, if the income is from U.S. sources and not from the sale or exchange of property.
Capital gains – The excess of net long-term capital gains (generally, gains from investments held for more than 12 months) over net short-term capital losses (net capital gains) is generally taxed at a maximum rate of 15%. Present law provides for higher rates on net capital gains recognized in taxable years beginning after 2010. The net capital gains rate is also applicable to dividends received in 2010 from domestic corporations generally and from certain foreign corporations.
Real property tax – Tax generally is imposed by the local governments at various rates.
Inheritance/estate tax – Estate tax and gift tax have long been imposed by the federal government, although the estate tax has "expired" effective for decedents dying after 2009 and before 2011. Legislation (including potentially retroactive legislation) to reinstate the federal estate tax for 2010 is anticipated.
For U.S. citizens and residents, the estate tax is assessed based on all assets of the deceased. A gift tax is imposed on gifts made during a person's life. For nonresident noncitizens, the taxes are imposed only to the extent of property situated in the U.S., and may be reduced by treaty. There are U.S. estate and gift tax treaties in force with over a dozen countries. In most cases, the gift tax only applies for aggregate gifts to any 1 person in a year in excess of an annual exclusion amount. As part of its overall transfer tax system, the U.S. imposes a generation-skipping tax on certain transfers. The states also impose various estate or inheritance taxes.
U.S. individual income tax rates are progressive
up to 35%, but limited to a maximum of 15% for certain 2010 capital gains
(see above). The applicable tax rate will depend on the amount of taxable income
and the return filing status of the taxpayer. Present law provides for higher
rates (to include a top rate of 39.6%) for income received in taxable years
beginning after 2010.
US citizens and other resident individuals are
subject to the same tax rules. Taxes are assessed on worldwide income reduced by
certain adjustments, deductions and exemptions. Non-resident individuals are
generally subject to tax on their income from US sources. Certain credits are
available to reduce the tax computed.
Generally, income consists of compensation from employment services, interest and dividends, income or loss from self-employment, capital gains and losses, rents and royalties and income or loss from pass-through entities. Allowable deductions include medical expenses, home mortgage and investment interest, state, local and real estate taxes, casualty losses, charitable contributions and other business and investment-related miscellaneous deductions.
Limitations exist for the amount of losses and deductions that may be claimed by a taxpayer. Most deduction limitations are based upon the income levels of the individual.
Income tax rates vary depending upon the filing status of the taxpayer. The five categories of filing status are:
(1) single
(2) married filing a joint return
(3) married filing separate returns
(4) head of household
(5) qualifying widow(er) with dependent child.
The current maximum tax rate is 35%.
The US requires employers to withhold federal and state income taxes, social security and Medicare from an employee's salary. These taxes must be remitted to the government on a periodic basis. Self-employed individuals are required to make quarterly estimated payments equal to at least 90% of their actual tax liability in most cases. Higher income individuals may need to pay in 100% of the current year's tax or 110% of the prior year's tax. Penalties and interest may be assessed for underpayment of these taxes.
Special tax rates apply to capital gains and dividend income of individuals. The rate is based on the length of time that the asset is held as well as the type of capital asset. Many dividends also receive a preferential tax rate. Non-resident individuals are typically subject to tax on income from US sources and are generally not taxed on US source capital gains unless the gains are directly or indirectly related to sales of US real property. Many non-resident individuals do not receive preferential tax rates on dividend income.
In addition to the regular income tax, individuals may also be liable for other taxes on their tax returns. These taxes include the alternative minimum tax (AMT), selfemployment tax, social security and Medicare tax and qualified retirement plan tax.
Most states and some municipalities also impose income taxes that vary in rates and bases. The US imposes other taxes on individuals such as gift tax and estate tax.
Residence – Aliens who have entered the U.S. as permanent residents and who have not officially surrendered or lost the right to permanent U.S. residence are taxed as U.S. residents. Also taxed as residents are individuals who meet a "substantial presence test", which requires, subject to further considerations, either physical presence in the U.S. for 183 days or more during a calendar year, or at least 31 days during a calendar year and a cumulative presence of 183 days or more based on a weighted number of days during the calendar year (taken at whole value) and the 2 immediately preceding calendar years (taken at 1/3 value for the first preceding calendar year and at 1/6 for the second).
Taxable income – Individuals generally must include nearly all gross income from whatever source derived in their taxable income (including in their compensation for services all forms of remuneration and allowances and the value of other perquisites that are not specifically exempted, fees and commissions, dividends, interest, royalties, rents, gains from dealings in property and income from a partnership). Nonresident aliens exclude non-ECI in computing taxable income and are subject to U.S. tax on the gross amounts of such income, generally collected on receipt via withholding, if the income is from U.S. sources and not from the sale or exchange of property.
Capital gains – The excess of net long-term capital gains (generally, gains from investments held for more than 12 months) over net short-term capital losses (net capital gains) is generally taxed at a maximum rate of 15%. Present law provides for higher rates on net capital gains recognized in taxable years beginning after 2010. The net capital gains rate is also applicable to dividends received in 2010 from domestic corporations generally and from certain foreign corporations.
Real property tax – Tax generally is imposed by the local governments at various rates.
Inheritance/estate tax – Estate tax and gift tax have long been imposed by the federal government, although the estate tax has "expired" effective for decedents dying after 2009 and before 2011. Legislation (including potentially retroactive legislation) to reinstate the federal estate tax for 2010 is anticipated.
For U.S. citizens and residents, the estate tax is assessed based on all assets of the deceased. A gift tax is imposed on gifts made during a person's life. For nonresident noncitizens, the taxes are imposed only to the extent of property situated in the U.S., and may be reduced by treaty. There are U.S. estate and gift tax treaties in force with over a dozen countries. In most cases, the gift tax only applies for aggregate gifts to any 1 person in a year in excess of an annual exclusion amount. As part of its overall transfer tax system, the U.S. imposes a generation-skipping tax on certain transfers. The states also impose various estate or inheritance taxes.
US Corporate Tax Rates
A flat tax of 35% applies to the taxable
income of a corporation that has taxable income for the year equal to or greater
than USD 18,333,333. Graduated rates, starting as low as 15%, apply to income of
a corporation with total taxable income less than USD 18,333,333. The gradations
in the rate brackets that apply to a single corporation's progressive amounts of
income phase out as the corporation's total taxable income rises from USD
100,000 to USD 18,333,333. For this purpose, members of a controlled group of
corporations are treated similarly to a single corporation.
US Corporate Tax Rates :
Taxable Income (US$) / Tax US$ + Tax Rate % of excess
$0 - $50,000 15%
$50,000 - $75,000 $7,500 + 25% of excess over $50,000
$75,000 - $100,000 $13,750 + 34% of excess over $75,000
$100,000 - $335,000 $22,250 + 39% of excess over $100,000
$335,000 - $10,000,000 $113,900 + 34% of excess over $335,000
$10,000,000 - $15,000,000 $3,400,000 + 35% of excess over $10,000,000
$15,000,000 - $18,333,333 $5,150,000 + 38% of excess over $15,000,000
Over $18,333,333 Flat 35%
U.S.Company tax is payable by all corporate entities, except for certain exempt organisations and pass-through corporations subject to special rules. Corporations incorporated in the US are subject to tax on their worldwide income and foreign corporations are generally only subject to tax on their income effectively connected to a US trade or business.
Generally, a corporation is required to prepay its estimated tax liability in four instalments. Penalties may be assessed if estimated instalments are less than 100% of the actual liability.
The US imposes income taxation at both the business and personal levels. Corporate earnings, taxed first to the corporation and again later when distributed as dividends to shareholders, may be taxed at a combined federal rate exceeding 45%. Therefore, business is increasingly being conducted through flow-through entities such as traditional partnerships, limited liability companies (LLC), and certain tax-election corporations ('S corporations'). S corporations may not have non-resident individuals or corporations as shareholders. Foreign-owned businesses in the US may not derive as much benefit from these structures as domestic businesses due to the interaction of US withholding and branch profits taxes.
US flow-through entities are often used by non-US persons as holding companies for US and non-US businesses and assets. Significant planning opportunities are available for both US domestic and foreign taxpayers through the use of 'hybrid' entities. These companies are treated as flow-through entities by one jurisdiction and as taxable entities by another. US rules are often flexible in allowing US taxpayers to select the desired tax status of the entity under the "check-the-box" regime.
Corporate tax returns and payments are due by the 15th day of the third month following the end of the fiscal year. Calendar year taxpayers must file by 15 March. An automatic extension of six months may be granted if requested by the original due date of the return. Extensions to file a return, however, do not extend the time for payment of tax due.
CAPITAL GAINS TAX
For corporations, the excess of the net gains from the sale of capital assets over net losses from the sale of assets or net capital gains is taxed at the same rates applicable to ordinary income. However, capital losses may only be used to offset capital gains and the excess of losses over gains may be carried back three years or forward five years. Losses must be applied to the earliest carry back year before any carry forwards may be used.
ALTERNATIVE MINIMUM TAX (AMT)
The US imposes an alternative minimum tax on certain corporations at a rate of 20%. The AMT income is derived from regular taxable income adjusted by specified items that received preferential treatment under the regular tax system. Such 'tax preference' items may include accelerated depreciation, depletion and intangible drilling costs. The AMT is imposed if the tax on the alternative minimum taxable income is greater than the regular tax. It does not apply to small corporations, defined as corporations with less than US$7.5 million of average annual gross receipts over a three-year period.
BRANCH PROFITS TAX
The tax on a foreign corporation's US branch's profits and earnings is the same as regular corporate tax, except that an additional 30% branch level tax (BLT) is imposed upon the after-tax earnings of the US branch that are not reinvested in the business by the close of the tax year or that are repatriated in a later tax year. The branch level taxable base is adjusted for any changes in the net equity of the US branch. The BLT may be reduced or eliminated by any relevant tax treaties or replaced by the secondary withholding tax.
In addition to the branch profits tax, a branch level interest tax is imposed at 30% of any interest paid by the US branch to a foreign entity not engaged in the same business activity. The tax also is assessed on any excess interest deducted on the US tax return over the amount actually paid.
SALES TAX
Sales taxes are imposed at the state and municipality levels and vary in rates and in bases. In general, sales tax is imposed on tangible goods sold to the final consumer.
A use tax is imposed on goods purchased for use in a business but only when no sales tax has been collected. Generally, vendors must register and collect sales tax in states where they are considered to be 'doing business'. The question of whether sellers are required to collect and pay sales taxes on sales of goods and services ordered via the internet or other electronic means is currently unsettled in the US.
Foreign sellers who merely ship products ordered over the internet to the US will typically not be subject to state and local taxation although many states are becoming increasingly aggressive in this area.
VALUE ADDED TAX (VAT)
The US does not impose any VAT.
FRINGE BENEFITS TAX (FBT)
The US does not impose any corporate level taxes on fringe benefits provided to its employees. However, certain fringe benefits are taxable to employees receiving the benefits and are required to be reported on their personal income tax returns.
The US does require employers and employees to pay certain payroll related taxes including:
(1) a portion of an employee's Social Security (FICA), taxable at 6.2% of the wage base ( currently $106,800, annually adjusted)
(2) federal unemployment tax (FUTA) at 6.2% of the first $7,000 of wages (less credits of up to 5.4% for state unemployment tax)
(3) state unemployment tax (SUT) which varies from state to state
(4) Medicare at 1.45% of total wages paid.
LOCAL TAXES
Most states and some municipalities of the US impose income taxes on corporations. Rates vary as do the tax bases. Most states allow income to be apportioned to a state if business is conducted in more than one state. Historically, a three-factor formula consisting of tangible assets, sales and receipts, and payroll has generally been used. However, many states are moving to formulas that are more heavily weighted to sales. Most states begin with federal taxable income in the computation of their taxable base but many states require adjustments to calculate taxable income for their purposes.
Several states have imposed a tax on gross margin or gross sales in lieu of a tax on net income. It is also important to note that state income taxes are not subject to the provisions of the various US income tax treaties and that, therefore, some states consider foreign companies to be subject to their state income tax even if the company is not subject to US federal income tax. It is also important to note that foreign sellers may be subject to other states taxes such as sales tax even if not subject to state or local income taxes.
Other taxes that may be levied at the state level include real and personal property tax, franchise tax, intangibles tax, transfer tax, and tax on capital. Taxes paid to the states and municipalities are deductible on the federal income tax return in the year paid or accrued.
OTHER TAXES
In addition to corporation income taxes, the US also imposes the following taxes.
ACCUMULATED EARNINGS TAX
Corporations accumulating over US$250,000 of prior and current period earnings and profits may be subject to this tax. The tax is imposed at a rate of 15% on 'accumulated taxable income'. The amount of accumulated taxable income subject to tax is reduced by earnings retained for the reasonable needs of the business.
PERSONAL HOLDING COMPANY (PHC) TAX
Closely-held corporations that receive substantial income from passive activities and do not distribute this income to shareholders are subject to the PHC tax. The tax is imposed at a rate of 15% on the undistributed income. This tax is in addition to the regular corporate tax.
DETERMINATION OF TAXABLE INCOME
Corporate taxable income is determined by ascertaining assessable gross income and reducing it by allowable deductions. Allowable deductions must be segregated into ordinary and special deductions. Corporations are taxed at the entity level.
For flow-through entities such as partnerships, limited liability companies and S corporations, taxable income is determined in a similar fashion. However, each entity flows through the income or loss and special deductions to its shareholders / members / partners who are taxed on their own returns.
DEPRECIATION AND DEPLETION
Property, plant and equipment may be written off over its effective useful life as established under a statutory cost recovery system. For property acquired or placed in service after 31 December 1986, the capitalised costs must be depreciated using the Modified Accelerated Cost Recovery System (MACRS) over a life of three to 39 years. Most tangible property is in the three, five and seven year category while real property is categorised as 27.5 or 39 year property. However, depreciation on certain components of buildings and real property improvements can be accelerated to shorter lives through the use of cost segregation studies designed to identify the proper categorisation of costs for tax asset classification purposes. Recently enacted tax law provides for a 15-year recovery period for qualified leasehold improvements and restaurant property placed in service before 1 January 2010.
For some smaller corporations, an election may be made to treat the cost of $134,000 of assets as an expense rather than as a capital expenditure. The maximum deduction is US $250,000 and is limited to taxable income determined without regard to the above election. This expense benefit is phased out if qualified purchases exceed a certain threshold amount (US $530,000).
A deduction for depletion is allowable for expenditures on natural resources. Generally, depletion may be calculated using either a cost or percentage method. Cost depletion is based on the adjusted basis of the property and an estimate of the number of units that make up the deposit and the number of units extracted during the year.
Under the percentage depletion method, a flat percentage of gross income is taken as the depletion deduction. It may not exceed 50% (100% for oil and gas properties) of the taxable income from the property before the depletion deduction. For independent oil and gas producers and royalty owners, the depletion deduction may not exceed 65% of the taxpayer's taxable income.
STOCK INVENTORY
Inventories are generally stated at the lower of cost or market value on the first in, first out (FIFO) method or cost only on the last in, first out (LIFO) method.
Uniform capitalisation rules may require the inclusion in inventory or capital accounts of certain otherwise deductible indirect and administrative costs incurred for real or personal property produced or acquired for resale.
CAPITAL GAIN AND LOSSES
See discussion above.
DIVIDENDS
A US corporation is entitled to a special deduction for dividends received from other domestic corporations. A deduction is allowed for 70% of the dividends received from corporations owned less than 20% by the recipient corporation. The deduction increases to 80% if the corporation is owned more than 20% but less than 80% by the recipient corporation and increases to 100% if the ownership is 80% or more. With some exceptions, dividends from foreign corporations are 100% taxable.
INTEREST DEDUCTIONS
A taxpayer generally may deduct business interest paid or accrued within the tax year on indebtedness. However, such debt must pertain to the debt of the taxpayer and must result from a genuine debtor-creditor relationship. Numerous exceptions and limitations exist regarding the deductibility of interest. For example, if a corporation's debt to equity ratio exceeds 1.5 to 1, then interest expense deductions on certain related party debt may be disallowed or deferred.
LOSSES
Generally, net operating losses from a trade or business may be carried back two years or forward 20 years to be applied against taxable income. A successor corporation may use carryovers of a predecessor to a limited extent in a change of ownership, a subsidiary liquidation or a specified reorganisation. Special rules apply to 2008 and 2009 losses which extend the carry back period if certain conditions are met.
FOREIGN SOURCE INCOME
US corporations are taxed on worldwide income, including any foreign branch income. To avoid any double taxation, foreign tax deductions or credits are available on the US return. Where US shareholders have more than a 50% interest in a foreign subsidiary, certain income of the foreign subsidiary may be taxed as if received directly by the US shareholder. Other special rules apply to certain types of foreign corporations with US shareholders.
INVESTMENT TAX CREDIT
The Investment Credit comprises four components:
(1) the rehabilitation credit
(2) the energy credit
(3) the qualifying advanced coal project credit and
(4) the qualifying gasification project credit.
For flow-through entities, the credits must be allocated to the individual partners / shareholders on a pro rata basis. Generally, the credit is 10% of qualifying expenses (20% in the case of certified historic structures).It should be noted that no investment credit is allowed for investment credit property to the extent it is financed with nonqualified non-recourse debt.
TAX INCENTIVES
In addition to investment tax credits, other preferential tax incentives are available for activities such as those related to export, activities engaged in US possessions, qualified private activity bonds, research and development expenditures, and for hiring certain specified individuals. Also, a deduction is available for certain manufacturing/production activities.
OTHER
Other issues that need to be mentioned include the following:
(1) Deductions are allowable for charitable contributions but for corporations may not exceed 10% of taxable income computed without regard to the contributions. Excess contributions may be carried forward for five years.
(2) Organisational and business start-up expenditures are deductible up to $5,000, subject to certain limitations and the remainder must be written off over 180 months.
(3) Meals and entertainment expenses are limited to 50% of expenses incurred in most circumstances. Certain entertainment expenses are entirely nondeductible.
(4) Bad debts, except for certain financial institutions, are deductible only under the specific method for receivables that become uncollectible in whole or in part during the tax year.
(5) Life insurance premiums paid on key employees are deductible only to the extent that they are:
(a) included in the employees' compensation
(b) not unreasonable in amount
(c) the employer is not directly or indirectly a beneficiary.
FOREIGN TAX RELIEF
A US corporation or a foreign corporation engaged in business in US may elect to claim either a credit or a deduction for income taxes paid to another country if the taxes are connected with or related to its business and if the income is also taxed by the US. Generally, the tax credit is available only if such foreign tax is based on foreign source income. The tax credit may not reduce the US tax liability on income from US sources. Any credit unusable in one year may be carried back to the prior year and forward ten years.
CORPORATE GROUPS
Affiliated groups of US corporations (parent has 80% ownership) are permitted to offset the losses of one affiliate against the profits of another via the filing of consolidated federal income tax returns. State and local rules vary from federal rules in this regard and may not permit loss offsetting. Some may also require, alternatively, that returns are filed to include results of all related companies, including companies that are not includable in a federal consolidated income tax return.
RELATED PARTY TRANSACTIONS
Related party transactions negotiated at arm's length are treated the same as nonrelated party transactions. However, in general, a deduction may not be taken by one party until the transaction has been included in gross income by the other party. The Internal Revenue Service may make any adjustments necessary to reflect the income of the related parties.
For multi-national groups, additional emphasis is placed on the 'transfer price' among members of the group. Several methods are provided to determine a proper arm's length price including the use of unrelated third party comparables, the comparable profits and the profit split methods. Significant compliance burdens now apply in these situations. Failure to maintain contemporaneous documentation of pricing determinations could result in substantial penalties (up to 40% of the tax due). US regulations require taxpayers to conduct transfer pricing studies to determine the 'best method' under the applicable circumstances.
Transfer pricing determinations must often meet standards in multiple jurisdictions. US rules for determining transfer pricing may vary from the rules of other countries that have introduced transfer pricing standards and from OECD guidelines. US states are increasingly interested in both multi-national and multi-state transfer pricing and may at times take positions differing from those of the Internal Revenue Service.
WITHHOLDING TAXES – NON-US PAYEES
Taxes are required to be withheld from portfolio dividends, interest, rents, and royalties, and certain other types of income paid to non-US payees. The statutory rate is 30% but reduced rates may apply if the recipient is a resident of a treaty country. Foreign persons or entities may also be exempted from withholding if the US source income is connected with conduct of a trade or business in the US. This exemption is not available unless the foreign recipient provides notice to the US payor prior to payment. Portfolio interest is exempt from withholding. Portfolio interest includes interest earned on US bank deposits and portfolio debt obligations.
Special withholding tax rules apply to non-US partners in US partnerships and non-US members of an LLC that conducts a trade or business in the US. A 35% withholding tax rate is applied to a foreign partner's (whether an individual or corporation) current year US source income. Special withholding tax rules also apply to direct or indirect sales or other dispositions of US real property by foreigners. A 10% withholding rate applies to the gross amount realised or sales price on the disposition unless specific permission is granted for a reduction.
EXCHANGE CONTROL
No direct exchange controls exist. Transactions in currency of $10,000 or more must be reported to the Internal Revenue Service. Multiple related transactions must be treated as a single transaction for disclosure purposes. The direct or indirect transportation of currency or other monetary instruments exceeding $10,000 to a foreign jurisdiction must also be reported. Transfers through normal banking procedures that do not involve the physical transportation of currency are not required to be disclosed.
US Corporate Tax Rates :
Taxable Income (US$) / Tax US$ + Tax Rate % of excess
$0 - $50,000 15%
$50,000 - $75,000 $7,500 + 25% of excess over $50,000
$75,000 - $100,000 $13,750 + 34% of excess over $75,000
$100,000 - $335,000 $22,250 + 39% of excess over $100,000
$335,000 - $10,000,000 $113,900 + 34% of excess over $335,000
$10,000,000 - $15,000,000 $3,400,000 + 35% of excess over $10,000,000
$15,000,000 - $18,333,333 $5,150,000 + 38% of excess over $15,000,000
Over $18,333,333 Flat 35%
U.S.Company tax is payable by all corporate entities, except for certain exempt organisations and pass-through corporations subject to special rules. Corporations incorporated in the US are subject to tax on their worldwide income and foreign corporations are generally only subject to tax on their income effectively connected to a US trade or business.
Generally, a corporation is required to prepay its estimated tax liability in four instalments. Penalties may be assessed if estimated instalments are less than 100% of the actual liability.
The US imposes income taxation at both the business and personal levels. Corporate earnings, taxed first to the corporation and again later when distributed as dividends to shareholders, may be taxed at a combined federal rate exceeding 45%. Therefore, business is increasingly being conducted through flow-through entities such as traditional partnerships, limited liability companies (LLC), and certain tax-election corporations ('S corporations'). S corporations may not have non-resident individuals or corporations as shareholders. Foreign-owned businesses in the US may not derive as much benefit from these structures as domestic businesses due to the interaction of US withholding and branch profits taxes.
US flow-through entities are often used by non-US persons as holding companies for US and non-US businesses and assets. Significant planning opportunities are available for both US domestic and foreign taxpayers through the use of 'hybrid' entities. These companies are treated as flow-through entities by one jurisdiction and as taxable entities by another. US rules are often flexible in allowing US taxpayers to select the desired tax status of the entity under the "check-the-box" regime.
Corporate tax returns and payments are due by the 15th day of the third month following the end of the fiscal year. Calendar year taxpayers must file by 15 March. An automatic extension of six months may be granted if requested by the original due date of the return. Extensions to file a return, however, do not extend the time for payment of tax due.
CAPITAL GAINS TAX
For corporations, the excess of the net gains from the sale of capital assets over net losses from the sale of assets or net capital gains is taxed at the same rates applicable to ordinary income. However, capital losses may only be used to offset capital gains and the excess of losses over gains may be carried back three years or forward five years. Losses must be applied to the earliest carry back year before any carry forwards may be used.
ALTERNATIVE MINIMUM TAX (AMT)
The US imposes an alternative minimum tax on certain corporations at a rate of 20%. The AMT income is derived from regular taxable income adjusted by specified items that received preferential treatment under the regular tax system. Such 'tax preference' items may include accelerated depreciation, depletion and intangible drilling costs. The AMT is imposed if the tax on the alternative minimum taxable income is greater than the regular tax. It does not apply to small corporations, defined as corporations with less than US$7.5 million of average annual gross receipts over a three-year period.
BRANCH PROFITS TAX
The tax on a foreign corporation's US branch's profits and earnings is the same as regular corporate tax, except that an additional 30% branch level tax (BLT) is imposed upon the after-tax earnings of the US branch that are not reinvested in the business by the close of the tax year or that are repatriated in a later tax year. The branch level taxable base is adjusted for any changes in the net equity of the US branch. The BLT may be reduced or eliminated by any relevant tax treaties or replaced by the secondary withholding tax.
In addition to the branch profits tax, a branch level interest tax is imposed at 30% of any interest paid by the US branch to a foreign entity not engaged in the same business activity. The tax also is assessed on any excess interest deducted on the US tax return over the amount actually paid.
SALES TAX
Sales taxes are imposed at the state and municipality levels and vary in rates and in bases. In general, sales tax is imposed on tangible goods sold to the final consumer.
A use tax is imposed on goods purchased for use in a business but only when no sales tax has been collected. Generally, vendors must register and collect sales tax in states where they are considered to be 'doing business'. The question of whether sellers are required to collect and pay sales taxes on sales of goods and services ordered via the internet or other electronic means is currently unsettled in the US.
Foreign sellers who merely ship products ordered over the internet to the US will typically not be subject to state and local taxation although many states are becoming increasingly aggressive in this area.
VALUE ADDED TAX (VAT)
The US does not impose any VAT.
FRINGE BENEFITS TAX (FBT)
The US does not impose any corporate level taxes on fringe benefits provided to its employees. However, certain fringe benefits are taxable to employees receiving the benefits and are required to be reported on their personal income tax returns.
The US does require employers and employees to pay certain payroll related taxes including:
(1) a portion of an employee's Social Security (FICA), taxable at 6.2% of the wage base ( currently $106,800, annually adjusted)
(2) federal unemployment tax (FUTA) at 6.2% of the first $7,000 of wages (less credits of up to 5.4% for state unemployment tax)
(3) state unemployment tax (SUT) which varies from state to state
(4) Medicare at 1.45% of total wages paid.
LOCAL TAXES
Most states and some municipalities of the US impose income taxes on corporations. Rates vary as do the tax bases. Most states allow income to be apportioned to a state if business is conducted in more than one state. Historically, a three-factor formula consisting of tangible assets, sales and receipts, and payroll has generally been used. However, many states are moving to formulas that are more heavily weighted to sales. Most states begin with federal taxable income in the computation of their taxable base but many states require adjustments to calculate taxable income for their purposes.
Several states have imposed a tax on gross margin or gross sales in lieu of a tax on net income. It is also important to note that state income taxes are not subject to the provisions of the various US income tax treaties and that, therefore, some states consider foreign companies to be subject to their state income tax even if the company is not subject to US federal income tax. It is also important to note that foreign sellers may be subject to other states taxes such as sales tax even if not subject to state or local income taxes.
Other taxes that may be levied at the state level include real and personal property tax, franchise tax, intangibles tax, transfer tax, and tax on capital. Taxes paid to the states and municipalities are deductible on the federal income tax return in the year paid or accrued.
OTHER TAXES
In addition to corporation income taxes, the US also imposes the following taxes.
ACCUMULATED EARNINGS TAX
Corporations accumulating over US$250,000 of prior and current period earnings and profits may be subject to this tax. The tax is imposed at a rate of 15% on 'accumulated taxable income'. The amount of accumulated taxable income subject to tax is reduced by earnings retained for the reasonable needs of the business.
PERSONAL HOLDING COMPANY (PHC) TAX
Closely-held corporations that receive substantial income from passive activities and do not distribute this income to shareholders are subject to the PHC tax. The tax is imposed at a rate of 15% on the undistributed income. This tax is in addition to the regular corporate tax.
DETERMINATION OF TAXABLE INCOME
Corporate taxable income is determined by ascertaining assessable gross income and reducing it by allowable deductions. Allowable deductions must be segregated into ordinary and special deductions. Corporations are taxed at the entity level.
For flow-through entities such as partnerships, limited liability companies and S corporations, taxable income is determined in a similar fashion. However, each entity flows through the income or loss and special deductions to its shareholders / members / partners who are taxed on their own returns.
DEPRECIATION AND DEPLETION
Property, plant and equipment may be written off over its effective useful life as established under a statutory cost recovery system. For property acquired or placed in service after 31 December 1986, the capitalised costs must be depreciated using the Modified Accelerated Cost Recovery System (MACRS) over a life of three to 39 years. Most tangible property is in the three, five and seven year category while real property is categorised as 27.5 or 39 year property. However, depreciation on certain components of buildings and real property improvements can be accelerated to shorter lives through the use of cost segregation studies designed to identify the proper categorisation of costs for tax asset classification purposes. Recently enacted tax law provides for a 15-year recovery period for qualified leasehold improvements and restaurant property placed in service before 1 January 2010.
For some smaller corporations, an election may be made to treat the cost of $134,000 of assets as an expense rather than as a capital expenditure. The maximum deduction is US $250,000 and is limited to taxable income determined without regard to the above election. This expense benefit is phased out if qualified purchases exceed a certain threshold amount (US $530,000).
A deduction for depletion is allowable for expenditures on natural resources. Generally, depletion may be calculated using either a cost or percentage method. Cost depletion is based on the adjusted basis of the property and an estimate of the number of units that make up the deposit and the number of units extracted during the year.
Under the percentage depletion method, a flat percentage of gross income is taken as the depletion deduction. It may not exceed 50% (100% for oil and gas properties) of the taxable income from the property before the depletion deduction. For independent oil and gas producers and royalty owners, the depletion deduction may not exceed 65% of the taxpayer's taxable income.
STOCK INVENTORY
Inventories are generally stated at the lower of cost or market value on the first in, first out (FIFO) method or cost only on the last in, first out (LIFO) method.
Uniform capitalisation rules may require the inclusion in inventory or capital accounts of certain otherwise deductible indirect and administrative costs incurred for real or personal property produced or acquired for resale.
CAPITAL GAIN AND LOSSES
See discussion above.
DIVIDENDS
A US corporation is entitled to a special deduction for dividends received from other domestic corporations. A deduction is allowed for 70% of the dividends received from corporations owned less than 20% by the recipient corporation. The deduction increases to 80% if the corporation is owned more than 20% but less than 80% by the recipient corporation and increases to 100% if the ownership is 80% or more. With some exceptions, dividends from foreign corporations are 100% taxable.
INTEREST DEDUCTIONS
A taxpayer generally may deduct business interest paid or accrued within the tax year on indebtedness. However, such debt must pertain to the debt of the taxpayer and must result from a genuine debtor-creditor relationship. Numerous exceptions and limitations exist regarding the deductibility of interest. For example, if a corporation's debt to equity ratio exceeds 1.5 to 1, then interest expense deductions on certain related party debt may be disallowed or deferred.
LOSSES
Generally, net operating losses from a trade or business may be carried back two years or forward 20 years to be applied against taxable income. A successor corporation may use carryovers of a predecessor to a limited extent in a change of ownership, a subsidiary liquidation or a specified reorganisation. Special rules apply to 2008 and 2009 losses which extend the carry back period if certain conditions are met.
FOREIGN SOURCE INCOME
US corporations are taxed on worldwide income, including any foreign branch income. To avoid any double taxation, foreign tax deductions or credits are available on the US return. Where US shareholders have more than a 50% interest in a foreign subsidiary, certain income of the foreign subsidiary may be taxed as if received directly by the US shareholder. Other special rules apply to certain types of foreign corporations with US shareholders.
INVESTMENT TAX CREDIT
The Investment Credit comprises four components:
(1) the rehabilitation credit
(2) the energy credit
(3) the qualifying advanced coal project credit and
(4) the qualifying gasification project credit.
For flow-through entities, the credits must be allocated to the individual partners / shareholders on a pro rata basis. Generally, the credit is 10% of qualifying expenses (20% in the case of certified historic structures).It should be noted that no investment credit is allowed for investment credit property to the extent it is financed with nonqualified non-recourse debt.
TAX INCENTIVES
In addition to investment tax credits, other preferential tax incentives are available for activities such as those related to export, activities engaged in US possessions, qualified private activity bonds, research and development expenditures, and for hiring certain specified individuals. Also, a deduction is available for certain manufacturing/production activities.
OTHER
Other issues that need to be mentioned include the following:
(1) Deductions are allowable for charitable contributions but for corporations may not exceed 10% of taxable income computed without regard to the contributions. Excess contributions may be carried forward for five years.
(2) Organisational and business start-up expenditures are deductible up to $5,000, subject to certain limitations and the remainder must be written off over 180 months.
(3) Meals and entertainment expenses are limited to 50% of expenses incurred in most circumstances. Certain entertainment expenses are entirely nondeductible.
(4) Bad debts, except for certain financial institutions, are deductible only under the specific method for receivables that become uncollectible in whole or in part during the tax year.
(5) Life insurance premiums paid on key employees are deductible only to the extent that they are:
(a) included in the employees' compensation
(b) not unreasonable in amount
(c) the employer is not directly or indirectly a beneficiary.
FOREIGN TAX RELIEF
A US corporation or a foreign corporation engaged in business in US may elect to claim either a credit or a deduction for income taxes paid to another country if the taxes are connected with or related to its business and if the income is also taxed by the US. Generally, the tax credit is available only if such foreign tax is based on foreign source income. The tax credit may not reduce the US tax liability on income from US sources. Any credit unusable in one year may be carried back to the prior year and forward ten years.
CORPORATE GROUPS
Affiliated groups of US corporations (parent has 80% ownership) are permitted to offset the losses of one affiliate against the profits of another via the filing of consolidated federal income tax returns. State and local rules vary from federal rules in this regard and may not permit loss offsetting. Some may also require, alternatively, that returns are filed to include results of all related companies, including companies that are not includable in a federal consolidated income tax return.
RELATED PARTY TRANSACTIONS
Related party transactions negotiated at arm's length are treated the same as nonrelated party transactions. However, in general, a deduction may not be taken by one party until the transaction has been included in gross income by the other party. The Internal Revenue Service may make any adjustments necessary to reflect the income of the related parties.
For multi-national groups, additional emphasis is placed on the 'transfer price' among members of the group. Several methods are provided to determine a proper arm's length price including the use of unrelated third party comparables, the comparable profits and the profit split methods. Significant compliance burdens now apply in these situations. Failure to maintain contemporaneous documentation of pricing determinations could result in substantial penalties (up to 40% of the tax due). US regulations require taxpayers to conduct transfer pricing studies to determine the 'best method' under the applicable circumstances.
Transfer pricing determinations must often meet standards in multiple jurisdictions. US rules for determining transfer pricing may vary from the rules of other countries that have introduced transfer pricing standards and from OECD guidelines. US states are increasingly interested in both multi-national and multi-state transfer pricing and may at times take positions differing from those of the Internal Revenue Service.
WITHHOLDING TAXES – NON-US PAYEES
Taxes are required to be withheld from portfolio dividends, interest, rents, and royalties, and certain other types of income paid to non-US payees. The statutory rate is 30% but reduced rates may apply if the recipient is a resident of a treaty country. Foreign persons or entities may also be exempted from withholding if the US source income is connected with conduct of a trade or business in the US. This exemption is not available unless the foreign recipient provides notice to the US payor prior to payment. Portfolio interest is exempt from withholding. Portfolio interest includes interest earned on US bank deposits and portfolio debt obligations.
Special withholding tax rules apply to non-US partners in US partnerships and non-US members of an LLC that conducts a trade or business in the US. A 35% withholding tax rate is applied to a foreign partner's (whether an individual or corporation) current year US source income. Special withholding tax rules also apply to direct or indirect sales or other dispositions of US real property by foreigners. A 10% withholding rate applies to the gross amount realised or sales price on the disposition unless specific permission is granted for a reduction.
EXCHANGE CONTROL
No direct exchange controls exist. Transactions in currency of $10,000 or more must be reported to the Internal Revenue Service. Multiple related transactions must be treated as a single transaction for disclosure purposes. The direct or indirect transportation of currency or other monetary instruments exceeding $10,000 to a foreign jurisdiction must also be reported. Transfers through normal banking procedures that do not involve the physical transportation of currency are not required to be disclosed.
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