Taxation

Taxation of individuals

The United States levies tax on its citizens and residents on their worldwide income. Non-resident aliens are taxed on their US-source income and income effectively connected with a US trade or business (with certain exceptions).

Personal income tax rates

For individuals, the top income tax rate for 2023 is 37%, except for long-term capital gains and qualified dividends (discussed below).

P.L. 115-97 reduced both the individual tax rates and the number of tax brackets. P.L. 115-97 sunsets after 2025 many individual tax provisions, including the lower rates and revised brackets, in order to comply with US Senate budget rules.

Alternative minimum tax (AMT)

In lieu of the tax computed using the above rates, the individual AMT may be imposed under a two-tier rate structure of 26% and 28%. For tax year 2022, the 28% tax rate applies to taxpayers with taxable incomes above USD 206,100 (USD 103,050 for married individuals filing separately). For tax year 2023, the 28% tax rate applies to taxpayers with taxable incomes above USD 220,700 (USD 110,350 for married individuals filing separately).

For 2022, the AMT exemption amount is USD 118,100 for married taxpayers filing a joint return (half this amount for married taxpayers filing a separate return) and USD 75,900 for all other taxpayers (other than estates and trusts), and the phase-out thresholds are USD 1,079,800 for married taxpayers filing a joint return and USD 539,900 for all other taxpayers (other than estates and trusts). For 2023, the AMT exemption amount is USD 126,500 for joint filers (half of this amount for married taxpayers filing a separate return), and USD 81,300 for all other taxpayers other than estates and trusts. The phase-out thresholds increase to USD 1,156,300 for joint filers and USD 578,150 for all other taxpayers other than estates and trusts.

The AMT is payable only to the extent it exceeds the regular net tax liability. The foreign tax credit is available for determining AMT liability to the extent of the foreign tax on the foreign-source AMT income (AMTI), subject to certain limitations.

AMTI generally is computed by starting with regular taxable income, adding tax preference deductions (claimed in the computation of regular taxable income), and making special adjustments to some of the tax items that were used to calculate taxable income. For example, the taxpayer must add back all state and local income taxes deducted in computing regular taxable income.

For non-resident aliens with a net gain from the sale of US real property interests, the AMT is calculated on the lesser of AMTI (before the exemption) or the net gain from the sale of the US real property interest.

Medicare contribution tax

For tax years beginning after 31 December 2012, a 3.8% 'unearned income Medicare contribution' tax applies on the lesser of (i) the taxpayer's net investment income for the tax year or (ii) the taxpayer's excess modified adjusted gross income over a threshold amount (generally, USD 200,000 for single taxpayers and heads of households; USD 250,000 for a married couple filing a joint return and surviving spouses; and USD 125,000 for a married individual filing a separate return). The tax, which is in addition to the regular income tax liability, applies to all individuals subject to US taxation other than non-resident aliens. Net investment income generally includes non-business income from interest, dividends, annuities, royalties, and rents; income from a trade or business of trading financial instruments or commodities; income from a passive-activity trade or business; and net gain from the disposition of non-business property.

State and local income taxes

Most states, and a number of municipal authorities, impose income taxes on individuals working or residing within their jurisdictions. Most of the 50 states impose some personal income tax, with the exception of Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, which have no state income tax. New Hampshire and Tennessee (until 1 January 2021) tax only dividend and interest income. Few states impose an income tax at rates that exceed 10%.

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Social Contribution  

For 2023, social security tax (old-age, survivors, and disability) will be withheld at the rate of 6.2% on the first USD 160,200 of wages paid.

Medicare hospital insurance taxes continue to be withheld on 1.45% of all wages. The social security taxes for resident self-employed individuals are equal to 12.4% of the first USD 147,000 for 2022 and USD 160,200 for 2023. Medicare hospital insurance taxes are equal to 2.9% of all net self-employment income. Note that non-resident aliens are not subject to social security and Medicare hospital insurance taxes on self-employment income.

For wages received in tax years beginning after 31 December 2012, the employee portion of Medicare hospital insurance tax is increased by an additional 0.9% on wages received in excess of USD 250,000 for a married couple filing a joint return, USD 125,000 for a married individual filing a separate return, and USD 200,000 for all other individuals (these thresholds are not indexed for inflation).

Social security and Medicare hospital insurance taxes are not deductible when determining an employee's taxable income. However, a deduction is allowed for an amount equal to one-half of the combined self-employment social security and Medicare hospital insurance taxes that are imposed.

Note that the United States has entered into Totalisation Agreements with several nations for the purpose of avoiding double taxation of income with respect to social security taxes and allowing individuals who participate in more than one social security system to qualify for benefits that would not be available under domestic law. These agreements must be taken into account when determining whether any alien is subject to US social security and Medicare hospital insurance taxes or whether any US citizen or resident alien is subject to the social security taxes of a foreign country.

Taxation of legal persons

US tax reform legislation enacted on 22 December 2017 (P.L. 115-97) moved the United States from a ‘worldwide’ system of taxation towards a ‘territorial’ system of taxation. Among other things, P.L. 115-97 permanently reduced the 35% CIT rate on resident corporations to a flat 21% rate for tax years beginning after 31 December 2017.

US taxation of income earned by non-US persons depends on whether the income has a nexus with the United States and the level and extent of the non-US person's presence in the United States.

Prior to enactment of P.L. 115-97, a non-US corporation engaged in a US trade or business was taxed at a 35% US CIT rate on income from US sources effectively connected with that business (i.e. effectively connected income or ECI). However, as noted above, P.L. 115-97 significantly revised the federal tax regime. P.L. 115-97 permanently reduced the 35% CIT rate on ECI to a 21% flat rate for tax years beginning after 31 December 2017. Certain US-source income (e.g. interest, dividends, and royalties) not effectively connected with a non-US corporation’s business continues to be taxed on a gross basis at 30% unless reduced by treaty.

Alternative minimum tax (AMT)

The Inflation Reduction Act, P.L. 117-169 (IRA) enacted a new corporate AMT, effective for tax years beginning after 2022, based on financial statement income (corporate alternative minimum tax or CAMT). The CAMT is a 15% minimum tax on adjusted financial statement income (AFSI) of C corporations. The CAMT increases a taxpayer’s tax to the extent that the tentative minimum tax exceeds regular tax plus base erosion and anti-abuse tax (BEAT).

AFSI determines whether a corporation is an applicable corporation subject to tax as well as the amount of the tax. In general, a taxpayer is an applicable corporation if its average annual AFSI over a three-tax-year period exceeds USD 1 billion. A corporation that is a member of a foreign-parented multinational group must apply a two-part test. It is an applicable corporation if (i) the three-year average AFSI of all members of the group exceeds USD 1 billion and (ii) the three-year average AFSI of US members of the group (and disregarded entities owned by members of the group), US trades or business of foreign group members that are not subsidiaries of US members, and foreign subsidiaries of US members exceeds USD 100 million.

Numerous adjustments are made to financial statement income to determine AFSI, and these rules also differ for purely domestic corporations and corporations that are part of a consolidated group with a foreign parent.

When a taxpayer pays CAMT because tentative minimum tax exceeds regular tax plus BEAT, the taxpayer will generate a minimum tax credit, which may be carried forward indefinitely and claimed against regular tax in future years (to the extent regular tax exceeds CAMT plus BEAT). The CAMT does not limit the general business credit, which corporate taxpayers may fully utilise against both their regular tax liability and the CAMT.  

The IRA also added a corporate AMT foreign tax credit (FTC), which is available to an applicable corporation that claims an FTC for the tax year. The AMT FTC reduces 15% of a taxpayer’s AFSI to arrive at the tentative minimum tax.

S corporations

Corporations with 100 or fewer eligible shareholders, none of whom may be corporations, that meet certain other requirements may elect to be taxed under Subchapter S of the Internal Revenue Code (IRC or 'the Code') and are thus known as S corporations. S corporations are taxed in a manner similar, but not identical, to partnerships (i.e. all tax items [e.g. income, deductions] flow through to the owners of the entity). Thus, S corporations generally are not subject to US federal income tax.

 
Sales Tax

No provisions exist for a sales tax or value-added tax (VAT) at the federal level; however, sales and use taxes constitute a major revenue source for the 45 states that impose such taxes and the District of Columbia. Sales and use tax rates vary from state to state and generally range from 2.9% to 7.25% at the state level. Many states also allow a 'local option' that permits local jurisdictions, such as cities and counties, to impose an additional percentage on top of the state-level tax and to keep the related revenues.

In general, a sales tax is a tax applied to the retail sale of tangible personal property and certain digital products and enumerated services. Although the form of the tax may vary, it is usually imposed directly upon the receipts from the retail sale of the taxable item. The person engaged in the business of making retail sales of the taxable item generally collects the sales tax from the purchaser and remits such amounts to the state. The use tax complements the sales tax and is usually assessed on purchases made out of state and brought into the jurisdiction for use, storage, or consumption. Typically, either a sales tax or a use tax can be assessed on a transaction, but not both.

The states generally impose a sales tax collection and remission liability on a seller once a minimum threshold is met with respect to either the number of sales transactions into or within a state or the dollar amount of sales into or within a state.

Liability for state and local sales taxes was governed by a physical presence nexus standard prior to the US Supreme Court's decision South Dakota v. Wayfair (21 June 2018). That decision voided the physical presence nexus standard and upheld South Dakota's statutory nexus standard of delivery into the state of more than USD 100,000 of sales or 200 or more transactions. Since the decision, most states that impose sales taxes have adopted similar standards. Some states, including South Dakota, have repealed the threshold based on number of transactions, leaving only the receipts threshold to determine whether a collection obligation exists.