After determining the taxable base, the next step is to determine the correct tax rate to apply.
Income tax is broken down into two categories, passive and active income (see here for further discussion on active v. passive). Passive income, sometimes referred to as FDAP because it is defined as “fixed, determinable, annual or periodic,” is generally taxed at a flat rate of 30% on the gross proceeds irrespective of deductions. This is a flat tax, there is normally no return required as the tax is withheld at the source. However, applicable income tax treaties can often lower the rate of the tax. It is the responsibility of the taxpayer to present a valid claim for treaty benefits with the applicable W-8 form to inform the payor of the proper withholding percentage. Another possible adjustment is that rental real estate can be treated as a U.S. trade or business if a proper election is filed. This will cause the tax rate to be at general progressive rates, but more importantly, will allow for deductions instead of a 30% tax on the gross rent, which could be extremely burdensome. Overall, the 30% rate on gross is very harsh, but it should be analyzed to make sure there are not any options to lower the rate such as treaties or elections.
On business income, foreign businesses that must file form 1120-F for foreign corporations with U.S. source income will pay tax at the new rate of 21%. Individuals with active income, such as wages, business income, or self-employment income, will be taxed at the same graduated rates as U.S. taxpayers, which starting in 2018 will max out at 37%. The key to effective tax planning for business / active income is not in the rate, as it is with passive income, but with the analysis in determining the taxable base.
The estate tax can have a very high rate, especially since sometimes the taxpayer may be from a country that doesn’t even have a transfer tax. The estate and gift tax rate maxes out at 40%. Again, the same as with business income, the analysis or planning is not involved with lowering the rate. The real planning with estate taxes is proper structuring to minimize the assets that are subject to being taxed.