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Taxation in Washington
 
 
 

Tax jurisdiction in the US is divided among the federal government, the 50 states plus the District of Columbia, and local counties and municipalities. All residents and foreign individuals and corporations engaging in business or investment transactions in the US are subject to some form of US taxation. A firm’s tax burden depends on the jurisdictions in which it operates and earns taxable income.

In general, US corporate tax rates are low compared with those in other industrialised countries. Most companies making a direct investment in the US choose to do so through a subsidiary rather than a branch for tax reasons. Licensing is an option that carries certain non-tax benefits (and drawbacks) compared with direct investment. Exporting to the US demands knowledge of complex and often changing tariff and duty regulations, but it is still a viable alternative to direct investment.

There are no uniform rules on the definition of taxable income or on the apportionment of income among the various tax jurisdictions. Hence the advice of a tax attorney is practically indispensable to any newcomer to multi-state business.

The US Congress passed the American Jobs Creation Act on October 7th 2004, the first broad-based restructuring of corporate taxes in two decades.

A key element of the 2004 legislation is the phasing out of the FSC/ETI regimes, both of which were declared illegal export subsidies by the WTO. The EU subsequently imposed retaliatory tariffs on US imports, which had increased to 12% in October 2004 and would further increase by 1% a month until the regimes were eliminated. Under the new legislation, the ETI exclusion is generally repealed for transactions after December 31st 2004, although under a two-year transition period (with a binding contract exception), ETI benefits will be available in 2005 and 2006 at 80% and 60%, respectively. The EU lifted the sanctions, but challenged certain aspects of the ETI repeal legislation.

Other important provisions of the new legislation include:

• The general tax rate for 'production activities' of manufacturing companies will drop by three percentage points to 32% for 2005 and 2006, to 29% for 2007, 2008 and 2009, and to 26% for 2010 and thereafter. The definition of both 'manufacturers' and 'production activities' for these purposes is broad. Along with traditional manufacturing, construction, engineering, energy production, computer software and agricultural processing are also included. When fully implemented in 2010, the deduction will amount to 9% on the lesser of qualified production income or total taxable income. Many companies that received no benefit under the FSC/ETI program will pay lower taxes under the new legislation. By 2010, the new program could cost a total of US$500 bn by some estimates, although offsetting investment and job creation seems certain.

• The Act provides a one-year tax benefit for corporations that are US shareholders and that receive dividends from CFCs. Subject to various limitations and conditions, a US corporation may elect to deduct 85% of certain 'cash dividends' it receives from its CFCs.

• The 2003 increase to US$100,000 in small-business expense write-offs, which was originally to drop back to US$25,000 for 2006, has been extended through 2007. The threshold is indexed for inflation, providing a limit of US$102,000 for 2004.

• S Corporation rules, governing small businesses, have been refined. The permitted number of shareholders has been increased to 100 from 75, and all members of one family can be treated as one shareholder. Other conditions have been relaxed and simplified, making S Corporation status more attractive for new business formations.

Several other measures affect companies with international operations. The number of foreign tax credit categories is reduced from nine to two (effective in 2007). Foreign tax credits may be carried forward for ten years (up from five) and carried back for one (down from two). The alternative minimum tax (AMT) foreign tax credit that was limited to 90% of total AMT has been eliminated.


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