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Effectively connected income (ECI)

Generally, when a foreign person is engaged in a trade or business in the United States (USTB), all United States (U.S.) source income connected with the conduct of that trade or business is considered Effectively Connected Income (ECI). A foreign person generally must be engaged in a U.S. trade or business during the tax year to treat income received in that year as ECI, which is taxable in the U.S. A foreign person may be a nonresident alien (NRA) or a foreign corporation.

If a foreign person owns and operates a business in the U.S. selling services, products, or merchandise, the foreign person is, with certain exceptions, engaged in a trade or business in the U.S. For example, profit from the sale in the U.S. of inventory property purchased either in the U.S. or in a foreign country is effectively connected trade or business income.

This applies whether or not there is a factual connection between the income item and the U.S. trade or business carried on . during the tax year. If the USTB sells inventory, the resulting U.S. source income generally is ECI. If a foreign corporation’s head office, which is located in another country, also directly sells inventory to U.S. customers, without involvement by the USTB, that income may also be ECI . if the sales produce U.S. source income. For example, for purchased inventory, if the sale is treated as occurring in the U.S. under the title, beneficial-ownership or risk-of-loss rules. For inventory produced by a foreign person, however, current sourcing generally depends on production activities, not merely where title passes.

Foreign persons generally are engaged in a U.S. trade or business when personal services are performed in the U.S. However, the business activities must be “considerable, continuous and regular” to qualify as a USTB. Certain kinds of fixed, determinable, annual, or periodical (FDAP) income are treated as ECI because:

  • Certain Internal Revenue Code Sections require the income to be treated as ECI,
  • Certain Internal Revenue Code Sections allow elections to treat the income as ECI,
  • Certain kinds of investment income are treated as ECI if they pass either of the two following tests:
    • The Asset-Use Test - The income must be associated with U.S. assets used in, or held for use in, the conduct of a U.S. trade or business.
    • Business Activities Test - The activities of that trade or business conducted in the United States are a material factor in the realization of the income.
  • In limited circumstances, some kinds of foreign source income may be treated as effectively connected with a trade or business in the United States. Refer to Publication 519, U.S. Tax Guide for Aliens.

The following categories of income are usually considered to be income effectively connected with a trade or business in the U.S..

  • The taxable part of any U.S. source scholarship or fellowship grant received by nonresident alien (NRA) student or trainees temporarily present the U.S. with F, J, M or Q, visa status.. An NRA temporarily presented in the U.S as a student, teacher or trainee in F, J, M, or Q nonimmigrant status is treated., under IRC 871(c), as  engaged in a U.S. trade or business for purpose of taxing certain U.S. source income. or purpose of taxing 
  • If a foreign person is a member of a partnership that at any time during the tax year is engaged in a trade or business in the U.S., then the  foreign person is  considered to be engaged in a trade or business in the U.S.
  • A foreign person usually is engaged in a U.S. trade or business when the foreign person performs personal services in the U.S.
  • Gains and losses from the sale or exchange of U.S. real property interests (whether or not they are capital assets) are taxed as if a foreign person is engaged in a trade or business in the U.S. A foreign person must treat the gain or loss as effectively connected with that trade or business.
  • Income from the rental of real property may be treated as ECI if an NRA elects to do so under IRC 871(d)

Note: If your only U.S. business activity is trading in stocks, securities, or commodities (including hedging transactions) through a U.S. resident broker or other agent, you are NOT engaged in a trade or business in the U.S.

Note: Certain kinds of income, which are normally treated as ECI or FDAP for income tax purposes, may not be treated as ECI or FDAP for withholding tax purposes.

Applicable tax rate

Income you receive during the tax year that is effectively connected with your trade or business in the United States is, after allowable deductions, taxed at the graduated rates that apply to U.S. citizens and resident aliens.

Tax year

Generally, you can receive effectively connected income only if you are a nonresident alien, or a foreign corporation, engaged in a trade or business in the U.S. during the tax year. However, income received in another tax year from the sale or exchange of property, the performance of services, or any other transaction is treated as effectively connected in that year, if it would have been effectively connected in the year the transaction took place or when services were performed.

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