Inbound Investor U.S. Tax Playbook, Part 3: Operating and Repatriating Profits

December 3, 2025December 3, 2025Nick Eusanio, Esq., LL.M. Leave a comment

Overview:

Once a U.S. structure is established, it’s important to manage day-to-day compliance, withholding obligations, and cash repatriation in a way that aligns commercial objectives and tax efficiency.

This is where many inbound investors run into trouble. Overlooked filings, employee visits, or intercompany payments can inadvertently create additional tax exposure.

This article outlines some key operational compliance considerations for inbound investors — including how to manage U.S. trade or business (USTB) risk, how to comply with withholding and reporting rules, and how to repatriate profits efficiently under U.S. and treaty frameworks.

This article summarizes considerations for entity selection, including notation of federal, treaty, and state regimes, and practical planning points.

1. Core Federal Compliance Framework

Once an inbound structure is live, foreign investors must quickly identify original and extended due dates (and filings necessary to obtain extension), and establish a compliance calendar to track federal, state, and local tax compliance obligations.

Key federal tax filings to note include:

Form 1040-NR – For foreign individuals with U.S. income.
Form 1120-F – For foreign corporations with U.S. income, even if limited to effectively connected income (ECI) or protective filings.
Form 1120 – For investments held through a U.S. C corporation (or LLC taxed as a C corporation).
Form 1065 – For investments held through a U.S. partnership (or LLC taxed as a partnership).
Form 5472 – For U.S. entities that are at least 25% foreign-owned, reporting related-party transactions.
Form 1042 and 1042-S – For withholding on payments to foreign persons (interest, dividends, royalties, services)

Failure to file or report properly can lead to disallowance of deductions, interest, penalties, and loss of treaty benefits.

2. Understanding U.S. Trade or Business (USTB) and Effectively Connected Income (ECI)

A foundational question for any inbound operation is whether the foreign investor itself — or one of its affiliates — has become engaged in a U.S. trade or business.

Once a USTB exists, U.S.-source income that is effectively connected with that business becomes ECI, taxable on a net basis (income minus deductions) through Form 1120-F.

A. When USTB Exposure Arises

A USTB exists where a foreign person conducts regular, substantial, and continuous commercial (profit seeking) activity in the U.S. — either directly or through dependent agents. Examples include:

Operating or managing a U.S. branch, office, or fixed place of business.
Having employees or dependent agents who habitually conclude contracts in the U.S.
Providing services or technical work in the U.S. for U.S. clients.
Participating in U.S. real property development or leasing.

In contrast, passive investment (holding stock, notes, or real estate for appreciation) generally does not create a USTB, provided contracting, management and decision-making occur offshore.

B. Treaty Overlay and Permanent Establishment (PE)

Under most U.S. income tax treaties, a nonresident is taxed on business profits only if attributable to a permanent establishment (PE) — generally a fixed place of business or a dependent agent with contracting authority. This overlay provides important protection but can be lost through day-to-day activities by foreign executives or employees.

3. Managing Executive Travel, Employee Presence, and Secondments

One of the most common ways a foreign investor unintentionally creates a USTB or PE is through foreign executives or employees performing services in the U.S.

Even short-term visits can be enough to shift the tax profile of the entire structure if those individuals perform core operational or revenue-generating functions while in the U.S

Risk scenarios include:

Executives negotiating or signing contracts during U.S. visits.
Technical staff providing services to U.S. customers on-site.
Management personnel directing local operations or overseeing projects.\

These activities can create a U.S. fixed place of business or a dependent agent PE, exposing the foreign parent to U.S. net income tax, Branch Profits Tax (IRC §884), and potential treaty complications.

Mitigating Exposure Through Secondment and Intercompany Structures

Inbound groups can mitigate this risk through:

Secondment arrangements, where the U.S. affiliate formally “borrows” employees and assumes day-to-day control, paying costs on a reimbursed (no markup) basis.
Intercompany service agreements, where cross-border support is formalized with arm’s-length pricing and defined scope under IRC §482.

Properly structured, these arrangements can:

Prevent the foreign parent from being viewed as conducting business directly in the U.S. or mitigate the associated amount of income.
Preserve treaty protection by keeping activities within the U.S. entity’s control.
Support transfer pricing compliance and deduction eligibility.

4. Withholding Obligations and Cross-Border Payments

Even when a foreign investor avoids direct USTB/ECI exposure, U.S. withholding tax applies to certain payments to foreign persons.

Key categories include:

FDAP (Fixed, Determinable, Annual, or Periodical) Income: Interest, dividends, rents, royalties, and similar payments are subject to 30% withholding, unless reduced by treaty.
Service Fees: Fees for services performed outside the U.S. are generally exempt, but services performed in the U.S. can become ECI.
Dividend Equivalent Amounts (DEA): Amounts subject to the Branch Profits Tax (IRC §884) and payments under equity-linked instruments that replicate U.S. stock dividends (IRC §871(m)) can be treated as dividend equivalents and subject to withholding.

U.S. payors must report and remit these withholdings on Forms 1042 and 1042-S, other than for a DEA subject to Branch Profits Tax which is reported on Form 1120-F.
For a reporting corporation (either a 25% foreign-owned U.S. corporation or U.S. disregarded entity, or a foreign corporation engaged in a USTB), Form 5472 remains the key disclosure for any payments to related foreign parties, including royalties, management fees, or cost allocations.

5. State and Local Considerations

Inbound investors often underestimate the complexity of state-level tax exposure.

Key Concepts:

Even absent a federal USTB, a foreign company (or its U.S. affiliate) may face state income or franchise tax based on economic nexus — often triggered by as little as $100,000 of in-state sales or 100,000 in-state transactions. Some state economic nexus thresholds are more favorably based on both the amount of sales and the number of transactions in state for the year.

Some states, such as California, require multinational groups to file combined reports, which can pull in global income under:

Worldwide combined reporting, or
A water’s-edge election, limiting inclusion to U.S. entities and their CFCs, foreign partnerships and foreign branches.

The water’s-edge election (e.g., California Form 100-WE) can be a significant planning tool for inbound investors, reducing compliance complexity and exposure to foreign-source income inclusion.

6. Repatriation and the Branch Profits Tax

When a foreign corporation earns ECI, it faces not only regular U.S. corporate income tax but also a Branch Profits Tax (BPT) under IRC §884.

The BPT, generally at 30% (potentially treaty-reduced to between 0% and 15%), applies to deemed remittances of after-tax earnings from the U.S. branch to its foreign parent.
Conceptually, it mirrors the dividend withholding tax that would apply if operations were conducted through a U.S. subsidiary instead of a branch.

Practical planning often favors operating through a U.S. subsidiary to simplify compliance and provide clearer control over repatriation timing. Dividends, interest or royalties from a U.S. subsidiary are typically subject to withholding at 30%, potentially reduced by treaty to between 0% and 15%.

7. Practical Compliance and Strategic Takeaways

File protective Form 1120-F returns when there’s potential USTB exposure — to preserve deductions and refund rights.
Maintain intercompany documentation (service, cost-sharing, royalty, and loan agreements) under IRC §482.
Review treaty applicability and PE thresholds before executives or employees travel to the U.S. Consider potential secondment or intercompany service agreements to manage as necessary. Consider documenting treaty positions in a tax-technical opinion, supporting expected rates and treatment of covered income streams or payments.
Monitor withholding and information reporting on all cross-border payments.
Evaluate annually: state nexus and water’s-edge election options, and state tax credits and incentives compliance and opportunities.
Plan repatriation to manage Branch Profits Tax or dividend / interest / royalty / service fee payment withholding efficiently.

In Conclusion

Running a U.S. operation successfully requires implementing the right structure, plus ongoing attention to compliance, withholding, and cross-border activity.

Inbound investors who proactively manage USTB risk, withholding compliance, and repatriation planning can operate confidently and minimize problematic surprises from both the IRS and state tax authorities.

Thinking about investing in the U.S.? Start with a consultation to evaluate your company’s readiness and identify strategies for success. Connect with Nick Eusanio, Tax & Compliance Partner at DBL Law, to learn how proper tax planning and investment structure can help you achieve the best possible outcome.

Inbound Investor U.S. Tax Playbook, Part 2

November 25, 2025Nick Eusanio, Esq., LL.M. Leave a comment

Structuring the Investment — Entity Choice & Tax-Efficiency

The United States is one of the most attractive places for foreign capital — deep markets, relative stability, and strong investor Once an inbound investor decides to enter the U.S. market, the next decision — how to structure the investment — can drive the ultimate tax result significantly. The U.S. system taxes differently depending on the type of entity, its ownership, and whether treaty benefits apply.. But the U.S. also has a uniquely complex tax environment.

This article summarizes considerations for entity selection, including notation of federal, treaty, and state regimes, and practical planning points.

1. Balancing Tax Efficiency, Liability Protection & Compliance

Every inbound structure should balance three objectives:

Liability protection — containing business legal risk within the U.S. entity.
Tax efficiency — minimizing both U.S. and home-country tax leakage.
Administrative manageability — minimizing annual administrative tasks and costs.

While the right structure depends on the investor’s facts — activity and income type, treaty position, and cash planning — there are key guardrails to consider.

2. Basic Options: Direct or U.S. Blocker, Foreign Holding Company Considerations

A. Direct Investment by the Non-Resident

This is the simplest on paper — the investor (either a foreign individual or foreign holding company) directly holds the U.S. asset, partnership interest, or LLC (treated as a partnership or disregarded for tax purposes) interest.

Tax result: The investor is directly subject to:
- U.S. tax on ECI and FDAP (with related withholding)
- Branch Profits Tax (if foreign corporation owner)
- FIRPTA (if any disposition of USRPI or USRPHC)
- U.S. estate tax on U.S.-situs assets (if foreign individual owner)
- Annual filing requirements for Form 1040-NR (individuals) or Form 1120-F (foreign corporations).
  - May require additional U.S. filings at entity level (e.g., U.S. partnership or LLC treated as partnership required to file Form 1065, related Schedules K-1 and Forms 8804 / 8805 / 8813 (withholding statements) issued).
- Pros: No interposed entity unless desired (e.g., partnership, LLC); may reduce foreign-country complications.
- Cons: Exposed to above-noted U.S. filing obligations and taxes and potentially no legal liability protections that would exist with a corporate structure (unless using U.S. LLC).
- Potential use case: Small passive investments or treaty-protected portfolio holdings.U.S. “Blocker” Corporation (or LLC treated as a corporation for tax purposes)

B. U.S. “Blocker” Corporation (or LLC treated as a corporation for tax purposes)

A common approach for institutional or fund investors. The foreign investor capitalizes a U.S. C-corporation to hold the operating business, real estate, partnership or disregarded LLC interest.

Tax result / Pros:
- The Blocker “absorbs” ECI, paying 21% corporate income tax.
- When profits are distributed, they are dividends subject to 30% withholding under IRC §881 (often reduced by treaty).
- Avoids the Branch Profits Tax that would otherwise apply to a foreign corporation’s U.S. branch.
- Potential insulation from FIRPTA (or ability for same with additional tiered structuring).
- Simplifies compliance — the foreign owner does not file Form 1120-F or 1040-NR; only the U.S. corporation files Form 1120 (and partnership files Form 1065 if there is a U.S. partnership in the structure).
Con: “Double” taxation — once at the corporate level and again on distribution — though effective rates can be moderated by treaty reductions or reinvestment strategies.

3. Withholding Tax & Using Treaties Strategically (Without Over-Engineering)

The U.S. imposes withholding tax on most payments to foreign persons, such as: dividends, interest, royalties, rent, service fees, and deemed branch remittances (DEA). This withholding tax is generally levied at a statutory rate of 30%, unless reduced by treaty. U.S. payors are responsible for withholding and reporting this tax via Form 1042 / 1042-S. Failure to withhold properly can shift liability for the original tax, plus penalties and interest, to the payor as withholding agent.

Treaties can dramatically reduce withholding and sometimes exempt outbound payments or business profits from U.S. taxation altogether.

Checklist for claiming treaty benefits:

Confirm investor’s residency certificate from home jurisdiction.
Evaluate specific treaty qualification articles (residency, dividends, interest, royalties, business profits, etc.).
Evaluate Limitation on Benefits (LOB) treaty article — are applicable requirements (such ownership and / or activity tests) satisfied?
Issue Form W-8BEN or W-8BEN-E to payor(s).
Disclose treaty position on Form 8833 if taking a treaty-based return position required to be reported.

4. Financing the U.S. Operation: Debt vs. Equity

Foreign investors often capitalize U.S. ventures through related-party debt, seeking to deduct interest while repatriating profits as interest payments (often subject to lower withholding than dividends).

Consideration:

Debt / equity analysis (common law, and IRC §385 if applicable): Debt can be reclassified as equity, disallowing deductions and potentially creating other unintended tax impacts in certain structures.
IRC §163(j) (generally applicable to taxpayers with average annual gross receipts of $30 million+) limits interest deductions to 30% of adjusted taxable income.
IRC § 267 loss disallowance and matching rules regarding timing of deduction and income recognition for accrued but unpaid interest between related parties.
IRC § 267A deduction disallowance for interest (and royalty) payments to related parties in hybrid transactions or with hybrid entities if the payment isn’t included int eh recipient’s income under foreign tax law.
Withholding: 30% on interest, unless reduced by treaty or portfolio interest exemption applies.
- Branch context: If the foreign corporation operates a U.S. branch, adjustments under Treas. Reg. §1.884-4 apply to determine the portion of deemed interest also subject to BPT at 30% (unless reduced by treaty), if any (i.e., the amount of excess interest not apportioned to ECI taxed at 21%).
Base Erosion and Anti-Abuse Tax (BEAT) under §59A, which targets large corporations (generally those with $500 million+ in average annual gross receipts) making base-eroding payments like interest to related foreign parties.
Documentation: Written loan agreements, arm’s-length terms and pricing / interest rates, contemporaneous intercompany pricing support.

5. State Tax Structuring Overlay

States have their own tax bases, nexus thresholds, and combination rules. Depending on the investment type and amount, and the state or states involved, state tax can be a material consideration.

Key Concepts:

Nexus: Physical presence (property, payroll) or economic nexus from sales into a state.
Separate vs. Combined Filing:
- Some states tax entities separately.
- Others (e.g., California, New York, Illinois) require or permit combined/unitary reporting for related entities.
Water’s-Edge Elections:
- Limit the combined group to U.S. members (and certain CFCs).
- Usually binding for 7 years (Cal. Rev. & Tax Code §25113).
- Must be modeled carefully — including impacts on foreign tax credit planning and apportionment.

Practical tips:

Where possible, isolate U.S. operations in one entity (or the fewest otherwise necessary entities) per state nexus profile.
Consider flexibility in deployment of property / assets, debt, and people in context of state credits and incentives, state apportionment, net worth tax, and separate vs. combined or unitary reporting rules.
Evaluate broader U.S. legal entity structure in multi-state operating structures (e.g., corporate holding company with use of wholly-owned disregarded / flow through LLCs or subsidiary corporations) for potential state tax planning or simplification.

6. Key Takeaways

Start with cash return in mind. Structure for efficient repatriation.
Contain ECI. Blockers or treaty planning can reduce compliance and tax cost.
Limit BPT exposure. It’s often the hidden double tax.
Remember FIRPTA. Structure real estate holdings to avoid FIRPTA.
Treaty benefits aren’t automatic. Evaluate, document, and claim them properly.
Don’t ignore state rules. Multiple states with differing rules can complicate matters, determine materiality and perform tax impact diligence and identify opportunities accordingly.

A well-planned structure can provide legal protections and tax efficiencies.

Coming Next

Part 3: Operating and Repatriating Profits: In our next article, we’ll explore what happens once the investment is operational: withholding regimes, filing obligations, profit distributions, and how to repatriate capital without triggering unnecessary tax.

Missed Part 1? Read it here.

Inbound Investor U.S. Tax Playbook, Part 1

November 19, 2025Nick Eusanio, Esq., LL.M. Leave a comment

U.S. Tax Basics for Non-Resident Investors

The United States is one of the most attractive places for foreign capital — deep markets, relative stability, and strong investor protections. But the U.S. also has a uniquely complex tax environment.

For inbound investors (non-U.S. individuals or entities investing in the U.S.), understanding the basic tax framework at the start is essential. This first post in our Inbound Investor U.S. Tax Playbook series outlines how the U.S. taxes inbound investors, some of the key filings required, and how federal and state systems interact in sometimes unexpected ways.

1. Who’s a “Non-Resident” for U.S. Tax Purposes?

The U.S. distinguishes between resident and non-resident taxpayers using two tests for individuals and one for entities.

A. Individuals

Green Card Test: If you hold a green card, you are a U.S. tax resident regardless of where you live or how long you spend in the U.S.
Substantial Presence Test (SPT): You’re a resident if you are physically present in the U.S. for at least 31 days in the current year and 183 days over a three-year period, counting:
- All days in the current year,
- ⅓ of days in the prior year,
- ⅙ of days in the year before that.

The SPT often surprises executives or investors with recurring business trips. Certain exceptions (teachers or students on certain visa programs, diplomats on certain visa programs, professional athletes participating in charitable sporting events) may apply.

Those who fail both tests are non-resident aliens (NRAs) — taxed only on U.S.-source income.

B. Entities

Formed under U.S. law → U.S. tax resident.
Formed under foreign law → non-resident entity, unless it has a U.S. trade or business.
Note: Check-the-box regulations under Treas. Reg. §301.7701 allow certain foreign entities to elect U.S. classification (corporation, partnership, or disregarded entity)

2. Three Buckets of Income: ECI, FDAP, and DEA

The U.S. system divides taxable income for non-residents into three broad categories:

A. Effectively Connected Income (ECI)

Income that is effectively connected with the conduct of a U.S. trade or business (USTB).

Typical examples:

Operating income from a U.S. business.
Rents or gains from real estate when the investor has elected to treat them as ECI under IRC §871(d) or §882(d).
Income from partnerships or other flow-through entities engaged in a USTB.

Tax treatment:

Taxed on a net basis at applicable rates (graduated rate scale for individuals (top rate 37%), flat 21% for corporations; subject to potential treaty reduction).
Foreign companies report this income on Form 1120-F (U.S. Income Tax Return of a Foreign Corporation).
Non-resident individuals report on Form 1040-NR.
Deductions are allowed for related expenses (assuming a return, or protective return, is filed; failure to file a return can result in denial of deductions).

A key concept is the “force of attraction” rule — once a non-resident is engaged in a U.S. trade or business, all U.S.-source income connected to that business can be treated as ECI.

B. Fixed, Determinable, Annual, or Periodical (FDAP) Income

Passive U.S.-source income — dividends, interest, royalties, and certain rents.

Taxed on a gross basis at 30% withholding, unless reduced by a tax treaty.
No deductions permitted (gross basis tax).
Reporting generally handled by the U.S. payor via Form 1042 (annual withholding return) and Form 1042-S (statement to the foreign payee).

C. DEA / The Branch Profits Tax

When a foreign corporation operates a U.S. business directly (without a U.S. subsidiary corporation or LLC taxed as a corporation “blocker”), it may face an additional Branch Profits Tax (BPT) under IRC §884.

This tax approximates the dividend withholding that would apply if the U.S. operation were conducted through a domestic corporation.
The BPT is imposed at a 30% rate (often reduced by treaty) on the corporation’s “dividend equivalent amount” (DEA) — essentially, the after-tax earnings deemed repatriated out of the U.S. branch during the year.
The calculation starts with the U.S. branch’s effectively connected earnings and profits (ECE&P), adjusted for increases or decreases in U.S. net equity.

Many investors assume that forming a “U.S. branch” is simpler than establishing a domestic corporation, but the BPT can make it significantly more expensive from an after-tax standpoint. This is because the BPT applies in addition to the 21% tax on ECI.

Treaty Note: Most modern U.S. tax treaties reduce or eliminate the Branch Profits Tax (e.g., 5% under the U.S.–U.K. treaty), but only if the foreign corporation qualifies under the treaty’s limitation on benefits (LOB) provisions.

3. Tax Treaties: Analyze & Document Relief

The U.S. has income tax treaties with about 60 countries. Key potential benefits common in treaties are:

Reduced withholding rates (e.g., sometimes 0% but commonly between 5%–15% on dividends, interest or royalties, instead of 30%).
Exemption for business profits if the foreign investor has no permanent establishment (PE) in the U.S.
Relief from double taxation through foreign tax credits or exemptions.
Legal and dispute resolution mechanisms such as the mutual agreement procedure (MAP) to resolve disputes between the U.S. and treaty partners.

Treaty benefits are claimed via applicable reporting which includes, based on the facts and circumstances, one or more of the following: Form W-8BEN (individuals) or W-8BEN-E (entities), Form 1120-F, Form 8833 Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), and Forms 1042 and 1042-S, provided the investor is a resident of a treaty country and satisfies the limitation on benefits (LOB) clause.

Avoid treaty shopping: intermediate holding companies without substantive activity may fail LOB tests, precluding treaty relief. The IRS increasingly reviews substance, management location, and beneficial ownership.

Consider obtaining a tax opinion to document the expected comfort level of treaty applicability and associated U.S. tax impact.

4. Structuring the Investment

Choosing an entry structure has long-term tax and compliance implications. The below chart offers a high-level overview of key considerations in structural options for nonresident investment in the U.S.

Structure	Pros	Cons
Direct ownership (individual)	(individual) Simple, transparent	Exposed to ECI, FIRPTA, U.S. estate tax for U.S. stock holdings, and personal filing obligations (Form 1040-NR, others as applicable), no corporate liability limits.
U.S. corporation or LLC taxed as corporation (C-corp “blocker”)	Generally shielded from ECI and Branch Profits Tax, potentially limits FIRPTA, simplifies compliance, corporate liability limitations for shareholders / members	Double taxation (21% corporate + dividend withholding)
U.S. LLC (treated as partnership or disregarded)	Flow-through taxation, flexibility, corporate liability limitations for members	Foreign owner becomes directly taxable and must file Form 1040-NR/Form 1120-F, exposed to FIRPTA
Foreign corporation holding U.S. assets (including LLC treated as disregarded or partnership)	Potential treaty benefits, estate tax protection, corporate liability limitations for shareholders / members	Branch Profits Tax, 30% withholding on certain payments, complex reporting (Forms 1120-F, 5472, 8833)

5. FIRPTA: The Real Estate Trap

The Foreign Investment in Real Property Tax Act (FIRPTA) taxes foreign persons on gain from the sale of U.S. real property interests (USRPI) (which includes interest in a U.S. real property holding company (USRPHC), very basically, a U.S. real-property rich – at least 50% FMV of its assets – holding company)) as if it were ECI.

Withholding: Buyers must withhold 15% of the gross sale price, unless the seller obtains a reduced-withholding certificate on Form 8288-B.
Reporting: Withholding submitted on Form 8288; seller receives Form 8288-A as credit evidence.
Election: Foreign investors in rental real estate may elect to treat rental income as ECI (thus deductible) under IRC §871(d)/§882(d) — often made by attaching a statement to Form 1040-NR or 1120-F.

6. Key Federal Tax Filings for Inbound Investors

Form	Description	General Filing Requirements / Purpose
1040-NR	Non-resident individual U.S. income tax return	Direct investor or member of U.S. LLC (if disregarded for tax purposes)
1120-F	U.S. income tax return for foreign corporations	Foreign corporation with ECI or U.S. branch
5472	Information return of a 25% foreign-owned U.S. corporation or a foreign corporation engaged in a U.S. trade or business	Reporting corporation required to disclose reportable transactions with foreign or domestic related parties
8833	Treaty-based return position disclosure	Claiming treaty benefits to override domestic law
1042 / 1042-S	Annual withholding return / statement for FDAP income	U.S. payor with foreign recipient
8288 / 8288-A / 8288-	FIRPTA withholding forms	Non-U.S. party disposition of real property interest / interest in U.S. real property holding company
8804 / 8805 / 8813	Partnership withholding on foreign partners	U.S. partnership with foreign investors

Failure to file can result in steep penalties and the loss of treaty benefits.

7. State Tax Considerations: The Overlooked Layer

Federal planning alone isn’t enough. States operate semi-autonomously, and foreign investors can create state “nexus” — a taxable presence — much more easily than they realize.

A. Key Triggers for State Nexus

Owning or leasing property in the state.
Having employees, agents, or contractors there.
Exceeding sales thresholds under economic nexus standards (post-Wayfair).
Holding a partnership interest in an entity operating in that state.

B. Filing Implications

Corporate income/franchise tax: Many states follow federal taxable income but have unique state tax addback or deductions based on whether the state conforms to or decouples from federal tax law. Income is also apportioned with state-specific income apportionment formulas.
Partnership or pass-through entity tax: Some states impose entity-level taxes or mandatory withholding on non-resident partners.
Sales/use tax: Separate compliance system — nexus rules differ from income tax nexus.
Net Worth tax: Some states impose taxes on net worth (generally, total assets less total liabilities) in the state as well.

C. Combined Reporting and Water’s-Edge Elections

For foreign corporate groups with U.S. subsidiaries:

Worldwide combined reporting: Some states (e.g., California) require or allow combination of worldwide income, including foreign affiliates.
Water’s-edge election: Available in certain states (notably California) to limit combined reporting to U.S. entities and controlled foreign corporations (CFCs) meeting specific ownership thresholds.
These elections are often binding for 7 years and must be carefully modeled before election — they can dramatically change state tax bases.

D. Apportionment

Most states use a single-sales factor or three-factor formula (sales, property, payroll) to determine what portion of income is taxable. The rules vary widely — meaning two states may tax the same income differently.

8. Common Pitfalls

1. Accidental U.S. Trade or Business: Taking an active role in management, hiring U.S. agents, or signing contracts in the U.S. can trigger ECI.

2. Overlooking FIRPTA: U.S. real estate is always within U.S. tax jurisdiction.

3. Neglecting State Taxes: Many foreign investors assume federal treaties cover states — they don’t necessarily as states may follow or not follow federal tax treaties, so a state-specific review is necessary.

4. Missing or Late Filings: Non-filing penalties can exceed the tax itself and be imposed on information-reporting only (no tax-due) filings that are missed or filed late.

5. Treaty Misuse: Claiming treaty benefits without satisfying LOB tests invites IRS scrutiny.

6. Improper Entity Selection: Legal entity form and tax treatment can differ (e.g., LLC treated as a corporation, partnership, or disregarded entity for tax purposes). These differences can have varying tax implications for inbound investors, so it is important to structure carefully.

9. Getting Started — A Practical Checklist

Before your first investment:

1. Confirm tax residency of all investors and entities.

2. Identify expected income types (ECI vs FDAP).

3. Review potentially applicable treaty benefits, document applicability with a tax opinion.

4. Model federal and state tax exposure, including combined reporting effects.

5. Select optimal entity structure and make elections early.

6. Implement withholding and filing procedures.

7. Keep contemporaneous records to support treaty positions and LOB compliance.

Coming Next

Part 2: Structuring the Investment — Entity Choice & Tax-Efficient Entry Point: In our next article, we’ll examine entity options for inbound investors, how to manage Branch Profits Tax, treaty planning, and how different structures affect ongoing operations and repatriation strategies.

Thinking about investing in the U.S.? Start with a consultation to evaluate your company’s readiness and identify strategies for success. Connect with Nick Eusanio, Tax Planning & Compliance Partner at DBL Law, to learn how proper tax planning and investment structure can help you achieve the best possible outcome.