ECI Tax for Non-Residents: A Comprehensive Guide
A Non-Resident Alien (NRA) is a person who is not a US citizen, not a Green Card holder and does not live in the US. For the most part, NRAs are not subject to US tax. An NRA with effectively connected income (ECI) is subject to US tax and must file US tax returns. But what is effectively connected income? Here’s how it works.
Key Takeaways
- ECI is any income earned by non-resident aliens that is connected to a US trade or business.
- ECI is taxed using the same rates as income earned by US citizens and residents, ranging from 10% to 37%.
- Non-residents with ECI can claim deductions and credits to help reduce their taxable income.
What Is ECI?
Effectively Connected Income (ECI) is income earned by non-resident aliens that is connected to a trade or business in the United States. This can mean:
- Income from active business operations: This includes profits from running a business in the US, such as a restaurant, retail store, or manufacturing operation. For instance, a non-resident owning a restaurant in New York would have their earnings from this business classified as ECI because the business operations are actively conducted within the US
- Wages and salaries for services performed in the US: Non-residents working in the US and earning wages or salaries for their services are generating ECI.
- Income from rental properties: If a non-resident is actively involved in managing rental properties in the US, the rental income can be classified as ECI. (Active management includes making decisions about tenants, maintenance, and other significant activities.)
- Income from personal services: Fees earned by non-residents for services performed in the US, such as consulting, performing arts, or freelance work, are considered ECI.
How Is ECI Taxed?
ECI earned by non-residents is taxed using the same progressive tax rates as income earned by US citizens and residents. For the 2024 tax year, the tax brackets for single filers are as follows:
- 10% on income up to $11,600
- 12% on income over $11,600 and up to $47,150
- 22% on income over $47,150 and up to $100,525
- 24% on income over $100,525 and up to $191,950
- 32% on income over $191,950 and up to $243,725
- 35% on income over $243,725 and up to $609,350
- 37% on income over $609,350
Comparison of ECI Taxation vs. Non-ECI Taxation for Non-Residents
ECI Taxation
Income that qualifies as ECI is taxed on a net basis, allowing non-residents to deduct allowable expenses related to earning the income. This can lead to lower taxable income and lower overall tax liability. For example, a non-resident who owns a business in the US can deduct business expenses such as rent, salaries, and supplies.
Non-ECI Taxation
Non-ECI income is typically taxed on a gross basis at a flat rate of 30% (or lower if a tax treaty applies) without any deductions. This includes passive income such as:
- Interest
- Dividends
- Royalties
- Certain rents.
For instance, if a non-resident earns $10,000 in interest from corporate bonds held in a US brokerage account, they would be subject to a flat 30% tax on the entire amount, resulting in $3,000 in taxes.
Non-residents with ECI can claim deductions and credits to help reduce their taxable income. To learn more about tax benefits available for taxpayers living overseas, check out this guide: US Expat Tax Deductions and Credits.
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Determining ECI
Income is considered ECI if it meets the criteria established by the IRS. These criteria primarily involve the asset-use test and the business-activities test:
- Asset-Use Test: The income is derived from assets used by a US trade or business. For example, if a non-resident alien owns machinery that is leased to a US company and the machinery is actively used in the company’s operations, the income from this lease can be considered ECI.
- Business-Activities Test: The income is derived from business activities conducted in the US. For instance, if a non-resident alien runs a consulting business and performs consulting services in the US, the fees earned from these services are considered ECI.
Step-by-Step Guide to Determining ECI
- Determine the origin of the income, such as wages, business profits, rental income, or investment returns.
- Apply the Asset-Use Test and the Business Activities Test to see if the income is effectively connected to a US trade or business. If the income meets the standards of either test, it’s ECI.
To make sure you’re correct about whether income qualifies as ECI, double-check with official IRS guidelines. The IRS provides detailed criteria and examples in Publication 519: US Tax Guide for Aliens.
Filing Requirements for ECI
When reporting ECI, the correct form will depend on whether you are filing as an individual or a corporation.
Individuals with ECI: Form 1040-NR
Non-resident aliens with ECI must file Form 1040NR: US Non-resident Alien Income Tax Return. This form is used to report income earned in the US and to claim any applicable deductions and credits.
Form 1040-NR is technically due on the standard US Tax Day, April 15. However, if you are outside of the US on April 15, you have an automatic two-month extension to June 15.
Corporations with ECI: Form 1120-F
Foreign corporations with ECI must file Form 1120-F: US Income Tax Return of a Foreign Corporation. This form is used to report the income, deductions, and taxes owed by foreign corporations doing business in the US.
Foreign corporations must file Form 1120-F by the 15th day of the fourth month after the end of their tax year. For example, if the tax year ends on December 31, the filing deadline is April 15 of the following year.
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Frequently Asked Questions
What types of income are considered ECI?
Any income that meets the standards of the Asset-Use Test or Business-Activities Test is considered ECI.
How can I determine if my rental income is ECI?
If you are actively managing your rental properties, such as making decisions on tenants and maintenance, it may qualify as ECI.
What deductions are available for ECI?
Deductions similar to those available to U.S. residents, including business expenses and depreciation.
Still Have Questions About ECI? Greenback Can Help!
If you need help determining whether you have ECI or paying taxes on your effectively connected income, Greenback can help!
Contact us, and one of our customer champions will gladly help. If you need very specific advice on your specific tax situation, you can also click below to get a consultation with one of our expat tax experts.
