What makes income effectively connected to a US business?
Two things have to be true. There has to be a US trade or business, meaning an activity carried on in the country that is considerable, continuous and regular rather than occasional. And the income has to be connected with it, which is tested by the part the activity played in producing the income and by where the assets used are. Once income is effectively connected it is taxed on a net basis at graduated rates on a return, and expenses become relevant. Income that fails the test is generally left to gross withholding at source, where expenses are irrelevant. That is why the distinction is worth arguing about.
Why was tax withheld on my gross receipts and not my profit?
Because the payer treated the income as falling outside a US trade or business. Withholding at source is applied to the amount paid, with no deduction for the costs of earning it, so it routinely exceeds the tax that would be due on the profit. If the income is in fact effectively connected, the route back is a return: the income is reported net, deductions are taken, and the tax withheld is set against the liability with the balance repaid. There is also a certification route that tells the payer to stop withholding on effectively connected amounts in future, worth using as soon as the position is settled.
Does selling to US customers create a US trade or business?
Not by itself. Selling into a country from outside it is usually not enough. What matters is what is done inside the country, by whom, and how regularly. Staff or a dependent agent concluding contracts there, a fixed place of business, inventory held and sold locally, or services performed on the ground all point towards a trade or business. Taking orders from abroad and shipping goods in generally does not. The analysis is fact-heavy and worth doing before the first filing season rather than after a notice, because the answer also decides whether a treaty position is available and what has to be disclosed.
Can I deduct expenses against my US rental income as a non-resident?
Only if the rental income is treated as effectively connected. Left alone, rents paid to a non-resident are withheld on a gross basis, and mortgage interest, property tax, repairs, insurance and depreciation give no relief at all, which is how a property running at a loss still produces tax. There is an election that puts the rentals onto a net basis so the ordinary deductions apply and the return reports a profit or loss. The election carries conditions and consequences for later years, including on sale, so it is a decision to take with the whole holding period in view rather than one year's figures.
Is effectively connected income the same as a permanent establishment?
No, although the two overlap. A US trade or business is a domestic law threshold. A permanent establishment is a treaty threshold, and it is usually the higher of the two. So a business can have effectively connected income under domestic law and still be protected by the treaty because it has no permanent establishment. But the protection has to be claimed on a filed return, with the position disclosed. Assuming the treaty applies and filing nothing is the version that goes wrong, because a treaty removes the tax rather than the filing obligation. The thresholds turn on different facts and should be analysed separately.
Do I need to file if the US business made a loss?
Filing is usually the right course. A return is what puts the loss on record, starts the period within which the authority can assess, and preserves deductions and credits that are lost where a return goes in late or not at all. It is also the document establishing that the income was reported on a net basis in the first place. Where nothing is filed the fallback treatment is gross, with income counted and expenses ignored, and a loss year can end up producing tax. The cost of a nil or loss return is small measured against reopening a position years later.
Is double taxation illegal?
It is legal. Two countries can each have a valid claim on the same income — one because the income arose there, the other because you live there — and nothing prohibits both from exercising it. What exists instead is relief: tax treaties allocate the claim, and domestic law gives a credit for foreign tax paid. The relief is not automatic, though. It is claimed on a return, and unclaimed relief is simply lost. See how double taxation is relieved.
What counts as foreign income, and what is a foreign tax?
Foreign income is income sourced outside the country you are filing in — where the work was done, where the property sits, where the payer is resident, depending on the type. A foreign tax, for credit purposes, is a levy imposed by another country that functions as an income tax and that you were legally required to pay. Consumption taxes, property taxes and most social contributions are not, however real the cost. Sourcing is decided by rule, not by which bank received it. See the foreign tax credit.
