FDAP Income

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Jason B. Freeman

Jason B. Freeman

Managing Member

214.984.3410
jason@freemanlaw.com

Mr. Freeman is the founding member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney.

Mr. Freeman has been named by Chambers & Partners as among the leading tax and litigation attorneys in the United States and to U.S. News and World Report’s Best Lawyers in America list. He is a former recipient of the American Bar Association’s “On the Rise – Top 40 Young Lawyers” in America award. Mr. Freeman was named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas for 2019 and 2020 by AI.

Mr. Freeman has been recognized multiple times by D Magazine , a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service. He has previously been recognized by Super Lawyers as a Top 100 Up-And-Coming Attorney in Texas.

Mr. Freeman currently serves as the chairman of the Texas Society of CPAs (TXCPA). He is a former chairman of the Dallas Society of CPAs (TXCPA-Dallas). Mr. Freeman also served multiple terms as the President of the North Texas chapter of the American Academy of Attorney-CPAs. He has been previously recognized as the Young CPA of the Year in the State of Texas (an award given to only one CPA in the state of Texas under 40).

FDAP Income

The United States generally taxes nonresident aliens and foreign corporations on their U.S.-source income.  A foreign taxpayer’s U.S.-source income falls into one of two general categories: (i) “fixed or determinable annual or periodical gains, profits, and income” (“FDAP income”) or (ii) income that is “effectively connected” with the conduct of a U.S. trade or business (“ECI”).  In this post, we focus on the taxation of FDAP income.

A non-U.S. person is generally taxed on a gross basis and at a 30-percent rate on U.S.-source FDAP income, which is subject to withholding.  In many cases, however, FDAP income is subject to a reduced rate of tax, or entirely exempt from tax, under the Code or a bilateral income tax treaty.

What is FDAP Income? 

Under Treasury regulations, FDAP income includes all gross income under section 61 except for specifically excepted items of income.  FDAP income includes, for example, interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, and emoluments.

FDAP income is indeed broad and includes the following items, which are merely examples:

Exclusions From FDAP Income

Although FDAP income captures a broad range of gross income, it is subject to a number of important exceptions. Capital gains of nonresident aliens generally are foreign source; however, capital gains of nonresident aliens present in the United States for 183 days or more during the year are income from U.S. sources.

In addition, gains from the sale of U.S. real property interests are treated as effectively connected income under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”).

Interest on bank deposits may be exempt from FDAP income treatment.  For example, interest on deposits with domestic banks, and certain amounts held by insurance companies, are U.S.-source income, although they are exempt from the 30-percent tax when paid to a foreign person.  Such portfolio interest does not, however, include interest received by a 10-percent shareholder, certain contingent interest, interest received by a CFC from a related person, or interest received by a bank on an extension of credit made pursuant to a loan agreement entered into in the ordinary course of its trade or business.

Interest on deposits with foreign branches of domestic banks is not U.S.-source income and, thus, is not subject to U.S. tax. Interest and original issue discount on certain short-term obligations are also exempt from U.S. tax when paid to a foreign person.

And as with any good fine print, other exclusions may apply.

Withholding on FDAP Income

Unlike effectively connected income, which is generally subject to the same U.S. tax rules and rates that apply to business income earned by U.S. persons, FDAP income is generally subject to a 30-percent tax and is collected by withholding.  In many cases, however, FDAP income is subject to a reduced rate of tax, or entirely exempt from tax, under the Code or a bilateral income tax treaty. Withholding on FDAP payments to foreign payees is required unless the withholding agent, i.e., the person making the payment to the foreign person, can establish that the beneficial owner of the amount is eligible for an exemption from withholding or a reduced rate of withholding under an income tax treaty.

 

Tax Treaties

The United States is a signatory to more than 60 income tax treaties.  While a non-U.S. person is generally subject to withholding on U.S.-source FDAP income, such income may be subject to a reduced rate of tax, or entirely exempt from tax, under the Code or a bilateral income tax treaty.

Our Freeman Law interactive tax treaty map provides a link to tax treaty materials for each U.S. treaty partner: