Taxation of nonresident alien investors
A non-resident alien will only be taxed on their US source income. US source income is either:
· Income effectively connected with a US trade or business (ECI), or
· US source income that is fixed, determinable, annual, or periodical (called FDAP) such as compensation for personal services, and interest and dividends that are not ECI.
There are exceptions to FDAP, for example, there is no US tax or withholding for the following types of interest:
· Bank deposit interest,
· Interest from foreign borrowers,
· Obligations payable 183 days or less from the date of original issue, and
· Portfolio interest as defined in §§ 871(h) and 881(c). Generally, a registered debt obligation where the beneficial person is not a US person.
There are also exceptions to ECI relating to investors, for example:
· Trading Safe Harbors §864(B)(2)(A), trading in stocks or securities or commodities for one’s own account through US agents.
Large Business and International Active Campaigns adds new compliance campaign focusing on foreign investors (June 28, 2021)
The campaign will focus on whether foreign investors were subject to US tax on effectively connected income from lending transactions through a US trade or business. Foreign investors who trade stocks and securities for their account through a US agent are not engaged in a US trade or business if they fall under the safe harbors of §864(B)(2)(A). This safe harbor is not available to dealers in stocks or securities. This includes entities engaged in a lending business or to foreign investors in partnerships engaged in such activities.
This is an issue-based exam in contrast to the IRS’ previous approach of entity-based exams. These issue-based approaches will focus on tax issues that are viewed as having a significant risk of noncompliance. The IRS views this approach as making the greatest use of limited IRS resources.