What Is a US Trade or Business for Tax Purposes?

A US trade or business, for federal tax purposes, is a level of profit-seeking activity in the United States considerable, continuous, and regular enough to pull a foreign person or foreign corporation into net-basis US income taxation on the income connected to that activity. The tax code does not spell out a checklist. Section 864(b) says performing personal services in the United States during the tax year counts, then carves out narrow exceptions for certain investment activities, and the IRS fills in the rest through a facts-and-circumstances test built on decades of case law.¹²

Cross that threshold and the tax rules change substantially. Graduated rates replace the flat 30% withholding that applies to passive US-source income, deductions become available, annual returns are required, and foreign corporations face a potential branch profits tax on top of the regular corporate rate.

What the Standard Actually Requires

The core requirement is that the foreign person’s US activities be “considerable, continuous and regular.”² Occasional or incidental US contact does not do it. Courts have said the taxpayer must be regularly and continuously transacting a substantial portion of its ordinary business in the United States.³ The IRS looks for a pattern of profit-seeking activity with real substance on US soil, not a stray transaction.

Activities That Cross the Line

Personal services performed in the United States are the most straightforward trigger. Any compensated service performed on US soil during the tax year counts as a US trade or business. The narrow exception: a nonresident working for a foreign employer, present no more than 90 days during the year, and earning $3,000 or less in aggregate compensation is excluded.¹

Selling goods through a US office, warehouse, retail location, or other fixed place of business is another clear trigger. So is operating through agents or employees in the United States who have authority to negotiate and close deals on behalf of a foreign person. When local representatives are making binding decisions, the IRS treats that as functionally identical to running your own office.

Foreign investors in US partnerships deserve special attention. Under Section 875, if a partnership is engaged in a US trade or business, every partner is treated as engaged in that business too, including nonresident aliens and foreign corporations holding purely passive interests.⁴ A limited-partner stake in a US operating partnership can pull a foreign investor into full filing obligations and net-basis tax.

Safe Harbors for Trading and Investment

Congress built safe harbors into Section 864(b)(2) to keep portfolio capital flowing. Trading in stocks, securities, or commodities for your own account is not a US trade or business, even when the trades run through a US-based broker or agent with full discretionary authority.¹

Three limits shape the safe harbor. It does not cover dealers who hold inventory for sale to customers. For commodities, it covers only commodities of a kind customarily dealt on organized exchanges through transactions of a kind customarily completed there. And the safe harbor for trading through an independent agent applies only if the foreign person has no US office or fixed place of business through which the trades are directed. Foreign hedge funds and trading firms with even modest US infrastructure lose the protection quickly.

Effectively Connected Income

Once the threshold is crossed, the next question is which income the United States taxes on a net basis. That income is called effectively connected income, or ECI. The IRS applies two tests:²

The asset-use test: the income was generated by assets used in, or held for use in, the US business.
The business-activities test: the activities of the US business were a material factor in producing the income.

Income passing either test is taxed at the same graduated rates that apply to US citizens and residents. Individual brackets run from 10% to 37%. Foreign corporations pay the flat 21% corporate rate on ECI.⁵ Because ECI is taxed on a net basis, ordinary business expenses like rent, wages, and equipment are deductible against gross income.

FDAP Income Is Taxed Differently

Not all US-source income earned by foreign persons is effectively connected. Income that is fixed, determinable, annual, or periodical, known as FDAP, includes dividends, interest, rents, and royalties untied to an active business. FDAP is taxed at a flat 30% rate on the gross amount, with no deductions allowed, and the US payer withholds before the money ever reaches the foreign recipient.⁶

That gap between gross 30% and net graduated rates is why Section 871(d) allows nonresident aliens to elect to treat US real property income as effectively connected, even if they are not otherwise engaged in a US trade or business.⁷ Once made, the election stays in effect for future years unless the IRS consents to revoke it.

US Real Estate Sales Get Pulled In Automatically

The Foreign Investment in Real Property Tax Act treats gain or loss from the sale of a US real property interest as if it were effectively connected with a US trade or business, regardless of whether the seller has any other US business activity. Section 897 creates this fiction so foreign sellers pay graduated-rate tax on the gain.⁸

Collection runs through the buyer. The general FIRPTA withholding rate is 15% of the amount realized.⁹ Two exceptions apply when the buyer is acquiring the property as a personal residence: the rate drops to 10% if the sale price does not exceed $1,000,000, and no withholding is required if the price does not exceed $300,000. Distributions of US real property interests by a foreign corporation carry a 21% withholding rate.¹⁰ The withheld amount is a credit against the seller’s actual tax, so filing a return to claim any refund is essential.

US real property interests reach beyond land and buildings. They include interests in domestic corporations that hold substantial US real property, plus natural resources, mines, wells, and improvements associated with the real property.¹¹

Branch Profits Tax on Foreign Corporations

Foreign corporations operating a US branch face an additional layer that individual nonresident aliens do not. Section 884 imposes a 30% branch profits tax on the “dividend equivalent amount,” which represents the branch’s after-tax earnings not reinvested in the US business.¹² The tax exists to match the withholding a US subsidiary would face when paying dividends to its foreign parent; without it, a foreign corporation could sidestep that layer by running its US operations as a branch.

The calculation begins with the branch’s effectively connected earnings and profits, then subtracts any increase in the branch’s US net equity (US assets minus US liabilities). Reinvesting profits into US operations shrinks or eliminates the taxable amount. Pulling money out or shrinking the US presence expands it. Many US tax treaties cut the rate well below 30%, some as low as 5%, and some to zero, though claiming a treaty reduction requires meeting the treaty’s limitation-on-benefits provisions and disclosing the position on the return.

How Tax Treaties Change the Analysis

The United States has income tax treaties with dozens of countries, and those treaties commonly override the domestic rules. Most replace the broad “trade or business” concept with the narrower “permanent establishment” standard. Under a typical treaty, a foreign company’s business profits are taxable in the United States only if the company operates through a permanent establishment here, generally a fixed place of business such as an office, factory, or workshop. Without a permanent establishment, the treaty country keeps exclusive taxing rights over those business profits, even where domestic law would classify the activity as a US trade or business.

A taxpayer taking a treaty position that overrides an Internal Revenue Code provision must file Form 8833, Treaty-Based Return Position Disclosure. The penalty for failing to file is $1,000 per position, or $10,000 for C corporations.¹³

Returns, Deadlines, and Penalties

Nonresident alien individuals report effectively connected income on Form 1040-NR, with FDAP income that is not effectively connected going on Schedule NEC.¹⁴ Foreign corporations use Form 1120-F, which handles both income tax and the branch profits tax calculation.¹⁵ Foreign-owned US corporations, foreign corporations with US business activity, and certain single-member LLCs owned by a foreign person may also owe Form 5472 to report related-party transactions. The penalty for failing to file Form 5472 is $25,000 per return, plus another $25,000 for each month the failure continues after 90 days of IRS notification, with no cap.¹⁶ Foreign-owned single-member LLCs with minimal activity are where this penalty most often catches people.

The filing deadline depends on the type of income and where the filer operates. A nonresident with wages subject to US income tax withholding files by April 15. A nonresident with no wages subject to withholding and no US office has a default due date of June 15, which is the standard deadline for that category, not an extension.¹⁷ Foreign corporations filing Form 1120-F can request an automatic six-month extension on Form 7004.¹⁸

Late filing is costly. The late-filing penalty is 5% of unpaid tax per month or partial month, capped at 25%.¹⁹ Information return penalties for returns due in 2026 begin at $60 per return within 30 days of the deadline, rise to $130 for returns filed between 31 days late and August 1, and reach $340 for returns filed after August 1 or not filed at all.²⁰

The most damaging penalty is indirect. A foreign corporation that fails to file a timely return can lose the right to claim deductions and credits against its effectively connected income. When that happens, the IRS taxes gross receipts rather than net income, which can multiply the tax owed several times over. Filing a protective return, even where no tax is believed due, is the reliable way to preserve those deductions.

1
Office of the Law Revision Counsel. 26 USC 864 – Definitions and Special Rules
2
Internal Revenue Service. Effectively Connected Income (ECI)
3
Justia Law. Commissioner of Internal Revenue v. Spermacet Whaling and Shipping Co.
4
Office of the Law Revision Counsel. 26 USC 875 – Partnerships; Beneficiaries of Estates and Trusts
5
Office of the Law Revision Counsel. 26 US Code 11 – Tax Imposed
6
Office of the Law Revision Counsel. 26 US Code 871 – Tax on Nonresident Alien Individuals
7
Office of the Law Revision Counsel. 26 USC 871 – Tax on Nonresident Alien Individuals
8
Office of the Law Revision Counsel. 26 USC 897 – Disposition of Investment in United States Real Property
9
Office of the Law Revision Counsel. 26 US Code 1445 – Withholding of Tax on Dispositions of United States Real Property Interests
10
Internal Revenue Service. FIRPTA Withholding
11
Internal Revenue Service. Foreign Investment in Real Property Tax Act
12
Office of the Law Revision Counsel. 26 USC 884 – Branch Profits Tax
13
Internal Revenue Service. Form 8833 – Treaty-Based Return Position Disclosure
14
Internal Revenue Service. Instructions for Form 1040-NR
15
Internal Revenue Service. About Form 1120-F, US Income Tax Return of a Foreign Corporation
16
Internal Revenue Service. Instructions for Form 5472
17
Internal Revenue Service. Taxation of Nonresident Aliens
18
Internal Revenue Service. About Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns
19
Internal Revenue Service. Failure to File Penalty
20
Internal Revenue Service. Information Return Penalties