The Role of Tax Treaties
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The Role of Tax Treaties for Nonresident Alien LLC Owners
A treaty might allow residents (not necessarily citizens) of their home country to be taxed at reduced rates on specified items of U.S.-sourced income, be exempt from U.S. tax on other income categories, and override statutory provisions of the Internal Revenue Code.
The United States has tax treaties with over 65 countries, and, for example, treaties with several countries offer an exemption from taxation of U.S.-sourced business income if your business does not have a permanent establishment (a fixed place of business through which the dealings of an enterprise is wholly or partially carried on) in the United States.
You can find general treaty information in our US Tax Guide for Aliens. Our guide includes an overview, sources of and links to treaty information, technical explanations, and some treaty examples. However, even with our in-depth manual, treaties can be a little tricky, so be sure to check with us or another tax professional before relying on a provision that appears to benefit you.
States and Tax Treaties for Nonresident Aliens
Federal treaty exemptions are allowed by most states, but not all. The states that tax treaty-exempt income include Alabama, Arkansas, California, Connecticut, Hawaii, Kansas, Kentucky, Maryland, Mississippi, Montana, New Jersey, North Dakota, and Pennsylvania. Therefore, even though you have no taxable business income on your federal return due to treaty exemption, you may owe state income tax if doing business in one of the nonconforming states, even if you do not have a permanent establishment.
Sales Tax Collections
Although a tax treaty might exempt your business income from Federal income taxation, the tax treaty might not apply at the state level. Additionally, sales taxes, which are imposed only under the authority of state and local governments, are not subject to the purview of federal income tax treaties. Therefore, even if a state honors a Federal treaty provision regarding income tax on business income, the state still could impose sales taxes on the treaty-exempt income.
How The Supreme Court Decision in Wayfair Affects Nonresident LLC Owners
For many years, states were precluded from imposing sales taxes on items sold by sellers who did not have a physical presence in the state. This was the position of the Supreme Court in Quill Corp. v. North Dakota (1992), in which the Court relied on the Dormant Commerce Clause, preventing states from interfering with interstate commerce unless authorized by the United States Congress.
That all changed due to South Dakota v. Wayfair, Inc. (2018), with the Court ruling that states may charge tax on purchases made from out-of-state sellers, even if the seller does not have a physical presence in the taxing state. The Court noted that the physical presence requirement of Quill put retailers with physical presence in the state at a disadvantage to solely online or remote retailers.
Helping to sway the Court, the South Dakota law had several features designed to prevent undue burdens on interstate commerce. For example, it applied a safe harbor for those who transact only limited business in South Dakota. The law said retailers with sales of $100,000 or less, or fewer than 200 instate transactions, were exempt. Additionally, South Dakota is one of more than 20 states to adopt the Streamlined Sales and Use Tax Agreement, which requires certain standardization in the rate structure to reduce administrative and compliance costs for remote sellers.
The Wayfair decision has created opportunities for the rest of the states to enact or revise their own sales tax laws to take advantage of the new standard. If you are an online retailer, you will want to keep up with what the states are up to, or purchase software that will do that for you. Several packages will track your sales, determine your filing requirements, compute the tax, and produce sales tax forms to file.