USA Law and Practice Contributed by: Devon M Bodoh, Joseph M. Pari and Blake D. Bitter, Weil, Gotshal & Manges LLP
putational entity), the income or loss is allocated to the partners pursuant to their respective distributive shares. Accordingly, partnerships provide owners sig - nificant flexibility (within parameters including that the allocations have “significant economic effect”) in how items of income and loss are allocated among them - selves for tax purposes. Another method of eliminating “entity-level” tax is for an entity to qualify for, and elect to be taxed as, an S corporation, RIC or REIT. While these regimes vary, they share a common theme – corporate income of a qualifying entity is taxed only to the shareholders, and not to the corporation itself (similar to a partner - ship). Due to strict ownership requirements, S corpo - rations are available only to US “individual” investors and generally involve closely held businesses. RICs and REITs, by contrast, can be significantly larger and attract different investor bases based on the types of assets owned by each such entity. For example, REITs are companies that own or finance income-producing real estate across a range of property sectors, while RICs are companies that derive their income primarily from passive investment sources (ie, dividends) and generally include mutual funds, closed-end invest - ment companies and exchange-traded funds. 1.3 Tests for Determining Tax Residence There are four classes of “person” for US income tax purposes: • individuals; • corporations; Under US tax rules, as under most countries’ tax sys - tems, such persons are further classified as “resident” or “non-resident” based on a variety of tests. For individuals, the US system treats both US citizens and resident alien individuals as income tax residents. “Resident” aliens are defined using two tests, as fol - lows. • First, lawful permanent residents (ie, US green card holders) are residents so long as they hold that status. • partnerships; and • trusts and estates.
• Second, other individuals are considered residents if they are in the USA under a day-count test. Under the day-count test, a person is considered a resident if the total number of days such person is present in the USA in the current year, plus one third of the days present in the prior year, plus one sixth of the days present in the second prior year, equals or exceeds 183 days. For corporations, the USA generally uses the “place of incorporation” rule for determining tax residence, under which a corporation is a “domestic corporation” if it is created or organised under the law of the USA, any US state or the District of Columbia. Note that a special set of rules, referred to as the “anti-inversion rules”, may in limited circumstances cause a non-US corporation to be treated as a US tax resident. Generally, partnerships are determined as domestic or foreign in the same manner as corporations – ie, based on the jurisdiction of formation. However, as partnerships are not subject to income tax (see 1.2 Transparent Entities ), their status as resident or non- resident is largely irrelevant for purposes of determin - ing their taxation (although the jurisdiction of the entity could impact on the tax treatment of the partners – eg, under a relevant income tax treaty). Trusts are classi - fied as “domestic” or “foreign” according to whether they have a US trustee and are subject to US legal jurisdiction, and then are subject to tax as “US per - sons” or non-resident aliens according to such status. Although estates do not have a formal classification, they tend to be categorised along principles similar to those used for trusts. 1.4 Applicable Corporate and Individual Tax Rates The maximum US corporate income tax rate is cur - rently 21%. In addition, US states and local govern - ments may levy corporate income taxes on the same (or similar) tax base, but such taxes are generally deductible from the federal income tax base for cor - porations (subject to certain limitations). Therefore, a corporation operating in the US could face a com - bined tax rate in excess of 21%. On average, corpo - rations have paid a combined US federal, state and local corporate income tax rate of approximately 26%.
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